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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-28467
Z-TEL TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 59-3501119
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
601 SOUTH HARBOUR ISLAND BOULEVARD, SUITE 220
TAMPA, FLORIDA 33602
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(813) 273-6261
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
At November 9, 2001 the Registrant had outstanding 33,974,591 shares
of $.01 par value common stock.
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Z-TEL TECHNOLOGIES, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2001 and December 31, 2000................... 3
Condensed Consolidated Statements of Operations for the three and nine
months ended September 30, 2001 and 2000....................................................... 4
Condensed Consolidated Statement of Changes in Stockholders' Equity
(Deficit) and Comprehensive Loss for the nine months ended September 30, 2001.................. 5
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2001 and 2000.............................................................. 6
Notes to Condensed Consolidated Financial Statements................................................ 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................................... 20
Item 2. Changes in Securities and Use of Proceeds........................................................... 21
Item 6. Exhibits and Reports on Form 8-K.................................................................... 21
SIGNATURE ................................................................................................... 25
2
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 20,352 $ 46,650
Accounts receivable, net of allowance for doubtful
accounts of $19,027 and $9,026 30,212 65,432
Prepaid expenses and other current assets 8,045 7,159
--------- ---------
Total current assets 58,609 119,241
Property and equipment, net 56,024 59,200
Intangible assets, net 6,403 64,267
Other assets 4,898 3,753
--------- ---------
Total assets $ 125,934 $ 246,461
========= =========
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued liabilities $ 49,100 $ 44,693
Deferred revenue 6,334 7,666
Current portion of long-term debt
and capital lease obligations 5,730 7,637
--------- ---------
Total current liabilities 61,164 59,996
Long-term debt and capital lease obligations 10,728 12,780
--------- ---------
Total liabilities 71,892 72,776
--------- ---------
Mandatorily redeemable convertible preferred stock, $.01 par value;
50,000,000 shares authorized; 8,855,089 and 8,854,914 issued and
outstanding (aggregate liquidation value of approximately $132,267
and $108,808) 108,011 84,585
--------- ---------
Commitments and contingencies (Notes 7 and 9)
Stockholders' equity (deficit):
Common stock, $.01 par value; 150,000,000
shares authorized; 34,316,141 and 34,033,910 shares issued;
33,974,591 and 33,754,235 outstanding, respectively 343 340
Notes receivable from stockholders (1,589) (839)
Unearned stock compensation (155) (255)
Additional paid-in capital 222,128 227,304
Accumulated deficit (274,308) (137,130)
Accumulated other comprehensive loss -- (2)
Treasury stock, 341,550 and 279,675 shares, at cost (388) (318)
--------- ---------
Total stockholders' equity (deficit) (53,969) 89,100
--------- ---------
Total liabilities, mandatorily redeemable
convertible preferred stock and
stockholders' equity (deficit) $ 125,934 $ 246,461
========= =========
The accompanying notes are an integral part of these financial statements.
3
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Revenues $ 68,569 $ 54,415 $ 216,755 $ 108,548
------------ ------------ ------------ ------------
Operating expenses:
Network operations 38,279 33,032 123,299 67,999
Sales and marketing 3,885 11,742 25,519 29,196
Research and development 2,250 2,132 7,172 5,221
General and administrative 31,089 24,429 123,489 55,768
Asset impairment charge -- -- 59,194
Depreciation and amortization 5,279 5,308 17,803 11,800
------------ ------------ ------------ ------------
Total operating expenses 80,782 76,643 356,476 169,984
------------ ------------ ------------ ------------
Operating loss (12,213) (22,228) (139,721) (61,436)
------------ ------------ ------------ ------------
Nonoperating income (expense):
Interest and other income 1,531 736 5,801 2,477
Interest and other expense (1,173) (1,617) (3,258) (2,681)
------------ ------------ ------------ ------------
Total nonoperating income (expense) 358 (881) 2,543 (204)
------------ ------------ ------------ ------------
Net loss (11,855) (23,109) (137,178) (61,640)
Less mandatorily redeemable convertible
preferred stock dividends and accretion (5,278) (1,257) (10,869) (1,257)
Less deemed dividend related to beneficial
conversion feature (8,885) (20,027) (8,885) (20,027)
------------ ------------ ------------ ------------
Net loss attributable to common stockholders $ (26,018) $ (44,393) $ (156,932) $ (82,924)
============ ============ ============ ============
Weighted average common shares outstanding 33,982,665 33,536,724 33,885,022 32,847,858
============ ============ ============ ============
Basic and diluted net loss per share $ (0.77) $ (1.32) $ (4.63) $ (2.52)
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
4
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
(UNAUDITED)
COMMON STOCK NOTES RECEIVABLE UNEARNED ADDITIONAL
------------------------ FROM STOCK PAID-IN
SHARES PAR VALUE STOCKHOLDERS COMPENSATION CAPITAL
---------- --------- ---------------- ------------ ----------
Balance, December 31, 2000 33,754,235 $340 $ (839) $(255) $227,304
Issuance of common stock for exercise
of stock options 254,731 3 (820) 1,001
Issuance of common stock for the
purchase of software 27,500 -- 155
Vesting of stock options granted below
intrinsic value 100
Accelerated vesting of stock options 49
Mandatorily redeemable convertible
dividends and preferred stock accretion (10,869)
Warrants issued with preferred stock 4,488
Treasury stock received upon cancellation
of notes receivable from stockholders (61,875) -- 70
Net loss
Foreign currency translation adjustment
Comprehensive loss
---------- ---- ------- ----- --------
Balance, September 30, 2001 33,974,591 $343 $(1,589) $(155) $222,128
========== ==== ======= ===== ========
ACCUMULATED
OTHER TOTAL
ACCUMULATED COMPREHENSIVE TREASURY STOCKHOLDERS'
DEFICIT LOSS STOCK EQUITY (DEFICIT)
----------- ------------- -------- ----------------
Balance, December 31, 2000 $(137,130) $ (2) $(318) $ 89,100
Issuance of common stock for exercise
of stock options 184
Issuance of common stock for the
purchase of software 155
Vesting of stock options granted below
intrinsic value 100
Accelerated vesting of stock options 49
Mandatorily redeemable convertible
dividends and preferred stock accretion (10,869)
Warrants issued with preferred stock 4,488
Treasury stock received upon cancellation
of notes receivable from stockholders (70) --
Net loss (137,178) (137,178)
Foreign currency translation adjustment 2 2
--------
Comprehensive loss (137,176)
--------- ----- ----- --------
Balance, September 30, 2001 $(274,308) $ -- $(388) $(53,969)
========= ===== ===== ========
The accompanying notes are an integral part of these financial statements.
5
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
--------- ---------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(137,178) $ (61,640)
--------- ---------
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 17,803 11,800
Provision for bad debts 51,033 4,842
Loss on sale of assets -- 572
Asset impairment charge 59,194 --
Expense charged for granting of stock options 149 --
Change in operating assets and liabilities:
Increase in accounts receivable (15,813) (45,079)
Increase in prepaid expenses and other current assets (4,875) (3,994)
Increase in accounts payable and accrued liabilities 4,407 9,427
Increase (decrease) in deferred revenue (1,332) 5,529
Other (283) (575)
--------- ---------
Total adjustments 110,283 (17,478)
--------- ---------
Net cash used in operating activities (26,895) (79,118)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Issuance of note receivable (100) --
Purchases of property and equipment (10,311) (26,257)
Purchase of securities -- (1,050)
Purchase of Touch 1, net of cash acquired -- (8,955)
--------- ---------
Net cash used in investing activities (10,411) (36,262)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of mandatorily redeemable convertible
preferred stock 17,050 55,875
Proceeds from exercise of stock options 184 2,097
Proceeds from notes receivable 7 894
Payments on long-term debt obligations (6,233) (21,760)
--------- ---------
Net cash provided by financing activities 11,008 37,106
--------- ---------
Net decrease in cash and cash equivalents (26,298) (78,274)
Cash and cash equivalents, beginning of period 46,650 101,657
--------- ---------
Cash and cash equivalents, end of period $ 20,352 $ 23,383
========= =========
The accompanying notes are an integral part of these financial statements.
6
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. NATURE OF BUSINESS
DESCRIPTION OF BUSINESS
Z-Tel Technologies, Inc. and subsidiaries ("Z-Tel" or the "Company")
incorporated in Delaware on January 15, 1998 as Olympus
Telecommunications Group, Inc. In March 1998, Olympus
Telecommunications Group, Inc. changed its name to Z-Tel Technologies,
Inc. The Company has eight wholly owned subsidiaries.
Z-Tel is an emerging provider of advanced, integrated
telecommunications services targeted to residential and small business
subscribers. Z-Tel offers local and long distance telephone services in
combination with enhanced communication features accessible through the
telephone, the Internet and certain personal digital assistants. Z-Tel
offers its Z-LineHOME, formerly Z-Line Home Edition, service, at least
on an initial test basis, in thirty-five states. Z-Tel also provides
long-distance telecommunications services to customers nationally.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared by the Company in accordance with generally accepted
accounting principles for interim financial information and are in the
form prescribed by the Securities and Exchange Commission in
instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete
financial statements. The interim unaudited financial statements should
be read in conjunction with the audited financial statements of the
Company as of and for the year ended December 31, 2000, included in the
Company's Annual Report on Form 10-K. In the opinion of management, all
adjustments considered necessary for a fair presentation have been
included. Operating results for the three and nine months ended
September 30, 2001 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2001.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All intercompany
accounts and transactions have been eliminated.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Standard ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets."
SFAS 141 addresses the initial recognition and measurement of goodwill
and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible
assets acquired outside of a business combination, whether acquired
individually or with a group of other assets, and the accounting and
reporting for goodwill and other intangible assets subsequent to their
acquisition. These standards require all future business combinations
to be accounted for using the purchase method of accounting. Goodwill
will no longer be amortized but instead will be subject to impairment
tests at least annually. The Company is required to adopt SFAS No. 141
and SFAS No. 142 on a prospective basis as of January 1, 2002; however,
certain provisions of these new standards may also apply to any
acquisitions occurring subsequent to June 30, 2001.
As of September 30, 2001, Z-Tel has $6.4 million of intangible assets,
net of accumulated amortization. The Company does not expect the
adoption of SFAS No. 142 to have a material impact on its future
operations and statement of position.
7
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SFAS No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities" has been applied
prospectively for transfers of financial assets occurring after March
31, 2001. SFAS No. 140 replaces SFAS No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities."
SFAS No. 140 revises the standards for accounting for securitizations
and other transfers of financial assets and collateral and requires
certain disclosures, but it carries over most of SFAS No. 125's
provisions without reconsideration.
SFAS No. 140 provides accounting and reporting standards for transfers
and servicing of financial assets and extinguishments of liabilities.
Those standards are based on consistent application of a
financial-components approach that focuses on control. Under that
approach, after a transfer of financial assets, an entity recognizes
the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. This
statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured
borrowings. Management believes that its current account policies and
procedures related to the transfer and servicing of financial assets
comply with SFAS No. 140.
In June of 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." The statement provides accounting and
reporting standards for recognizing obligations related to asset
retirement costs associated with the retirement of tangible long-lived
assets. Under this statement, legal obligations associated with the
retirement of long-lived assets are to be recognized at their fair
value in the period in which they are incurred if a reasonable estimate
of fair value can be made. The fair value of the asset retirement costs
is capitalized as part of the carrying amount of the long-lived asset
and subsequently allocated to expense using a systematic and rational
method over the assets' useful life. Any subsequent changes to the fair
value of the liability due to passage of time or changes in the amount
or timing of estimated cash flows is recognized as an accretion
expense. The Company will be required to adopt this statement no later
than January 1, 2003. The Company is currently assessing the impact of
this statement on its results of operations, financial position and
cash flows.
In October of 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which is effective for
fiscal years beginning after Dec 15, 2001. This statement supercedes
FASB Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of." However, it
retains the fundamental provisions of SFAS No. 121 for the recognition
and measurement of the impairment of long-lived assets to be held and
used and the measurement of long-lived assets to be disposed of by
sale. Impairment on Goodwill is not included in the scope of SFAS No.
144 and will be treated in accordance with the accounting standards
established in SFAS No. 142, Goodwill and Other Intangible Assets."
According to SFAS No. 144, long-lived assets are to be measured at the
lower of carrying amount or fair value less cost to sell, whether
reported in continuing or discontinued operations. The statement
applies to all long-lived assets, including discontinued operations,
and replaces the provisions of APB Opinion No. 30, "Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions", for the disposal of segments of a business.
The Company will be required to adopt this statement no later than
January 1, 2002. The Company is currently assessing the impact of this
statement on its results of operations, financial position and cash
flows.
3. ACCOUNTS RECEIVABLE AGREEMENT
In July 2000, the Company entered into an accounts receivable agreement
with RFC Capital Corporation ("RFC"), a division of Textron, Inc.,
providing for the sale of certain of the Company's accounts receivable
to RFC. RFC has agreed to purchase up to $25.0 million of the Company's
accounts receivable at any given time.
In July 2001, the Company extended its agreement with RFC under
substantially similar terms for an additional year.
8
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In connection with the accounts receivable agreement described above,
the Company sold approximately $131.1 million of accounts receivable
for the nine months ended September 30, 2001. Cash received from these
sales and advances on unbilled receivables was approximately $87.0
million and is included in cash flows from operating activities. At
September 30, 2001, a net receivable servicing asset of approximately
$8.0 million is included in accounts receivable and approximately $4.2
million of advances on unbilled receivables are included in accounts
payable and accrued liabilities. The costs related to the agreement of
approximately $0.4 and $0.9 million are included in interest and other
expense for the three and nine months ended September 30, 2001,
respectively.
4. ACCOUNTS RECEIVABLE WRITE-OFF
During the second quarter of 2001, management performed a detailed
analysis of accounts receivable and also reviewed its credit policies
relating specifically to acceptance of and provisioning of service to
new customers. As a result of the analysis and subsequent change in
credit policy, the Company switched its focus from collection efforts
on overdue and delinquent account balances to a stringent credit policy
surrounding customer acceptance and a collection effort focused on
fewer delinquent accounts. The detailed analysis and change in credit
policy lead the Company to write-off delinquent receivables and revise
the estimates used to develop the allowance for doubtful accounts in
the current period and future periods.
As a result of the receivables write-off, an additional $29.9 million
of bad debt expense was recorded in the second quarter of 2001 and is
included in general and administrative expense for the nine months
ended September 30, 2001.
5. MANDATORILY CONVERTIBLE REDEEMABLE PREFERRED STOCK
In July 2001, the Company filed a Certificate of Designation
authorizing the issuance of 175 shares of Series G junior convertible
preferred stock ("Series G Preferred"). In July and August 2001,
the Company issued an aggregate of 175 shares of Series G Preferred for
aggregate proceeds of $17.5 million, initially convertible into
11,739,970 shares of common stock, subject to adjustment upon the
occurrence of certain events that would cause dilution in the ownership
of the holders of the Series G Preferred. In conjunction with the
issuance of the Series G Preferred, the Company issued warrants to
purchase 3,000,000 shares of common stock at an exercise price of $0.01
per share. The Series G Preferred is mandatorily redeemable 5 years
from September 18, 2001, has a 12% cumulative dividend, is convertible
at the option of the holder and has certain liquidation rights;
however, there are certain circumstances that provide for automatic
conversion of the Series G Preferred.
In accordance with generally accepted accounting principles, the
Company recorded a deemed dividend of approximately $1.1 million, which
results from the value assigned to the warrants and a beneficial
conversion feature associated with the Series G Preferred transaction.
These deemed dividends are accreted over an expected life through
December 31, 2001 (the earliest redemption date). Once shareholder
approval is obtained, the remaining balance will be accreted over the
remaining 5 year redemption period.
As a result of certain anti-dilution clauses in the Series D Preferred
stock agreement, the issuance of Series G Preferred triggered an
additional beneficial conversion feature related to the Series D
Preferred agreement. The deemed dividend of approximately $7.8 million
was accreted immediately.
9
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
6. ASSET IMPAIRMENT
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be disposed of,"
management assesses on an ongoing basis if there has been impairment in
the carrying value of its long-lived assets. As a result of
management's decision in the second quarter to reduce telemarketing
efforts, a majority of the operations and assets of telemarketing
centers acquired from Touch 1 Communications, Inc. ("Touch 1") have
been either voluntarily closed or sold. On June 30, 2001, the
telemarketing centers sold accounted for approximately $1.0 million in
property, plant and equipment. For these assets, the Company received
270,000 shares of preferred stock of the privately-held acquiring
company and a note receivable of approximately $0.5 million. The loss
recorded from this transaction equated to approximately $1.0 million.
As a result of the decision to reduce telemarketing efforts noted above
and the subsequent transactions, management performed an assessment of
the value of the intangible assets recorded in the Touch 1 acquisition.
In the second quarter of 2001, it was determined that undiscounted
future cash flows over the remaining amortization period of certain
intangible assets indicated that the value assigned to the intangible
asset might not be recoverable. Therefore, the Company undertook an
effort to determine the amount of expense to be recorded relating to
the impairment.
The carrying value of the goodwill and identifiable intangibles
recorded on the books approximated $61.7 million prior to the
impairment analysis. The Company calculated the fair value of the
intangibles by performing a discounted cash flow analysis related to
the remaining assets acquired in the Touch 1 purchase. As the Company
determined that it would effectively cease any telemarketing efforts in
the future, the sole remaining assets from the Touch 1 purchase were
certain amounts of property, plant and equipment and intangibles
(consisting of customer lists and goodwill) acquired in the Touch 1
transaction. Assuming a monthly attrition rate of 4.5% and a discount
rate of 17.5% over an 18 month period, it was determined that the
remaining operations acquired from Touch 1 had a liquidation value
which approximated the carrying value of the customer lists acquired
from Touch 1. At June 30, 2001, the carrying value of the identifiable
intangibles associated with the customer lists was approximately $6.8
million. Therefore, during the second quarter of 2001, the Company
recorded a loss of $54.9 million, the difference between the carrying
value of all intangibles and the carrying value of the customer lists.
For the nine months ended September 30, 2001, during the second
quarter, the Company recorded an additional $4.3 million of impaired
asset charges, composed of $3.0 million relating to unrealizable
software and development projects, $0.9 million of telemarketing
property and equipment and $0.4 million of securities deemed to be
worthless.
7. COMMITMENTS AND CONTINGENCIES
The Company has disputed billings and access charges from certain
inter-exchange carriers (IXCs) and incumbent local exchange carriers
(ILECs). The Company contends the invoicing of billings and access
charges received from certain IXCs and ILECs are not in accordance with
the interconnection, service level, or tariff agreements entered
between the Company and certain IXCs and ILECs. The Company has not
paid for a portion of these disputes and management believes that the
Company will prevail in these disputes. At September 30, 2001 the total
disputed amounts from all IXCs and ILECs was approximately $15.4
million.
8. COMPUTATION OF NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss attributable
to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted net loss per share assumes the
exercise of common stock equivalents for which the market price exceeds
the exercise price, less shares assumed purchased by the Company with
related proceeds. Incremental shares of common stock equivalents are
not included in the calculation of net loss per share, as the inclusion
of such equivalents would be anti-dilutive; therefore, for each of the
periods presented basic and diluted net loss per share are the same.
10
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Net loss per share is calculated as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
BASIC AND DILUTED NET LOSS PER SHARE:
Loss attributable to common stockholders:
Net loss $ (11,855) $ (23,109) $ (137,178) $ (61,640)
Less mandatorily convertible redeemable
preferred stock dividends (5,278) (1,257) (10,869) (1,257)
Less deemed dividend related to beneficial
conversion feature (8,885) (20,027) (8,885) (20,027)
------------ ------------ ------------ ------------
Loss attributable to common stockholders $ (26,018) $ (44,393) $ (156,932) $ (82,924)
============ ============ ============ ============
Weighted average common shares outstanding 33,982,665 33,536,724 33,885,022 32,847,858
============ ============ ============ ============
Basic and diluted net loss per share $ (0.77) $ (1.32) $ (4.63) $ (2.52)
============ ============ ============ ============
The following table outlines the shares of common stock equivalents
that could potentially dilute basic earnings per share in the future
that were not included in the computation of diluted net loss per
share:
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
2001 2000
---------- ---------
Unexercised stock options 10,931,225 9,139,495
Unexercised warrants 10,440,723 2,981,455
Mandatorily redeemable convertible preferred
stock convertible into common shares 25,298,188 4,688,247
9. LEGAL AND REGULATORY PROCEEDINGS
On March 15, 2001, the Company filed a lawsuit against AT&T Corp.
(AT&T). In July 2001, AT&T and the Company agreed to settle a lawsuit
in which the Company alleged that AT&T had received originating and
terminating access service from the Company and had unlawfully withheld
access charges for such services. In connection with that settlement,
which approximated the amounts recorded by the Company as receivables,
the Company resolved the issues relating to charges for access services
rendered. The Company entered into a switched access agreement setting
forth terms and conditions under which AT&T will purchase access
services from the Company in the future.
During June and July 2001, three separate class action lawsuits were
filed against the Company, certain of the Company's current and former
directors and officers (the "D&Os") and firms engaged in the
underwriting (the "Underwriters") of our initial public offering of
stock (the "IPO"). Each of the lawsuits is based on the allegations
that the Company's registration statement on Form S-1, filed with the
Securities and Exchange Commission ("SEC") in connection with the IPO,
contained untrue statements of material fact and omitted to state facts
necessary to make the statements made not misleading by failing to
disclose that the underwriters had received additional, excessive
11
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
and undisclosed commissions from, and had entered into unlawful tie-in
and other arrangements with, certain customers to whom they allocated
shares in the IPO. Plaintiffs have asserted claims against the Company
and the D&Os pursuant to Sections 11 and 15 of the Securities Act of
1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated by the SEC thereunder. The plaintiffs
seek an undisclosed amount of damages, as well as pre-judgment and
post-judgment interest, costs and expenses, including attorneys' fees,
experts' fees and other costs and disbursements. The lawsuits, along
with all other lawsuits filed against other issuers arising out of IPO
allocations, have been assigned to Judge Shira A. Scheindlin for
pretrial coordination. As of the filing of this quarterly report on
Form 10-Q, only one complaint has been served, and the Company is not
required to file answers or other responsive pleadings at this time.
In the ordinary course of business, the Company is involved in legal
proceedings that are generally incidental to its operations. In
addition, from time to time, the Company is the subject of customer
complaints filed with the state utility commissions of the states in
which it operates or the FCC. Most complaints are handled informally.
While there can be no assurance of the ultimate disposition of
incidental legal proceedings or customer complaints, the Company does
not believe their disposition will have a material adverse effect on
the Company's consolidated results of operations or financial position.
10. SUBSEQUENT EVENTS
On October 30, 2001, a Special Meeting of Stockholders was held, at
which the stockholders of the Company approved and ratified the
issuance of the Series G Preferred and the warrants issued in
connection therewith.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion together with the condensed
consolidated financial statements and related notes and other sections of this
Quarterly Report on Form 10-Q. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results may differ
materially from those projected in the forward-looking statements as a result of
certain factors. Factors that may affect our results of operations include, but
are not limited to, our limited operating history and cumulative losses,
uncertainty of customer demand, rapid expansion, potential software failures and
errors, potential network and interconnection failure, dependence on local
exchange carriers, dependence on third party vendors, dependence on key
personnel, uncertainty of government regulation, legal and regulatory
uncertainties, and competition. We disclaim any obligation to update information
contained in any forward-looking statement. In addition to these factors, other
factors that could affect our financial results are described in our Annual
Report on Form 10-K, filed with the Securities and Exchange Commission on March
30, 2001.
OVERVIEW
We are an emerging provider of advanced, integrated telecommunications services
targeted primarily to residential subscribers and small business. For management
purposes, we are organized into one reportable operating segment. We offer local
and long distance telephone services in combination with enhanced communication
features accessible through the telephone, the Internet, and certain personal
digital assistants. The nature of our business is rapidly evolving, and we have
a limited operating history. We do not believe that our historical growth rates
are indicative of future results.
Z-LineHOME is our principal service offering. Z-LineHOME, formerly Z-Line Home
Edition, includes local and long distance (1+) residential telephone services
using a customer's existing telephone number, bundled with enhanced features,
including caller identification, call forwarding, three-way calling, speed
calling, remote access to long distance calling through our travel card service,
the full functionality of the Z-Line Features and, for an additional fee,
Internet access. We offer Z-LineHOME service, at least on an initial test basis,
in thirty-five states, however, nearly all of our customers are concentrated in
ten states.
12
We intend to continue to pursue offering Z-LineHOME in additional states as soon
as favorable pricing and implementation rules are imposed in those states. We
also have developed other bundled combinations of our services at varied price
points in order to stimulate and expand customer interest in our services. For
example, we have begun to offer a lower price version of Z-LineHOME that
includes fewer bundled long distance minutes and features. Additional long
distance minutes and features are being offered separately for an additional
monthly fee. We also have offered to all of our Z-LineHOME subscribers the
ability, through our member-to-member program, to make unlimited long distance
telephone calls to other Z-LineHOME subscribers for an additional monthly fee.
Z-LineBUSINESS is a package that combines local and long distance service with
traditional calling features and our proprietary Z-Line features, including Find
Me multiple number call forwarding, Notify Me message notification and an online
address book that can be synchronized with most office email programs.
Z-LineBUSINESS customers will also receive an access card free of charge, which
allows users to remotely place calls, check voicemail and change feature
preferences. Z-LineBUSINESS is targeted at small businesses and is expected to
begin to generate revenue as early as the first half of 2002.
Touch 1 Long Distance is our (1+) long distance product. Touch 1 Long Distance
is also available nationwide, although we are not actively marketing the
service.
RESULTS OF OPERATIONS
The following is a discussion of significant changes in the results of
operations of the Company, which occurred in the three and nine months ended
September 30, 2001 compared to the three and nine months ended September 30,
2000. The following tables summarize the approximate changes in selected
operating items and include dollar changes, percentage changes and percent of
net sales to facilitate the discussions that follow.
13
THREE MONTHS ENDED AMOUNT PERCENTAGE
SEPTEMBER 30, CHANGE CHANGE
------------------ FAV/ FAV/ PERCENT OF REVENUES
2001 2000 (UNFAV) (UNFAV) 2001 2000
----- ------ ------- ---------- ------ -----
(IN THOUSANDS, EXCEPT PERCENTAGES)
Revenues $ 68.6 $ 54.4 $14.2 26 % 100 % 100 %
------ ------ ----- ---- --- ---
Operating expenses:
Network operations 38.3 33.0 (5.3) (16)% 56 % 61 %
Sales and marketing 3.9 11.7 7.8 67 % 6 % 21 %
Research and development 2.2 2.1 (0.1) (5)% 3 % 4 %
General and administrative 31.1 24.4 (6.7) (27)% 45 % 45 %
Depreciation and amortization 5.3 5.4 0.1 2 % 8 % 10 %
------ ------ ----- ---- --- ---
Total operating expenses 80.8 76.6 (4.2) (5)% 118 % 141 %
------ ------ ----- ---- --- ---
Operating loss (12.2) (22.2) 10.0 45 % (18)% (41)%
------ ------ ----- ---- --- ---
Nonoperating income (expense):
Interest and other income 1.5 0.7 0.8 114 % 2 % 1 %
Interest and other expense (1.2) (1.6) 0.4 25 % (2)% (3)%
------ ------ ----- ---- --- ---
Total nonoperating income (expense) 0.3 (0.9) 1.2 133 % 0 % (2)%
------ ------ ----- ---- --- ---
Net loss (11.9) (23.1) 11.2 48 % (17)% (43)%
Less mandatorily convertible redeemable
preferred stock dividends and accretion (5.2) (1.3) (3.9) (300)% (8)% (2)%
Less deemed dividend related to beneficial
conversion feature (8.9) (20.0) 11.1 56 % (13)% (37)%
------ ------ ----- ---- --- ---
Net loss attributable to common stockholders $(26.0) $(44.4) $18.4 41 % (38)% (82)%
====== ====== ===== ==== === ===
EBITDA $ (6.9) $(16.8) $ 9.9 59 % (10)% (31)%
====== ====== ===== ==== === ===
14
NINE MONTHS ENDED AMOUNT PERCENTAGE
SEPTEMBER 30, CHANGE CHANGE
--------------------- FAV/ FAV/ PERCENT OF REVENUES
2001 2000 (UNFAV) (UNFAV) 2001 2000
-------- -------- -------- ----------- ------ ------
(IN THOUSANDS, EXCEPT PERCENTAGES)
Revenues $ 216.8 $ 108.5 $ 108.3 100 % 100 % 100 %
-------- -------- -------- -------- ------ -----
Operating expenses:
Network operations 123.3 68.0 (55.3) (81)% 57 % 63 %
Sales and marketing 25.5 29.2 3.7 13 % 12 % 27 %
Research and development 7.2 5.2 (2.0) (38)% 3 % 5 %
General and administrative 123.5 55.8 (67.7) (121)% 57 % 51 %
Impairment of assets 59.2 -- (59.2) (100)% 27 % 0 %
Depreciation and amortization 17.8 11.8 (6.0) (51)% 8 % 11 %
-------- -------- -------- -------- ------ -----
Total operating expenses 356.5 170.0 (186.5) (110)% 164 % 157 %
-------- -------- -------- -------- ------ -----
Operating loss (139.7) (61.5) (78.2) (127)% (64)% (57)%
-------- -------- -------- -------- ------ -----
Nonoperating income (expense):
Interest and other income 5.8 2.5 3.3 132 % 3 % 2 %
Interest and other expense (3.3) (2.7) (0.6) (22)% (2)% (2)%
-------- -------- -------- -------- ------ -----
Total nonoperating income (expense) 2.5 (0.2) 2.7 1350 % 1 % 0 %
-------- -------- -------- -------- ------ -----
Net loss (137.2) (61.7) (75.5) (122)% (63)% (57)%
Less mandatorily convertible redeemable
preferred stock dividends and accretion (10.8) (1.3) (9.5) (731)% (5)% (1)%
Less deemed dividend related to beneficial
conversion feature (8.9) (20.0) 11.1 56 % (4)% (18)%
-------- -------- -------- -------- ------ -----
Net loss attributable to common stockholders $ (156.9) $ (83.0) $ (73.9) (89)% (72)% (76)%
======== ======== ======== ======== ====== =====
EBITDA $ (121.9) $ (49.7) $ (72.2) (145)% (56)% (46)%
======== ======== ======== ======== ====== =====
REVENUES
Revenues increased by $14.2 million to $68.6 million for the quarter ended
September 30, 2001, compared to $54.4 million for the same quarter in the prior
year. The increase is primarily attributable to an increase in average
Z-LineHOME subscriber lines in service of 280,000, for the quarter ended
September 30, 2001, compared to 213,000 for the same quarter in the prior year.
Revenues increased by $108.3 million to $216.8 million for the nine months ended
September 30, 2001, compared to $108.5 million for the same period in the prior
year. The increase is primarily attributable to average Z-LineHOME subscriber
lines in service of 300,000 for the nine months ended September 30, 2001,
compared to 148,000 for the same period in the prior year.
We continue to pursue a moderate revenue and line count growth plan while
focusing on increased customer quality. This approach is expected to generate
increased revenues per line and contribute to our goal of achieving operating
profitability.
The following tables outline the approximate number of subscriber lines for
Z-LineHOME and Touch 1 (1+) long distance services:
15
TYPE OF SERVICE SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
Z-LineHOME 260,000 256,000
Touch 1 (1+) Long Distance Services 175,000 281,000
NETWORK OPERATIONS
Network operations expense primarily consists of fixed and variable transmission
expenses for interconnection agreements with incumbent local exchange carriers
(ILECs), service level agreements with inter-exchange carriers (IXCs), and
transmission services based on tariff arrangements.
Network operations expense increased by $5.3 million to $38.3 million for the
quarter ended September 30, 2001, compared to $33.0 million for the same quarter
in the prior year. Our gross margin increased to 44.2% for the quarter, compared
to 39.3% for the same quarter in the prior year.
Network operations expense increased by $55.3 million to $123.3 million for the
nine months ended September 30, 2001, compared to $68.0 million for the same
period in the prior year. Our gross margin increased to 43.1% for the nine
months ended September 30, 2001, compared to 37.3% for the same period in the
prior year.
The increase in network operation expenses is a result of subscriber growth. Our
improved gross margins is primarily the result of improved negotiated local and
long distant rates and effective subscriber management that has resulted in an
increased quality to the embedded subscriber base.
SALES AND MARKETING
Sales and marketing expense primarily consists of telemarketing, direct mail,
brand awareness advertising, agent commissions and salaries and benefits paid to
employees engaged in sales and marketing activities.
Sales and marketing expense decreased $7.8 million to $3.9 million, or 6% of
revenues, for the quarter ended September 30, 2001, compared to $11.7 million,
or 22% of revenues, for the same quarter in the prior year.
Sales and marketing expense decreased $3.7 million to $25.5 million, or 12% of
revenues, for the nine months ended September 30, 2001, compared to $29.2
million, or 27% of revenues, for the same period in the prior year.
The decrease in sales and marketing is a result of our continued effort to focus
on sales and marketing channels with more attractive acquisition costs per
subscriber. This focus led to the reduction or elimination of distribution
channels deemed to be marginal, including direct mail and certain independent
agent programs and outsourced telemarketing. Our telemarketing activity was
dramatically reduced during the first half of 2001 resulting in the closure of a
call center and the sale of two other call centers at the end of the second
quarter of 2001.
We will continue to build the overall awareness of our "Z" brand, primarily
through radio, television, and billboard advertising, and pursue alliances and
ventures with other companies. This brand advertising and a focus on partnering
in future quarters should result in a continued lower acquisition cost per
subscriber in 2001.
RESEARCH AND DEVELOPMENT
Research and development expense consists primarily of salaries and benefits
paid to employees engaged in research and development activities and outside
third party development costs.
Research and development expense increased $0.1 million to $2.2 million, or 3%
of revenues, for the quarter ended September 30, 2001, compared to $2.1 million,
or 4% of revenues, for the same quarter in the prior year.
16
Research and development expense increased $2.0 million to $7.2 million, or 3%
of revenues, for the nine months ended September 30, 2001, compared to $5.2
million, or 5% of revenues, for the same period in the prior year.
The increase in research and development expense for the quarter and nine months
ended September 30, 2001 compared to the same periods in the prior year is a
result of increased employees and outside professional fees related to research
and development relating to speech recognition and other new service offerings
to provide additional functionality and service enhancements to our primary
service offering. Z-Tel expects to continue to dedicate resources to research
and development throughout the remainder of 2001.
GENERAL AND ADMINISTRATIVE
Our general and administrative expense includes employee salaries, bad debt
expense, billing and collection expense, occupancy costs, and provisioning
costs.
General and administrative expense increased $6.7 million to $31.1 million, or
45% of revenues, for the quarter ended September 30, 2001, compared to $24.4
million, or 45% of revenues, for the same quarter in the prior year.
General and administrative expense increased $67.7 million to $123.5 million, or
57% of revenues, for the nine months ended September 30, 2001, compared to $55.8
million, or 51% of revenues, for the same period in the prior year.
General and administrative expense increased in total dollars but was flat as a
percentage of revenues for the quarter ended September 30, 2001 compared to the
same quarter in the prior year. General and administrative expense increased in
total dollars but was lower as a percentage of revenues for the nine months
ended September 30, 2001 compared to the same period in the prior year, after
eliminating the $29.9 million of non-recurring bad debt expense recorded in the
second quarter of 2001. We have implemented various cost control measures during
2001 that have resulted in lower general and administrative expenses as a
percentage of revenue. We continue to evaluate our operations for efficiencies
and our employee staffing requirements as they relate to increased efficiency,
and we expect to see reductions as a percentage of revenue in the coming
quarters. We expect our efforts to result in an overall reduced general and
administrative cost per subscriber.
ASSET IMPAIRMENT CHARGE
We recorded a $59.2 million expense related to impaired assets in the second
quarter of 2001.
See Note 6 in the Condensed Consolidated Financial Statements for complete
discussion.
DEPRECIATION AND AMORTIZATION.
Depreciation and amortization expense decreased $0.1 million to $5.3 million, or
8% of revenues, for the quarter ended September 30, 2001, compared to $5.4
million, or 10% of revenues, for the same quarter in the prior year.
Depreciation and amortization expense increased $6.0 million to $17.8 million,
or 8% of revenues, for the nine months ended September 30, 2001, compared to
$11.8 million, or 11% of revenues, for the same period in the prior year.
The increase in depreciation and amortization for the nine months ended
September 30, 2001 is primarily due to higher levels of fixed assets and
capitalized software, as well as amortization of intangible assets related to
our purchase of Touch 1 in April 2000. Depreciation and amortization will
continue to decline, as a percentage of revenue, as a result of the asset
impairment write-off of $59.2 million in the second quarter of 2001 and our
decreased capital expenditures.
INTEREST AND OTHER INCOME
Interest and other income includes late fees from subscriber and carrier
receivables, interest earned from our cash balances invested in interest bearing
accounts and any gains from the sale of investments or securities.
17
Interest and other income increased $0.8 million to $1.5 million, or 2% of
revenues, for the quarter ended September 30, 2001, compared to $0.7 million, or
1% of revenues, for the same quarter in the prior year.
Interest and other income increased $3.3 million to $5.8 million, or 3% of
revenues, for the nine months ended September 30, 2001, compared to $2.5
million, or 2% of revenues, for the same period in the prior year.
The increase for the quarter and nine months ended September 30, 2001 was
primarily due to late fees charged on the increased number of retail customers
and carrier access related receivables. This increase was partially offset by
the lower interest earned on cash investments as a result of lower cash balances
for the quarter and nine months ended September 30, 2001 compared to the same
periods in the prior year.
INTEREST AND OTHER EXPENSE
Our interest expense is a result of the interest charged on our capital leases,
the sale of receivables and our debt obligations.
Interest and other expense decreased $0.4 million to $1.2 million, or 2% of
revenues, for the quarter ended September 30, 2001, compared to $1.6 million, or
3% of revenues, for the same quarter in the prior year.
Interest and other expense increased $0.6 million to $3.3 million, or 2% of
revenues, for the nine months ended September 30, 2001, compared to $2.7
million, 2% of revenues, for the same period in the prior year.
The decrease for the quarter was the result of our reduction of outstanding debt
assumed through our acquisition of Touch 1. The overall increase for the nine
months ended September 30, 2001 was a result of increased fees associated with
the sale of our accounts receivable through a factoring arrangement.
INCOME TAX EXPENSE
No provision or benefit for federal or state income taxes has been recorded due
to the recording of a full valuation allowance against the net deferred tax
asset for the quarters and nine months ended September 30, 2001 and 2000.
EBITDA
Many securities analysts use the measure of earnings before deducting interest,
taxes, depreciation and amortization, also commonly referred to as "EBITDA," as
a way of evaluating our financial performance. EBITDA is not a measure under
generally accepted accounting principles, is not meant to be a replacement for
generally accepted accounting principles and should not be considered an
alternative to net income as a measure of performance or to cash flows as a
measure of liquidity. We have included EBITDA data because it is a measure
commonly used in the telecommunications industry and is presented to assist in
understanding our operating results. Our negative EBITDA decreased $9.9 million
to $6.9 million, or 10% of revenues, for the quarter ended September 30, 2001,
compared to $16.8 million, or 31% of revenues, for the same quarter of 2000. Our
negative EBITDA increased $72.2 million to $121.9 million, or 56% of revenues,
for the nine months ended September 30, 2001, compared to $49.7 million, or 46%
of revenues, for the same period in the prior year. We recorded $89.1 million of
non-recurring non-cash charges in the second quarter of 2001. These charges are
composed of $59.2 million, primarily relating to the impairment of intangible
assets, and $29.9 million relating to a non-recurring write-off of accounts
receivable. Excluding these charges, negative EBITDA decreased $16.9 million to
$32.8 million, or 15% of revenues, for the nine months ended September 30, 2001.
We expect to continue our improvement of EBITDA. We believe the attainment of
positive EBITDA will primarily arise from our strategic growth, which is focused
on improved operating efficiencies and lowered subscriber acquisition and
maintenance costs.
LIQUIDITY AND CAPITAL RESOURCES
The competitive local telecommunications service business is traditionally
considered to be a capital intensive business owing to the significant
investments required in fiber optic communication networks and the co-location
of switches and transmission equipment in incumbent local exchange carriers'
central offices. Although we will continue our capital expenditures, we do not
expect the growth of our business will require the levels of capital investment
in fiber optics and switches that existed in
18
historical telecommunications facilities-based models. Instead, we will devote
significant amounts of our capital resources and investments to continued
operations, software development and marketing efforts that we have designed to
achieve penetration of our target markets.
We have incurred accumulated losses since our inception as a result of
developing our business, research and development activities, building and
maintaining network infrastructure and technology, sales and promotion of our
services, and administrative expenditures. At September 30, 2001, we had an
accumulated deficit of $274.3 million and $20.4 million in cash and cash
equivalents. We have funded our expenditures primarily through operating
revenues, private securities offerings, a sale-leaseback credit facility, a
receivables sale agreement, and an initial public offering that raised net
proceeds of $109.1 million.
In February 2000, we paid $14.4 million to extinguish the outstanding CMB
Capital, LLC capital lease obligation and purchase the related assets. This was
the repayment of transactions involving the sale-leaseback of various furniture
and equipment payable over four years from the date of the transactions.
In July 2001, we filed a Certificate of Designation authorizing the issuance of
175 shares of Series G junior convertible preferred stock ("Series G
Preferred"). In July and August 2001, we issued an aggregate of 175 shares of
Series G Preferred for aggregate proceeds of $17.5 million, initially
convertible into 11,739,970 shares of common stock, subject to adjustment upon
the occurrence of certain events that would cause dilution in the ownership of
the holders of the Series G Preferred. In conjunction with the issuance of the
Series G Preferred, we issued warrants to purchase 3,000,000 shares of common
stock at an exercise price of $0.01 per share. The Series G Preferred is
mandatorily redeemable 5 years from September 18, 2001, has a 12% cumulative
dividend, is convertible at the option of the holder and has certain liquidation
rights; however, there are certain circumstances that provide for automatic
conversion of the Series G Preferred.
In accordance with generally accepted accounting principles, we recorded a
deemed dividend of approximately $5.8 million, which results from the value
assigned to the warrants and a beneficial conversion feature associated with the
Series G Preferred transaction. These deemed dividends are accreted over a life
through December 31, 2001, the earliest redemption date. Shareholder approval
was obtained on October 30, 2001, therefore, the remaining balance will be
accreted over the remaining 5 year redemption period.
As a result of certain anti-dilution clauses in the Series D Preferred
agreement, the issuance of Series G Preferred triggered an additional beneficial
conversion feature related to the Series D agreement. The deemed dividend of
approximately $7.8 million was accreted immediately.
In July 2001, we agreed to settle a lawsuit with AT&T in which we alleged that
AT&T had received originating and terminating access service from us and had
unlawfully withheld access charges for such services. We entered into a switched
access agreement setting forth terms and conditions under which AT&T will
purchase access services from us in the future.
Net cash used in operating activities improved by $52.2 million to $26.9 million
for the nine months ended September 30, 2001, compared to $79.1 million used for
the same period in the prior year. The improvement resulted from improved
accounts receivable and accounts payable management, and from reductions in
payroll expenses, sales and marketing expenses and an overall decrease in
operating costs.
Included in our net cash used in operating activities for the nine months ended
September 30, 2001 was the sale of $131.1 million of receivables, for proceeds
of $87.0 million. At September 30, 2001, a net receivable servicing asset of
$8.0 million is included in accounts receivable and $4.2 million of advances on
unbilled receivables are included in accounts payable and accrued liabilities.
The costs relating to the agreement of $0.4 and $0.9 million is included in
interest and other expense for the three and nine months ended September 30,
2001, respectively.
Our cash used in investing activities decreased by $25.9 million as a result of
capital expenditures of $10.3 million for the nine months ended September 30,
2001, compared to $26.2 million in the same period of the prior year. The
remaining difference is the purchase of Touch 1 for $9.0 million and the
purchase of $1.0 million of securities in 2000. During 2000, our efforts were
directed toward enhancing our network and billing infrastructure. Our focus in
2001 has been to conserve capital.
19
We had payments on long-term debt and capital lease obligations totaling $6.2
million for the nine months ended September 30, 2001. These payments related to
the retirement of a $3.0 million balloon facility and $3.2 million relating to
the payment of other debt we assumed in the Touch 1 acquisition. Our payments
for the nine months ended September 30, 2001 are substantially less than the
$21.8 million paid for the same period in the prior year due to the
extinguishment of our sale-leaseback facility. Our debt is primarily related
party with fixed interest that is payable in monthly installments.
Our ongoing capital requirements will depend on several factors, including
market acceptance of our services, the amount of resources we devote to
investments in our networks, facilities, build-out of additional enterprise
management centers, services development and brand promotions, the resources we
devote to sales and marketing of our services, and other factors. We believe
there is an opportunity to provide our back-office and the technology we have
developed to other companies seeking the capability of offering residential and
small business telecommunication services. As growth dictates, we expect to make
strategic investments in technology and our network architecture in the future.
We will make investments in sales and marketing to build our overall "Z" brand,
build strategic partnerships, and develop new service offerings in an attempt to
attract new customers. We will focus on what we expect to be more attractive
distribution channels such as our on-line agent program, which are expected to
achieve acceptable acquisition costs per subscriber.
In the first quarter of 2001, we eliminated approximately 20% of our workforce
through a formal reduction in force, a hiring freeze, and normal attrition.
During the remainder of 2001, we will examine the possibility of further
reductions, consistent with our goals of achieving moderate revenue and line
growth and our focus on attaining profitability. We believe that we have
sufficient funding to execute our current business plan; however, an
acceleration or change to the business plan may require additional equity or
debt financing which may not be available on attractive terms, or at all, or may
be significantly dilutive.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We currently have instruments sensitive to market risk relating to exposure to
changing interest rates and market prices. We do not enter into financial
instruments for trading or speculative purposes and do not currently utilize
derivative financial instruments. Our operations are conducted primarily in the
United States and as such are not subject to material foreign currency exchange
rate risk.
The fair value of our investment portfolio or related income and our long-term
debt obligations would not be significantly impacted by either a 100 basis point
increase or decrease in interest rates due mainly to the short-term or fixed
nature of these types of items.
PART II --OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Proceeding 1 previously was reported in our Quarterly Report on Form 10-Q for
the quarterly period ending June 30, 2001.
1. Grosinger v. Z-Tel Technologies, Inc. et al., Case No. 01 CV 5074; in
the United States District Court for the Southern District of New York
(filed June 7, 2001).
Brody v. Z-Tel Technologies, Inc. et al., Case No. 01 CV 6013, in the
United States District Court for the Southern District of New York
(filed July 2, 2001).
Scholes v. Z-Tel Technologies, Inc. et al., Case No. 01 CV 6139; in the
United States District Court for the Southern District of New York
(filed July 6, 2001)
On the respective dates referenced above, the captioned lawsuits were filed
against us, certain of our current and former directors and officers (the
"D&Os") and firms engaged in the underwriting (the "Underwriters") of our
initial public offering of stock (the "IPO"). Each of the captioned lawsuits is
based on the allegations that our registration statement on Form S-1, filed with
the Securities and Exchange Commission ("SEC") in connection with the IPO,
contained untrue statements of material fact and omitted to state facts
20
necessary to make the statements made not misleading by failing to disclose
that the underwriters had received additional, excessive and undisclosed
commissions from, and had entered into unlawful tie-in and other arrangements
with, certain customers to whom they allocated shares in the IPO. Plaintiffs
have asserted claims against us and the D&Os pursuant to Sections 11 and 15 of
the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated by the SEC thereunder. The
plaintiffs seek an undisclosed amount of damages, as well as pre-judgment and
post-judgment interest, costs and expenses, including attorneys' fees, experts'
fees and other costs and disbursements. The cases, along with all other cases
filed against other issuers arising out of IPO allocations, have been assigned
to Judge Shira A. Scheindlin for pretrial coordination. As of the filing of this
quarterly report on Form 10-Q, only the Scholes complaint has been served, and
we are not required to file answers or other responsive pleadings at this time.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 2, 2001, in consideration for the agreement by certain investors, led by
The 1818 Fund III, L.P., a fund sponsored by Brown Brothers Harriman & Co. that
previously has invested in us, as well as several private investors who are our
directors and officers, to purchase up to an aggregate amount of 175 shares of
our 12% Junior Redeemable Convertible Preferred Stock, Series G (the "Series G
Preferred Stock"), we issued warrants to such investors to purchase, in the
aggregate, 3,000,000 shares of our common stock, $0.01 par value per share
("Common Stock"), at an exercise price of $0.01 per share. On July 2 and August
3, we sold a total of 175 shares of the Series G Preferred Stock to the
investors for aggregate consideration of $17,500,000. We claim an exemption from
registration under Section 4(2) of the Securities Act of 1933 because the
transaction was by an issuer and did not involve a public offering.
The Series G Preferred is currently convertible into 11,739,970 shares of Common
Stock. The conversion rate of the Series G Preferred is subject to adjustment
upon the occurrence of certain events that would cause dilution in the ownership
of the holders of the Series G Preferred.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
The following exhibits are filed as part of this report:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Agreement and Plan of Merger dated April 10, 2000 by and among Z-Tel
Technologies, Inc., Tiger Acquisition Subsidiary, Inc., Touch 1
Communications, Inc., and certain shareholders of Touch 1
Communications, Inc.(A)
3.1 Amended and Restated Certificate of Incorporation of Z-Tel, as
amended(H)
3.2 Amended and Restated Bylaws of Z-Tel(B)
4.1 Form of Common Stock Certificate(B)
4.2 See Exhibits 3.1 and 3.2 of this Form 10-Q for provisions of the
Amended and Restated Certificate of Incorporation, as amended, and the
Bylaws of Z-Tel defining rights of security holders
4.3 Stock Purchase Agreement, dated July 6, 2000, by and between the
Registrant and the various purchasers of the Registrant's Series D
Convertible Preferred Stock(C)
4.4 Certificate of Designations, Preferences and Relative Rights,
Qualifications, Limitations and Restrictions relating to the
Registrant's Series D Convertible Preferred Stock(C)
21
4.5 Form of Registration Rights Agreement by and between the Registrant and
each of the purchasers of the Registrant's Series D Convertible
Preferred Stock(C)
4.6 Form of Warrant for the purchase of shares of common stock of the
Registrant by each of the purchasers of the Registrant's Series D
Convertible Preferred Stock(C)
4.7 Stock and Warrant Purchase Agreement, dated October 19, 2000, by and
among the Registrant and The 1818 Fund III, L.P.(D)
4.8 Certificate of Designation of 8% Convertible Preferred Stock, Series E,
Setting Forth the Powers, Preferences, Rights, Qualifications,
Limitations and Restrictions of Such Series of Preferred Stock, as
amended(H)
4.9 Registration Rights Agreement between and among the Registrant and The
1818 Fund III, L.P.(D)
4.10 Warrant for the purchase of shares of common stock of the Registrant by
The 1818 Fund III, L.P.(D)
4.11 Certificate of Designation of Series F Junior Participating Preferred
Stock(G)
4.12 Rights Agreement dated as of February 19, 2001 between Z-Tel
Technologies, Inc. and American Stock Transfer Trust Company, as Rights
Agent, as amended July 2, 2001(H)
4.13 Stock and Warrant Purchase Agreement, dated as of July 2, 2001, by and
between Z-Tel, D. Gregory Smith, and others (incorporated by reference
to Exhibit 1 to Amendment No. 1 of the Schedule 13D filed July 12, 2001
with respect to Z-Tel's common stock by, among other persons, The 1818
Fund III, L.P.)
4.14 Warrant for the Purchase of Shares of Common Stock of Z-Tel, dated as
of July 2, 2001 (incorporated by reference to Exhibit 2 to Amendment
No. 1 of the Schedule 13D filed July 12, 2001 with respect to Z-Tel's
common stock by, among other persons, The 1818 Fund III, L.P.)
4.15 Certificate of Designation for the Series G Preferred Stock
(incorporated by reference to Exhibit 3 to Amendment No. 1 of the
Schedule 13D filed July 12, 2001 with respect to Z-Tel's common stock
by, among other persons, The 1818 Fund III, L.P.)
4.16 Backup Purchase Agreement, dated as of July 2, 2001, by and among Z-Tel
Communications, Inc., a Delaware corporation and a wholly owned
subsidiary of Z-Tel, Touch 1 Communications, Inc., an Alabama
corporation and a wholly owned subsidiary of Z-Tel, D. Gregory Smith
and others (incorporated by reference to Exhibit 4 to Amendment No. 1
of the Schedule 13D filed July 12, 2001 with respect to Z-Tel's common
stock by, among other persons, The 1818 Fund III, L.P.)
4.17 Additional Investor Registration Rights Agreement, dated as of July 2,
2001, between Z-Tel, D. Gregory Smith and others (incorporated by
reference to Exhibit 5 to the Schedule 13D filed July 24, 2001 with
respect to Z-Tel's common stock by, among other persons, D. Gregory
Smith)
4.18 Voting Agreement, dated as of June 29, 2001, between Z-Tel and certain
stockholders of Z-Tel (incorporated by reference to Exhibit 5 to
Amendment No. 1 of the Schedule 13D filed July 12, 2001 with respect to
Z-Tel's common stock by, among other persons, The 1818 Fund III, L.P.)
4.19 Employee Stock Restriction Agreement, dated September 1, 1999, by and
between the Company and D. Gregory Smith (incorporated by reference to
Exhibit 7 to the Schedule 13D filed July 24, 2001 with respect to
Z-Tel's common stock by, among other persons, D. Gregory Smith)
10.1.1 Stockholders' Agreement dated October 8, 1999, between and among the
Company, BA Capital Corporation, Sewanee Partners II, L.P., Gramercy
Z-Tel LLC and the other parties set forth therein(B)
22
10.1.2 Employment Agreement dated July 1998 between the Company and D. Gregory
Smith(B)
10.1.3 Employment Agreement dated September 1999 between the Company and John
Hutchens(B)
10.1.4 Employment Agreement dated August 1998 between the Company and Charles
W. McDonough(B)
10.1.5 Employment Agreement dated August 1998 between the Company and J. Bryan
Bunting(B)
10.1.6 Employment Agreement dated July 1998 between the Company and James A.
Kitchen(B)
10.1.7 Investment Agreement dated March 15, 1999 between the Company and CMB
Capital LLC(B)
10.2.1 1998 Equity Participation Plan(B)
10.2.2 2000 Equity Participation Plan(F)
10.3 Form of Employment Agreement for certain key Touch 1 employees,
including James F. Corman, President of Touch 1(A)
10.4 Receivables Sales Agreement dated as of July 27, 2000 by and between
Z-Tel Communications, Inc., as seller and subservicer, Touch 1
Communications, Inc., as seller and subservicer, and RFC Capital
Corporation, as purchaser(C)
10.5 Form of Indemnification Agreement for executive officers and directors
of the Company(G)
10.6 Loan and Guaranty Agreement dated January 11, 2001 between the Company
and James A. Kitchen(G)
10.7 Secured Promissory Note dated January 11, 2001 delivered by James A.
Kitchen to the Company(G)
10.8 Pledge and Security Agreement dated January 11, 2001 between James A.
Kitchen and the Company(G)
10.9 Promissory Note, dated September 10, 1999, between Touch 1
Communications, Inc. and Corman Elegre Capital(G)
10.10 Promissory Note, dated May 11, 1999, between Touch 1 Communications,
Inc. and Corman Elegre Capital(G)
10.11 Promissory Note, dated September 10, 1999, from Touch 1 Communications,
Inc. and William F. Corman (First Revocable Trust)(G)
10.12 Promissory Note, dated September 10, 1999, from Touch 1 Communications,
Inc. and James F. Corman(G)
--------------
(A) Incorporated by reference to the correspondingly numbered exhibit to
the Registrant's Current Report on Form 8-K filed April 28, 2000.
(B) Incorporated by reference to the correspondingly numbered exhibit to
the Registrant's Registration Statement on Form S-1 (File No.
333-89063), originally filed October 14, 1999, as amended and as
effective December 14, 1999.
(C) Incorporated by reference to the correspondingly numbered exhibits to
the Registrant's Quarterly Report on Form 10-Q for the quarterly period
ending June 30, 2000, filed on August 14, 2000.
23
(D) Incorporated by reference to the correspondingly numbered exhibits to
the Registrant's Quarterly Report on Form 10-Q for the quarterly period
ending September 30, 2000, filed on November 14, 2000.
(E) Incorporated by reference to Exhibit 4.1 to the Registrant's Form 8-A
Registration Statement filed February 21, 2001.
(F) Incorporated by reference to Appendix B to the Registrant's Preliminary
Proxy Statement filed on April 14, 2000.
(G) Incorporated by reference to the correspondingly numbered exhibits to
the Registrant's Annual Report on Form 10-K for the annual period
ending December 31, 2000, filed on March 30, 2001.
(H) Incorporated by reference to the correspondingly numbered exhibits to
the Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 2001, filed on August 13, 2001.
(b) Reports on Form 8-K.
None.
24
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, Registrant's principal financial officer, thereunto duly
authorized.
Z-TEL TECHNOLOGIES, INC
(Registrant)
Date: November 13, 2001 By: /s/ Horace J. Davis, III
-----------------------------------------------
Horace J. Davis, III
Senior Vice President - Chief Financial Officer
(Authorized officer of Registrant and principal
financial officer)
25