UNITED STATES
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 April 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File Number 0-2180
[COVISTA LOGO]
COVISTA COMMUNICATIONS, INC.
(Exact name of Company as specified in its charter)
New Jersey 22-1656895
---------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
721 Broad Street, Suite 200
Chattanooga, TN 37402
(Address of principal executive offices)(Zip Code)
(423) 648-9500
Company's telephone number, including area code:
Indicate by check mark whether Covista Communications, Inc. ("Covista" or the
"Company")(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 Covista was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at June 1, 2004
- ----------------------------- ---------------------------
Common Share, $0.05 par value 17,822,025
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
SECOND QUARTER REPORT ON FORM 10-Q
INDEX
PAGE No.
--------
PART I - FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets 3
April 30, 2004 (unaudited), and January 31, 2004
Condensed Consolidated Statements of Operations for three months ended April 30, 2004 and 2003 4
(unaudited)
Condensed Consolidated Statements of Cash Flows 5
Three months ended April 30, 2004 and 2003 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited) 6 - 11
Management's Discussion and Analysis of 12 - 14
Financial Condition and Results of Operations
Critical Accounting Policies 15 - 16
PART II - OTHER INFORMATION
Items 1-5 Not Applicable 17
Items 6 - 17
CERTIFICATIONS AND SIGNATURES 18
2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
April 30, 2004 January 31, 2004
-------------- ----------------
(Unudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,493,272 $ 3,797,245
Trade accounts receivable, net 10,161,861 10,532,728
Prepaid expenses and other current assets 1,036,204 867,670
------------ ------------
Total current assets 14,691,336 15,197,643
------------ ------------
Property and equipment, net 10,843,483 11,654,365
Deferred line installation costs, net 541,273 547,201
Intangible assets, net 4,240,035 4,774,324
Goodwill 8,205,850 8,205,850
Other Assets 534,449 507,449
------------ ------------
$ 39,056,426 $ 40,886,832
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued line cost
Other accrued liabilities $8,644,028 $10,695,055
Salaries and wages payable 8,184,145 7,609,543
Current portion of long term debt due to 184,175 396,925
related party 1,258,327 1,258,327
Current portion of long-term debt 3,488,210 1,325,930
------------ ------------
Total current liabilities 21,758,885 21,285,780
------------ ------------
Other long-term liabilities 191,890 195,395
Long-term debt due to related party 258,440 573,023
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock 967,922 967,672
Additional paid-in capital 52,931,049 52,916,949
Accumulated deficit (35,606,320) (33,606,547)
Treasury stock (1,445,440) (1,445,440)
------------ ------------
Total shareholders' equity $ 16,857,211 $ 18,832,634
------------ ------------
$ 39,056,426 $ 40,886,832
============ =============
See notes to condensed consolidated financial statements
3
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended April 30,
2004 2003
---- ----
NET REVENUE $18,194,305 $23,269,857
----------- -----------
Costs and Expenses
Cost of revenue 9,957,663 13,288,202
Selling, general and administrative 8,656,102 9,116,065
Depreciation and amortization 1,488,694 1,567,096
----------- -----------
Total costs and expenses 20,102,459 23,971,363
----------- -----------
OPERATING LOSS (1,908,154) (701,506)
----------- -----------
Other Income (Expense)
Interest income 13,135 4,909
Interest expense (104,756) (81,204)
----------- -----------
Total other income (expense) (91,621) (76,295)
----------- -----------
Loss before income taxes (1,999,775) (777,801)
Income taxes -- --
----------- -----------
NET LOSS $(1,999,775) $ (777,801)
=========== ===========
BASIC LOSS PER COMMON SHARE $(.11) $ (0.04)
=========== ===========
DILUTED LOSS PER COMMON SHARE $(.11) $ (0.04)
=========== ===========
See notes to condensed consolidated financial statements.
4
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended April 30,
2004 2003
---- ----
OPERATING ACTIVITIES:
Net loss $(1,999,775) $ (777,801)
Adjustment for non-cash charges 1,821,117 2,191,494
Changes in assets and liabilities (1,849,767) (1,706,712)
----------- -----------
Net cash used in operating activities (2,028,425) (293,019)
----------- -----------
INVESTING ACTIVITIES:
Purchase of property and equipment (96,357) (83,620)
Additions to deferred line installation cost (41,233) (126,560)
----------- -----------
Net cash used in investing activities (137,590) (210,180)
----------- -----------
FINANCING ACTIVITIES:
Exercise of Stock Options 14,350 --
Bank Borrowing - net of repayment 2,162,273 1,232,086
Note payable to related party (314,583) --
----------- -----------
Net cash provided by financing activities 1,862,040 1,232,086
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (303,975) 728,887
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,797,247 3,444,307
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $3,493,272 $ 4,173,194
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $91,621 $64,001
See notes to condensed consolidated financial statements
5
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. They do not include all information and notes
required by generally accepted accounting principles for complete financial
statements. However, except as disclosed herein, there has been no material
change from the information disclosed in the notes to the consolidated financial
statements included in the Annual Report on Form 10-K of Covista Communications,
Inc. and Subsidiaries (Covista) for the fiscal year ended January 31, 2004. In
the opinion of management, all adjustments (consisting of normal recurring
accruals only) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended April 30, 2004 are not
necessarily indicative of the results that may be expected for the year ending
January 31, 2005. Certain reclassifications have been made to conform prior
years' balances to the current year presentation.
Revenue Recognition
The Company's revenues, net of sales discounts, are recognized in the
period in which the service is provided, based on the number of minutes of
telecommunications traffic carried, and a rate per minute. Access and other
service fees charged to customers, typically monthly, are recognized in the
period in which service is provided.
Deferred Line Installation Costs
The Company defers charges from other common carriers related to the
cost of installing telephone transmission facilities (lines). Amortization of
these costs is provided using the straight-line method over the related contract
life of the lines ranging from three to five years.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could differ
from those estimates.
Intangible Assets
Intangible assets consist of prepaid network capacity and purchased
customer and agent relationships being amortized over a straight-line basis over
periods varying between 10 and 120 months. The Company incurred amortization
expense on intangible assets of approximately $534,000, and $519,000 for the
quarters ended April 30, 2004, and 2003 respectively. The Company's balance of
intangible assets with a definite life was approximately $4,240,000, net of
accumulated amortization of approximately $5,042,000 at April 30, 2004 and
approximately $4,774,000, net of accumulated amortization of approximately
$4,508,000 at January 31, 2004. Approximate amortization expense on intangible
assets for the next 5 years as of January 31, is as follows:
2005 $1,914,000
2006 $1,032,000
2007 $400,000
2008 $400,000
2009 $400,000
Thereafter $966,667
6
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Risks and Uncertainties
Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and cash flows
and cause actual results to vary materially from historical results include, but
are not limited to:
o Changes in government policy, regulation and enforcement or
adverse judicial or administrative interpretations and rulings or
legislative action relating to regulations, enforcement and
pricing, including, but not limited to, changes that affect
continued availability of the unbundled network element platform
of the local exchange carriers network and the costs associated
therewith
o Dependence on the availability and functionality of the networks
of the incumbent local exchange carriers as they relate to the
unbundled network element platform
o Increased price competition in local and long distance services,
including bundled services, and overall competition within the
telecommunications industry.
Negative developments in these areas could have a material effect on
the Company's business, financial condition and results of operations.
Concentrations of Credit Risk
The Company sells its telecommunications services and products
primarily to small to medium size businesses, residential and wholesale
customers. The Company performs ongoing credit evaluations of both its retail
and wholesale customers. The Company generally does not require collateral;
however, when circumstances warrant, deposits are required. Recent conditions in
the telecommunications industry have given rise to an increase in potential
doubtful accounts. Allowances are maintained for such potential credit losses.
The Company has entered into offset arrangements with certain of its customers,
which are also vendors, allowing for the ability to offset receivables against
the Company's payables balance.
Reclassifications
Certain amounts for 2003 have been reclassified to conform to the
current year presentation.
NOTE B - NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities." This interpretation of
Accounting Research Bulletin 51, "Consolidated Financial Statements", addresses
consolidation by business enterprises of variable interest entities that possess
certain chracteristics. The interpretation requires that if a business
enterprise has a controlling financial interest in a variable interest entity,
the assets, liabilities, and results of the activities of the variable interest
entity must be included in the consolidated financial statements with those of
the business enterprise. This interpretation applies immediately to variable
interest entities created after January 31, 2003 and to variable interest
entities in which an enterprise obtains an interest after that date. The Company
does not have any ownership in any variable interest entities as of April 30,
2004. The Company will apply the consolidation requirements of the
interpretation in future periods if the Company should own any interest in any
variable interest entity.
7
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE C - STOCK BASED COMPENSATION
The following disclosure complies with the adoption of SFAS No. 123,
amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure - an amendment of FASB Statement No. 123", and includes pro forma
net loss as if the fair value based method of accounting had been applied:
Three Months Ended April 30,
2004 2003
---- ----
Net Loss as reported (000's) $(2,000) $(778)
Total stock-based compensation expense determined under fair
value based method for all options (000's) (192) (58)
-------- -----
Pro forma net loss (000's) $(2,192) $(836)
======== =====
Three Months Ended April 30,
2004 2003
---- ----
Basic Earnings Per Share:
As reported $(.11) $(.04)
Pro forma $(.12) $(.05)
Diluted Earnings Per Share:
As reported $(.11) $(.04)
Pro forma $(.12) $(.05)
8
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For purposes of pro forma disclosures under SFAS 123, the estimated
fair value of the options is assumed to be amortized to expense over the
options' vesting periods. The fair value of the options granted has been
estimated at the various dates of the grants using the Black-Scholes
option-pricing model with the following assumptions:
o Fair market value based on the Company's closing common stock price on the
date the option is granted;
o Risk-free interest rate based on the weighted averaged U.S. treasury note
rates;
o Volatility based on the historical stock price over the expected term;
o No expected dividend yield based on future dividend payment plans.
9
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE D - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted loss
earnings per common share:
Three Months Ended April 30,
2004 2003
---- ----
Numerator:
Loss available to Common Shareholders
used in basic and diluted loss per Common Share $(1,999,775) $ (777,801)
Denominator:
Weighted-average number of Common Shares used in
basic loss per Common Share 17,822,025 17,783,092
Effect of diluted securities:
Common share options (1) -- --
----------- ----------
Weighted-average number of Common Shares and diluted potential Common
Shares used in diluted loss per Common Share 17,822,025 17,783,092
----------- -----------
Basic loss per Common Share $(.11) $(0.04)
----------- -----------
Diluted loss per Common Share $(.11) $(0.04)
----------- -----------
1) Common Shares subject to options are not included in the calculation of
diluted loss per Common Share for the three-month period ended April 30, as
doing so would be antidilutive due to the net loss per common share. At
April 30, 2004, 723,000 Common Shares subject to options have been
excluded from this calculation.
NOTE E - SEGMENT REPORTING
The Company sells telecommunication services to three distinct
segments: a retail segment, consisting primarily of small to medium size
businesses, a wholesale segment, with sales to other telecommunications carriers
and KISSLD which targets residential users.
In addition to direct costs, each segment is allocated a proportion of
the Company's operating expenses, including utilization of its switch and
facilities. The allocation of expenses is based upon the minutes of use flowing
through the Company's switching network. There are no intersegment sales. When
specifically identified, assets are allocated to each segment. All intangible
assets and goodwill have been allocated to the retail segment. Capital
expenditures and other assets are allocated based on total revenue. Management
evaluates performance on operating results of the three business segments.
10
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information (000's) concerning Covista's
reportable segments is shown in the following table:
Retail Wholesale KISSLD Total
------ --------- ------ -----
Three Months Ended April 30, 2004
Net Sales $12,943 $582 $4,669 $18,194
Operating profit (loss) $(1,106) $(482) $(320) $(1,908)
Assets $31,125 $1,583 $6,348 $39,056
Capital expenditures $68 $3 $25 $96
Three Months Ended April 30, 2003
Net Sales $17,367 $1,631 $4,272 $23,270
Operating profit (loss) $(364) $(388) $50 $(702)
Assets $39,773 $4,547 $5,476 $49,796
Capital expenditures $63 $6 $15 $84
NOTE F - INCOME TAXES
For the fiscal year ended January 31, 2004, Covista established a
valuation allowance against its net deferred tax asset due to the uncertainty of
realizing certain tax credits and loss carryforwards. In the quarter ended April
30, 2004, Covista continued this accounting treatment and recorded a full
valuation allowance against the net tax benefit arising from the quarter's net
operating loss. The result is that the net deferred tax asset of approximately
$3,078,000 is fully offset by the valuation allowance and as such, does not
appear as an asset on the balance sheet. It will be reflected in the Company's
balance sheet when the net deferred tax asset can be utilized in future periods
or when managements' assessment is substantially changed.
NOTE G - LONG TERM DEBT
Effective April 16, 2003, Covista executed a revolving credit and
security agreement with Capital Source Finance, LLC. This credit facility
provides the Company with an $8 million loan of which approximately $1,000,000
was available at April 30, 2004, based on eligible accounts receivable. This
thirty-six month facility allows the Company to borrow funds based on a portion
of eligible customer accounts receivable and bears interest at the Prime Rate
plus 2.00% with a floor of 6.25%. Interest, unused line and collateral
management fees are payable monthly in arrears. Covista is required to maintain
certain covenants that include cash velocity and fixed charge coverage ratios as
defined in the agreement. The Company is in compliance with these covenants as
of April 30, 2004. The loan is secured by all of the Company's assets.
The loan balance at April 30, 2004 was approximately $3,488,000 and is included
in current portion of long-term debt.
On June 17, 2002, Covista entered into a term loan agreement with a
major bank. The initial principal amount of this note was $3,775,000, payable in
36 monthly installments at a fixed interest rate of 4.495% for the first year
and converting to 2% over LIBOR on June 17, 2003 and thereafter or 3.1%.
Effective June 17, 2003, Covista's Chairman of the Board paid the bank in full
and assumed the remaining balance of this loan under the identical terms and
conditions. This note is secured by certain of the Company's switching
equipment. The balance on this facility was approximately $1,517,000 at April
30, 2004 of which approximately $1,258,000 is classified as current.
11
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE H - COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal and administrative actions
arising in the normal course of business. While the resolution of any such
actions may have an impact on the financial results for the period in which it
is resolved, management believes that the ultimate disposition of these matters
will not have a material adverse effect upon its consolidated results of
operations, cash flows or financial position.
NOTE I - SUBSEQUENT EVENT
On May 25, 2004, the Company signed a definitive agreement to sell
selected commercial customers, switches and related facilities to PAETEC
Communications, Inc., a Fairport, New York based competitive local exchange
carrier.
On closing, PAETEC shall be obligated to pay approximately $15.1
million in cash, subject to final adjustment, based on a multiple of monthly
operating revenue associated with the selected customers, assets and facilities.
Payment is due in three installments with the majority payable upon closing. In
addition, PAETEC will assume leases for existing switch facilities in New York
and Philadelphia, as well as office locations in Bensalem, PA and Paramus, NJ.
The approximate book value of the long-lived assets to be included in the
transaction is $3.7 million. Covista will also execute a Wholesale Service
Agreement to purchase $12 million of services from PAETEC over 24 months.
The transaction is expected to close during the third fiscal quarter of
2004 and is subject to, among other conditions, obtaining necessary regulatory
approvals.
12
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS:
Certain matters discussed in this Quarterly Report on Form 10-Q are
"forward-looking statements" intended to qualify for the safe harbor from
liability provided by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements generally can be identified as such because the
context of the statement will include words such as Covista "believes",
"anticipates", "expects", or words of similar import. Similarly, statements,
which describe Covista's future plans, objectives or goals, are also
forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties, which are described in, close proximity to such
statements and which could cause actual results to differ materially from those
anticipated as of the date of this Report. Shareholders, potential investors and
other readers are urged to consider these factors in evaluating the
forward-looking statements and are cautioned not to place undue reliance upon
such forward-looking statements. The forward-looking statements included herein
are made only as of the date of this Report and Covista undertakes no obligation
to publicly update such forward-looking statements to reflect subsequent events
or circumstances, except as required under applicable laws.
Results of Operations
Net sales were approximately $18,194,000 for the first three months of the
current fiscal year, a decrease of approximately $5,076,000 or 22% as compared
to the approximately $23,270,000 recorded in the first three months of the prior
fiscal year. The overall decrease is primarily related to intense competitive
pressure in the retail segment combined with planned reductions in wholesale
revenue, as discussed in further detail below.
For the quarter ended April 30, 2004, retail revenues were
approximately $12,943,000, a decrease of approximately $4,424,000 or 25% versus
the comparative quarter in the last fiscal year. Retail minutes sold in the
three-month period ended April 30, 2004 were approximately 193,642,000 minutes,
a decrease of approximately 58,451,000 minutes or 23%. The overall blended
retail rate per minute decreased to $.067 versus $.069 from the first quarter of
the previous year as the industry continues to experience decreased price per
minute of usage. Covista does not foresee that this trend in pricing will abate
in the near future. The current year decrease in the retail segment is primarily
attributed to intense competitive pressure from other providers, especially
those which have the ability to bundle local dial tone with traditional long
distance offerings. While the Company has recently launched local services to
the retail segment in certain markets, the Company has experienced significant
loss of former retail customers, which have taken advantage of competitive
providers bundled service offerings. The Company does not foresee this intensely
competitive climate abating in the near future. The Company has recently
announced plans to sell the majority of its retail customer base. Upon closing
of that transaction, quarterly retail revenues are expected to decrease by
approximately $8,100,000 subject to final adjustment. This transaction is
expected to close during the quarter ended October 31, 2004.
For the quarter ended April 30, 2004, KISSLD revenues were
approximately $4,669,000, an increase of approximately $397,000 or 9% versus the
first quarter from the prior fiscal year. Approximately $932,000 of the current
quarter total was for local service versus $0 in the comparative quarter of last
fiscal year. KISSLD minutes sold for the three-month period ended April 30, 2004
were approximately 70,414,000, a decrease of approximately 4,741,000 or 6%. The
overall blended rate per minute for long distance revenue was $.053 versus $.057
from the first quarter of the previous year. The current year increase in the
KISSLD segment is primarily attributed the launch of local service to these
residential users in selected markets in addition to direct marketing via mail
and web based affinity marketing campaigns. While the Company has launched local
services to the KISSLD segment in certain markets, the Company plans to expand
the number of markets in which it has the ability to offer its local and long
distance bundled product offering. Additionally, the Company plans to expand its
marketing resources to target new geographic market areas where the Company has
the ability to offer competitive bundled services to residential users.
13
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
The Company has continued to successfully reduce reliance on lower
margin wholesale revenue. For the quarter ended April 30, 2004, wholesale
revenue was approximately $582,000, a decrease of approximately $1,049,000 or
64% versus the comparative quarter in the last fiscal year. The Company
continues its planned efforts to reduce volume in the wholesale segment. The
Company plans to maintain nominal wholesale volume in the future, based on
network capacity and gross margin opportunities, while balancing any possible
financial exposure related to un-collectable balances.
Cost of revenue for the current three-month period was approximately
$9,958,000, a decrease of approximately $3,330,000 or 25%. These changes were
favorable in relation to the 22% decrease in revenue for the three-month period.
The decrease in cost of revenue was primarily due to an overall decrease in
revenue volume of approximately $2,923,000. In addition, the Company has
improved its purchasing and line cost auditing functions. These improvements
have allowed the Company to generate an additional savings of approximately
$407,000 versus the prior year as a result of overall rate reductions and
improved auditing and dispute resolution capabilities. On Wednesday June 9,
2004, the U.S. Solicitor General opted not to appeal a recent U.S. Court of
Appeals for the D.C. Circuit's decision vacating the Federal Communications
Commissions' Triennial Review Order on local telephone unbundling rules.
Changes to these rules could have an adverse impact on the cost we incur to
provide local services. We are currently working closely with our regulatory
advisors regarding the impact of these continuing events.
For the quarter ended April 30, 2004, selling, general and
administrative expense, excluding depreciation and amortization was
approximately $8,656,000, a decrease of approximately $460,000 or 5% versus the
comparative quarter in the last fiscal year. The overall decrease was primarily
due to decreases in commissions of approximately $729,000, building and
equipment rent of approximately $118,000, decreases in postage and billing fees
of approximately $102,000, decreases in bad debt expense of approximately
$292,000 and other general decreases of approximately $128,000. These decreases
were partially offset with increases in advertising of approximately $803,000,
and payroll of approximately $106,000.
For the reasons described above, the operating loss for the three-month
period ended April 30, 2004 was approximately $1,908,000, an increase of
approximately $1,206,000 from the three-month period ended April 30, 2003.
Basic and diluted loss per Common Share was $(.11) per share for the
current three-month period ended April 30, 2004 as compared to $(.04) loss per
share for the three-months ended April 30, 2003.
Liquidity and Capital Resources
At April 30, 2004, Covista had a working capital deficit of
approximately $7,068,000, an increase of approximately $980,000 as compared to
January 31, 2004. The ratio of current assets to current liabilities at April
30, 2004 was .68:1 as compared to the ratio of .71:1 at January 31, 2004. The
Company has recently announced plans to sell the majority of its commercial
customer base. Upon closing, the buyer is obligated to pay approximately
$15.1 million in cash subject to final adjustment to Covista. Payment will be
due in three installments with the majority being payable upon closing.
Capital Expenditures
Capital expenditures for the three-month period ended April 30, 2004
were approximately $96,000. Capital expenditures for the remainder of Fiscal
2004 are estimated at approximately $300,000 and are expected to be funded from
operations.
Prepaid Network Capacity
In July 2001, Covista purchased 2.8 billion DS-0 channel miles of
telecommunications network capacity from an unaffiliated party that expires on
June 30, 2011. The unaffiliated party has recently emerged from Chapter 11
reorganization and, as of the date of this report, has continued to perform
under the agreement. As of the date hereof, Covista has used approximately 356
million DS-0 channel miles of telecommunications network capacity against the
2.8 billion DS-0 total prepaid network capacity, of which $400,000 has been
classified as a current asset and based on anticipated usage in the next 12
months the remainder of the prepaid capacity amount of approximately $2,467,000
is included in intangible assets.
14
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
Accounts Receivable and Credit Risk
Accounts receivable subject Covista to the potential for credit risk
with customers in the retail and wholesale segments. To reduce credit risk,
Covista performs ongoing evaluations of its customers' financial condition and,
except in situations where the risk warrants it, Covista does not require a
deposit or other collateral. Accounts receivable of approximately $10,162,000,
net of the reserve for uncollectible accounts totaling approximately $1,772,000,
represents approximately 26% of the total assets of Covista.
No one customer accounts for greater than eight percent of the total
revenues. In the wholesale segment, which contains Covista's largest customers,
Covista has been able to reduce credit risk by using reciprocal arrangements
with certain customers, which are also Covista's suppliers, to offset
outstanding receivables. Covista has historically maintained a ratio of bad
debts to revenues of less than 3%. For the three-month period ended April 30,
2004, this ratio was approximately 2%. Covista also measures accounts
receivable turnover (as measured in days sales outstanding). For the periods
ended April 30, 2004 and 2003, days sales outstanding were 50.3 days and 52.5
days, respectively.
Related Party Transactions
Jay J. Miller, a Director of Covista, has provided various legal
services for Covista in Fiscal 2005. In the first quarter, Covista accrued
approximately $6,000 to Mr. Miller for services rendered.
Leon Genet, a Director of Covista, has provided agent services for
Covista through his wholly owned firm, LPJ, Inc. During the first quarter, LPJ,
Inc. was paid commissions of $8,969. The commissions paid to LPJ, Inc. were
computed on the same basis as other independent agents retained by Covista.
Jeff Alward, a relative of Kevin Alward, Chief Operating Officer of
Covista has provided agent services for Covista through his wholly owned firm,
KTI, Inc. During the quarter ended April 30, 2004, KTI, Inc. was paid
commissions of approximately $34,000. The commissions paid to KTI, Inc. were
computed on the same basis as other independent sales agents retained by
Covista.
On June 17, 2002, Covista entered into a term loan agreement with a
major bank. The initial principal amount of this note was $3,775,000, payable in
36 monthly installments at a fixed interest rate of 4.495% for the first year
and converting to 2% over LIBOR on June 17, 2003 and thereafter or 3.1%.
Effective June 17, 2003, Covista's Chairman of the Board paid the bank in full
and assumed the remaining balance of this loan under the identical terms and
conditions. This note is secured by certain of the Company's switching
equipment. The balance on this facility was approximately $1,517,000 at April
30, 2004 of which approximately $1,258,000 is classified as current.
15
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
Nature of Operations
Covista Communications, Inc. ("Covista"), and its wholly-owned
subsidiaries (collectively, the "Company") operates as a switch based resale
common carrier providing domestic and international long distance and local
telecommunications service to customers throughout the United States. Prior to
the Capsule acquisition, the Company's principal customers were primarily
businesses and other common carriers. On September 15, 2000, the Company changed
its name from Total-Tel USA Communications, Inc. to Covista Communications, Inc.
On February 8, 2002, Covista completed the acquisition of Capsule
Communications, Inc. As a result, Capsule became a wholly owned subsidiary of
Covista. Capsule is a switch-based interexchange carrier providing long distance
telephone communications services primarily to small and medium-size business
customers as well as residential accounts. The results of Capsule's operations
have been included in the Company's statement of operations since the
acquisition date.
Revenue Recognition
Covista's revenues, net of sales discounts, are recognized in the
period in which the service is provided, based on the number of minutes of
telecommunications traffic carried, and a rate per minute. Access and other
service fees charged to customers, typically monthly, are recognized in the
period in which service is provided.
Property and Equipment
Property and equipment are stated at cost. Depreciation and
amortization is being provided by use of the straight-line method over the
estimated useful lives of the related assets. Leasehold improvements are
amortized over the shorter of the term of the lease or the useful lives of the
asset.
The estimated useful lives of the principal classes of assets are as follows:
Classification Years
-------------- -----
Machinery and equipment 5-10
Office furniture, fixtures and equipment 5-10
Vehicles 3-5
Leasehold improvements 2-10
Computer equipment and software 5-7
Deferred Line Installation Costs
The Company defers charges from other common carriers related to the
cost of installing telephone transmission facilities (lines). Amortization of
these costs is provided using the straight-line method over the related contract
life of the lines ranging from three to five years.
Intangible Assets
Intangible assets consist of prepaid network capacity and purchased
customer and agent relationships being amortized over a straight-line basis over
periods varying between 10 and 120 months.
16
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
Goodwill
Goodwill consists of the excess purchase price over the fair value of
identifiable net assets of acquired businesses. Goodwill is not being amortized
in accordance to SFAS 142. The carrying value of goodwill is evaluated for
impairment on an annual basis. Management also reviews goodwill for impairment
whenever events or changes in circumstances indicate that the carrying amount
of goodwill may be impaired.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could differ
from those estimates.
Vendor Disputes
The Company records disputed line cost expenses in accordance with FASB
Statement No. 5, "Accounting for Contingencies". Billings from line cost vendors
are compared to the Company's engineering and operations data, with differences
filed with the vendors as a disputed billing. Disputed line cost billings are
recorded by the Company at the estimated liability due based upon the Company's
historical experience in settling similar disputes. Actual settlement of
disputes may differ from original estimates. Management adjusts the dispute
reserve each month. The net reserve for dispute losses at April 30, 2004 and
2003 was approximately $2.2 million and $5.3 respectively and is included in
accounts payable and accrued line cost.
Risks and Uncertainties
Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and cash flows
and cause actual results to vary materially from historical results include, but
are not limited to:
o Changes in government policy, regulation and enforcement or
adverse judicial or administrative interpretations and rulings or
legislative action relating to regulations, enforcement and
pricing, including, but not limited to, changes that affect
continued availability of the unbundled network element platform
of the local exchange carriers network and the costs associated
therewith
o Dependence on the availability and functionality of the networks
of the incumbent local exchange carriers as they relate to the
unbundled network element platform
o Increased price competition in local and long distance services,
including bundled services, and overall competition within the
telecommunications industry.
Negative developments in these areas could have a material effect on
the Company's business, financial condition and results of operations.
Concentrations of Credit Risk
The Company sells its telecommunications services and products
primarily to small to medium size businesses, residential and wholesale
customers. The Company performs ongoing credit evaluations of both its retail
and wholesale customers. The Company generally does not require collateral,
however when circumstances warrant, deposits are required. Recent conditions in
the telecommunications industry have given rise to an increase in potential
doubtful accounts. Allowances are maintained for such potential credit losses.
The Company has entered into offset arrangements with certain of its customers,
who are also vendors, allowing for the ability to offset receivables against the
Company's payables balance.
Market Risk
Market risk represents the risk of changes in value of a financial
instrument, derivative or non-derivative, caused by fluctuations in interest
rates, foreign exchange rates and equity prices. As Covista holds no marketable
securities at April 30, 2004, the exposure to interest rate risk relating to
marketable securities no longer exists. Covista does not hold any derivatives
related to its interest rate exposure. Covista also maintains long-term debt at
fixed rates. Due to the nature and amounts of Covista's note payable, an
immediate 10% change in interest rates would not have a material effect in
Covista's results of operations over the next fiscal year. Covista's exposure to
adverse changes in foreign exchange rates is also immaterial to the consolidated
statements as a whole.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash on hand, demand deposits and money market accounts.
17
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEMS 1 - 5 Not applicable
ITEM 6 Exhibits and Reports on Form 8K
8K - Dated April 16, 2004, Press Release Regarding Fiscal 2004 Results
8K - Dated May 26, 2004, Press Release Regarding the Sale of Certain Assets
18
SIGNATURES
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 thereunto duly authorized.
COVISTA COMMUNICATIONS, INC.
(Registrant)
Date: June 14, 2004 By: /s/ A. John Leach, Jr.
------------- -----------------------
A. John Leach, Jr.
President and Chief Executive Officer
Date: June 14, 2004 By: /s/ Frank J. Pazera
------------- ---------------------
Executive Vice President,
Chief Financial Officer
and Principal Accounting Officer
19