SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
For Quarter ended June 30, 2002
Commission File Number 0-27505.
CTC COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3469590
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
220 Bear Hill Rd., Waltham, Massachusetts 02451
(Address of principal executive offices) (Zip Code)
(781) 466-8080
(Registrant's telephone number including area code)
(Former name, former address and former fiscal year,
if changed since last report)
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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the Issuer's
classes of Common Stock, as of the latest practicable date:
As of August 14, 2002, 27,367,767 shares of Common Stock, $.01
par value, were outstanding.
INDEX PAGE
NUMBER
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of
June 30, 2002 and December 31, 2001 3
Unaudited Condensed Consolidated Statements of Operations
for the Three and Six Months Ended June 30, 2002 and 2001 4
Unaudited Condensed Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 2002 and 2001 5
Notes to Unaudited Condensed Consolidated Financial Statements 6-12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13-22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22-23
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings Inapplicable
Item 2. Changes in Securities 24
Item 3. Default Upon Senior Securities Inapplicable
Item 4. Submission of Matters to a vote of Security Holders 24
Item 5. Other Information 24-25
Item 6. Exhibits & Reports on Form 8-K 25
CTC COMMUNICATIONS GROUP, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
----------- ------------
ASSETS
Current assets:
Cash and cash equivalents $27,000,035 $66,289,140
Restricted cash - current 1,850,000 550,000
Accounts receivable, net 47,780,669 47,059,065
Prepaid expenses and other current assets 6,551,823 4,762,692
----------- ------------
Total current assets 83,182,527 118,660,897
Property and equipment:
Property and equipment 410,337,482 366,087,446
Accumulated depreciation and amortization (184,164,719) (135,762,149)
------------- -------------
Total property and equipment, net 226,172,763 230,325,297
Restricted cash - noncurrent 5,650,000 6,950,000
Deferred financing costs and other assets 14,323,048 11,502,131
------------- -------------
Total assets $329,328,338 $367,438,325
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses $75,816,144 $58,298,679
Accrued salaries and related taxes 3,513,798 2,995,383
Current portion of obligations
under capital leases (See Note 1 and 3) 67,963,180 33,036,325
Current portion of notes payable
(See Note 1 and 3) 227,623,305 3,354,399
------------- -------------
Total current liabilities 374,916,427 97,684,786
Long term liabilities:
Obligations under capital leases,
net of current portion 30,170,340 60,324,538
Notes payable, net of current portion -- 225,000,000
Other 2,383,706 2,665,710
------------- -------------
Total long term liabilities 32,554,046 287,990,248
Commitments and contingencies
Series B redeemable convertible preferred
stock, par value $1.00 per share:
authorized 10,000,000 shares, 200,000 shares
issued and outstanding at June 30, 2002 and
December 31, 2001, respectively (liquidation
preference $256,531,611 at June 30, 2002) 233,476,331 222,812,360
Stockholders' deficit:
Common stock, par value $0.01 per share;
authorized, 100,000,000 shares, 27,206,681
and 27,103,730 shares issued and outstanding
at June 30, 2002 and December 31, 2001,
respectively 272,067 271,037
Additional paid-in capital 98,000,970 95,528,040
Other accumulated comprehensive loss (2,788,153) (2,886,424)
Retained deficit (407,103,350) (333,961,722)
------------- -------------
Total stockholders' deficit (311,618,466) (241,049,069)
------------- -------------
Total liabilities and
stockholders' deficit $329,328,338 $367,438,325
============= =============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
CTC COMMUNICATIONS GROUP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended For the six months ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---------------------------------------------------------
Telecommunications revenue $81,912,855 $74,512,308 $164,997,799 $142,133,452
Operating costs and expenses:
Cost of telecommunications revenues
(excluding depreciation
and amortization) 60,572,300 59,852,566 123,983,027 115,196,751
Selling, general and administrative
expenses 19,789,990 20,587,956 40,387,157 41,787,722
Depreciation and amortization 24,444,941 17,094,524 48,487,312 33,728,760
----------------------------------------------------------
Total operating costs and expenses 104,807,231 97,535,046 212,857,496 190,713,233
----------------------------------------------------------
Loss from operations (22,894,376) (23,022,738) (47,859,697) (48,579,781)
Other income (expense), net:
Interest income 351,330 541,979 732,763 1,403,328
Interest expense (8,746,880) (5,132,995) (15,350,722) (9,385,954)
----------------------------------------------------------
Total other expense, net (8,395,550) (4,591,016) (14,617,959) (7,982,626)
----------------------------------------------------------
Net loss ($31,289,926) ($27,613,754) ($62,477,656) ($56,562,407)
==========================================================
Net loss available to
common stockholders ($36,729,903) ($32,457,901) ($73,141,627) ($66,161,163)
==========================================================
Net loss per common share:
Basic and Diluted ($1.35) ($1.21) ($2.69) ($2.47)
==========================================================
Weighted average number of common
shares used in computing net loss
per common share:
Basic and Diluted 27,206,681 26,810,572 27,197,007 26,736,549
==========================================================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
CTC COMMUNICATIONS GROUP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended
June 30, June 30,
2002 2001
----------------------------
Cash flows from operating activities:
Net loss ($62,477,656) ($56,562,407)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization 48,487,312 33,728,760
Non-cash interest related to warrants 699,670 429,126
Stock-based compensation -- 26,910
Changes in operating assets and liabilities:
Accounts receivable (793,483) 1,090,568
Prepaid expenses and other current assets (1,533,953) (920,324)
Deferred financing costs and other assets (1,592,399) (150,096)
Accounts payable and accrued expenses 17,517,465 (7,894,238)
Accrued salaries and related taxes 518,415 758,497
-----------------------------
Net cash provided (used) by operating
activities 825,371 (29,493,204)
-----------------------------
Cash flows from investing activities:
Additions to property and equipment (27,815,186) (40,249,319)
Repayments of notes receivable
from stockholders 290,064 5,414,676
Notes receivable from stockholders (545,243) (90,000)
-----------------------------
Net cash used by investing activities (28,070,365) (34,924,643)
-----------------------------
Cash flows from financing activities:
Proceeds from the issuance of common stock 349,176 1,349,237
Borrowings under notes payable -- 25,000,000
Repayment of notes payable (731,094) (812,455)
Repayment of capital lease obligations (11,662,193) (11,074,326)
-----------------------------
Net cash provided (used) by financing
activities (12,044,111) 14,462,456
-----------------------------
Decrease in cash (39,289,105) (49,955,391)
Cash and cash equivalents, beginning of year 66,289,140 80,029,442
-----------------------------
Cash and cash equivalents, end of period $27,000,035 $30,074,051
=============================
Noncash investing and financing activities:
Network and related equipment
under capital leases $16,434,850 $17,025,993
=============================
Accretion of preferred stock $10,663,971 $9,598,756
=============================
Issuance of warrants $2,214,417 --
=============================
The accompanying notes are an integral part of these
consolidated financial statements.
CTC COMMUNICATIONS GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. LIQUIDITY, CAPITAL RESOURCES AND IMPAIRMENT CONSIDERATIONS
Financing Requirements
The current sector and economic environment in which the Company operates
has adversely affected the Company's ability to attract new customers and
expand services provided to existing customers. During the first half of
2002, the telecommunications industry experienced a series of negative
events that has caused many potential customers to delay or reduce their
purchases. Due to these factors, the Company's operating results have not
met its previous estimates and, as a result, the Company will need to raise
additional capital early in the fourth quarter of 2002. In addition, as a
result of these factors, the Company currently believes it is probable it
will not be in compliance with certain of the covenant requirements
(described below) under its debt and vendor financing facilities during the
next 12 months. If this occurs, the Company would be in default and the
lenders under these facilities would have the right to demand immediate
payment of amounts outstanding under these facilities. In addition, our
vendor would no longer be required to advance us additional funds under the
Vendor Financing Facility. The Company has retained a financial advisor,
Miller Buckfire Lewis & Co., LLC, to assist in developing a plan to amend,
restructure or refinance its existing financing facilities and to raise
additional capital. There can be no assurance that additional financing
will be available, or that the Company will be able to amend, restructure or
refinance its financing facilities. In addition, any additional financing,
if obtained, may result in substantial dilution to the Company's common
stockholders. The inability of the Company to raise the needed additional
capital would have a material adverse effect on the operations and business
of the Company. If the Company is unable to raise additional funds and
satisfactorily amend, restructure or refinance its financing facilities, the
Company would need to curtail some or all of its operations and may need to
seek protection under the Federal bankruptcy laws.
Reclassification of Debt
The Company's covenants under its debt and vendor financing facilities (see
Note 3) contemplate quarterly increases in the Company's operating results
in fiscal 2002 compared with 2001. Among other things, these covenants, as
amended, require significant increases in earnings before interest, taxes,
depreciation and amortization (EBITDA), as defined in the Senior Facility
and the Vendor Financing Facility. The Company's ability to remain in
compliance with the covenants is dependent upon the Company's ability to
execute its business plan and improve its operating results. However,
notwithstanding the Company' efforts to remain in compliance by, among other
things, curtailing expenses, the Company currently believes it is probable
it will not be in compliance with certain of the covenant requirements under
its debt and vendor financing facilities during the next 12 months. If this
occurs, the Company will be in default and the lenders would have the right
to demand immediate payment of amounts outstanding under these facilities.
Accordingly, obligations under the Company's debt and vendor financing
agreements have been classified as current liabilities in the accompanying
condensed consolidated balance sheet as of June 30, 2002.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and do not
include all the information and footnote disclosures required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) necessary for the fair presentation have been
included. Operating results for the three and six months ended June 30,
2002 are not necessarily indicative of the results that may be expected for
the fiscal year ending December 31, 2002, as noted below. These statements
should be read in conjunction with the financial statements and related
notes included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2001.
The accompanying unaudited condensed consolidated financial statements have
been prepared assuming that the Company will continue as a going concern,
which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. At June 30, 2002, the Company
has experienced recurring losses from continuing operations and has negative
working capital, and, as discussed above, requires additional capital to
sustain operations and believes it is probable it will not be in compliance
with certain of the covenant requirements under its debt and vendor
financing facilities during the next 12 months. These conditions raise
substantial doubt about the Company's ability to continue as a going
concern. The accompanying unaudited condensed consolidated financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
Recoverability of Long-Lived Assets
If the Company is required to make changes to its business plan to meet the
covenants under its debt and vendor financing facilities, or if present
negative economic trends continue, the Company would be required to re-
evaluate the recoverability of its long-lived assets. The recoverability of
our long-lived assets may also be affected by the continued downward
pressure on our stock price and the evaluation of our business plans during
the capital raising process. Depending on the outcome of these evaluations,
the Company could be required to record impairment charges in future periods
(see Note 2).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Telecommunication revenues primarily relate to customer usage of services
and recurring monthly fees to customers for certain other services.
Revenues related to usage are recognized as usage accrues. Revenues related
to recurring monthly fees are deferred and recognized in the period in which
the service is available to the customer.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" ("SFAS No. 121"), the Company reviews its long-
lived assets, including property and equipment, and identifiable intangibles
for impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be fully recoverable. To determine
recoverability of its long-lived assets, the Company evaluates the
probability that future discounted net cash flows will be less than the
carrying amount of the assets. Impairment is measured at fair value.
Derivatives and Hedging Activities
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities", and its Amendments, FASB Statements Nos. 137 and 138, in June
1999 and June 2000, respectively (collectively, FAS 133). FAS 133 requires
the Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is designated and qualifies as a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives are
either offset against the change in fair value of assets, liabilities, or
firm commitments through earnings (fair value hedge), or, for the effective
portion of the hedge, recorded in other comprehensive income until the
hedged item is recognized in earnings (cash flow hedge). The ineffective
portion of a derivative's change in fair value will be immediately
recognized in earnings. The Company adopted FAS 133 on January 1, 2001. The
adoption of this statement resulted in a cumulative effect adjustment to
other comprehensive income (loss) of $(716,504), (see Note 8).
Cash Flow Hedging Strategy
As required by the Company's credit facility with TD Securities (US) Inc.
(the Senior Facility), the Company maintains an interest rate collar and an
interest rate swap. These instruments hedge the variable rate of interest
due on the Senior Facility. The interest rate collar effectively locks $33
million of the Senior Facility borrowings between 12.25% and 9.67%. The
interest rate swap effectively caps $17 million of the Senior Facility
borrowings at 10.75%. Both the collar and the swap mature on September 22,
2003. In December 2001 and January 2002, the Company entered into two
interest rate cap agreements of 6.5% maturing in October 2003 and September
2003 on $12.5 million and $50 million of the Senior Facility borrowings,
respectively. All of these instruments have been entered into for non-
trading purposes.
During the three and six months ended June 30, 2002, the Company recorded a
loss of $1,406,513 and a gain of $98,271, respectively, in other
comprehensive (loss) for the change in fair value of the collar and swap.
During the three and six months ended June 30, 2001, the Company recorded a
loss of $44,297 and $828,134, respectively, in other comprehensive (loss)
for the change in fair value of the collar and swap. Furthermore, during
the three and six months ended June 30, 2002, the Company reclassified out
of other comprehensive (loss) to interest expense a loss of ($143,626) and a
gain of $149,466, respectively, related to the ineffective portion of the
collar and the swap and a gain of $37,529 and $34,267 for the same periods
related to the collar and the swap excluded from the assessment of hedge
effectiveness. During the three and six months ended June 30, 2001, the
Company reclassified out of other comprehensive (loss) to interest expense a
gain of $1,215 and a loss of $52,942, respectively, related to the
ineffective portion of the collar and the swap and gains of $295,357 and
$122,866 for the same periods related to the collar and the swap excluded
from the assessment of hedge effectiveness.
For the period from January 1, 2002 to December 31, 2002, the Company
expects to reclassify approximately $495,000 of losses on the collar and the
swap from accumulated other comprehensive (loss) to interest expense due to
the payment of variable interest associated with the Senior Facility.
3. FINANCING ARRANGEMENTS
In March 2000, TD Securities (U.S.) Inc. underwrote a $225 million senior
secured credit facility ("Senior Facility") to fund our base plan for
expansion of our branch sales offices and our PowerPath(R) Network. The
proceeds were used to retire the $43 million balance of a $75 million
existing credit facility and to repay in full a $25 million vendor financing
facility. The Senior Facility includes a $50 million senior secured 7-1/2
year revolving credit facility, a $100 million senior secured 7-1/2 year
delayed draw term loan and a $75 million senior secured 8 year term loan.
In March 2002, we amended the agreement covering our Senior Facility to
include new covenant levels as well as an increase in the interest rate
grids. The Senior Facility provides for certain financial and operational
covenants, including but not limited to minimum access lines installed and
billable, minimum quarterly revenue and operating cash flow, and maximum
capital expenditures and other investments. As of June 30, 2002, the
Company is in compliance with all amended covenants. In connection with the
amendment, the bank syndicate will receive common stock warrants, which
could total 3.25% of our outstanding shares of common stock if warrants to
purchase common stock are issued in conjunction with the Company's Vendor
Finance Facility, as discussed in the following paragraph. The issuance,
terms and prices of the warrants are structured in the same manner as the
warrants issuable under the Vendor Finance Facility. As of June 30, 2002,
the full $225 million of the Senior Facility has been utilized. Reference
is made to Exhibit 10.27 filed as part of our Annual Report on Form 10-K for
the year ended December 31, 2001 for a complete description of the amended
Senior Facility.
We have various covenants in our debt and vendor financing facilities. Key
financial covenants at June 30, 2002 and for the remainder of this fiscal
year include:
Quarter Ended
June 2002 September 2002 December 2002
------------ -------------- --------------
Minimum ALEs installed and billed 535,000 555,000 N/A
Minimum Revenue $78,000,000 $84,000,000 N/A
Minimum Consolidated EBITDA $1,500,000 $8,000,000 N/A
Maximum Total Leverage Ratio N/A 10.50:1 6.50:1
Minimum Interest Coverage Ratio N/A 1.00:1 1.50:1
Minimum Unrestricted Cash Balance $25,900,000 $13,100,000 $13,100,000
The Company reported positive EBITDA of $1,550,565 and $627,615 for the 2002
Quarter and 2002 Six Months, respectively. For the quarter ended June 30,
2002, we were in compliance with our covenants.
In March 2002, we entered into an agreement with a vendor ("Vendor Finance
Facility"), which an executive officer thereof is on the Board of Directors
of the Company, which restructures approximately $48 million in outstanding
capital leases. The leases have been restructured into 36-month leases
beginning in February 2002. There will be no principle or interest payments
for the first six months and the leases will then be amortized over the
remaining 30 months. In addition, subject to meeting the conditions for the
financing, we will also receive up to $40 million in capital lease financing
from the finance subsidiary of this vendor for equipment purchases in 2002
available in four separate tranches of $10 million each. These are available
quarterly on the first days of February, May, August and November 2002. For
each new tranche of capital drawn, there are no payments required for the
first six months, and then the leases will be amortized over the next 30
months. This additional capital is dependent upon our compliance with the
conditions in the agreement, including compliance with financial and
operating covenants. These covenants are virtually the same as those in the
amended Senior Facility with an additional covenant relating to minimum
unrestricted cash balance of $25,900,000 at June 30, 2002.
Prior to each tranche period, we must elect to utilize the financing tranche
for that period or decline it and the remaining tranches. If we elect to use
a tranche, we will issue warrants before the beginning of the tranche period
equal to 2% of our outstanding common stock for the first $10 million, 1% of
the then outstanding common stock for each of tranches two and three, and
2.5% of the then outstanding common stock for the fourth tranche. The number
of shares of common stock outstanding for the first tranche was determined
as of January 1, 2002. The second through fourth tranches are determined as
of the first day of the month immediately preceding the first day of the
tranche period. The initial warrants were issued at an exercise price of
$4.10. Subsequent warrants, if issued, would be priced at the average of
our stock price for the period from the 10th to the 14th trading days of the
month during which such warrants are issued.
On February 27, 2002, the company elected to fully utilize the first $10
million tranche of the Vendor Financing Facility, resulting in the issuance
of 542,075 warrants to the vendor and 271,038 warrants to the bank
syndicate, at an exercise price of $4.10. At the date of issuance, these
warrants were valued at approximately $1,488,000 and will be recorded as
interest expense over the remaining term of the facility.
On May 1, 2002, the Company elected to fully utilize the second $10 million
tranche of the Vendor Finance Facility, resulting in the issuance of 272,067
warrants to the vendor and 136,034 to the bank syndicate, at an exercise
price of $2.408. At the date of issuance, these warrants were valued at
approximately $726,000 and will be recorded as interest expense over the
remaining term of the facility.
On August 1, 2002, the Company elected to fully utilize the third $10
million tranche of the Vendor Finance Facility, resulting in the issuance of
272,067 warrants to the vendor and 136,034 to the bank syndicate, at an
exercise price of $2.08. At the date of issuance, these warrants were
valued at approximately $126,511 and will be recorded as interest expense
over the remaining term of the facility.
The aforementioned warrants are subject to anti-dilution adjustments for
certain events.
4. SERIES B PREFFERED STOCK
The conversion ratio for the Series B Preferred Stock is subject to anti-
dilution adjustments for certain events. As a result of the warrants issued
associated with the first tranche of the Vendor Financing Facility, the
conversion ratio associated with the series B Preferred Stock converts into
an additional 50,000 shares of common stock. The fair value associated with
these additional shares, $2,500,000 (as determined at the commitment date),
will be accreted as additional dividends to preferred stock from the date of
issuance of the warrants to the redemption date of the Series B Preferred
Stock.
5. NET LOSS PER COMMON SHARE
The following tables set forth the computation of basic and diluted net loss
per share:
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
----------------------------------------------------------
Numerator:
Net loss ($31,289,926) ($27,613,754) ($62,477,656) ($56,562,407)
Less:
Preferred stock dividends and
accretion to redemption value
of preferred stock (5,439,977) (4,844,147) (10,663,971) (9,598,756)
------------- ------------- ------------- -------------
Numerator for basic and diluted
net loss per share ($36,729,903) ($32,457,901) ($73,141,627) ($66,161,163)
============= ============= ============= =============
Denominator:
Denominator for basic and diluted
net loss per share - weighted
average shares 27,206,681 26,810,572 27,197,007 26,736,549
============= ============= ============= =============
Basic and diluted loss
per common share ($1.35) ($1.21) ($2.69) ($2.47)
============= ============= ============= =============
6. RELATED PARTY TRANSACTIONS
As of December 31, 2001, the Company had advanced funds to certain
stockholders, who are executives and officers, amounting to $1,217,281
evidenced by fully secured promissory notes. These notes bear interest at
10.75%. In February 2002, the Company advanced $545,243, to two executives,
that have been secured fully by promissory notes bearing interest at 10.75%.
During the quarter ended March 31, 2002, $100,000 was repaid. In April and
May 2002, an additional $190,064 was repaid. At June 30, 2002 $1,519,203 of
these loans remains outstanding.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board issued Statement No.
145, "Rescission on FASB Statements 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (FAS 145). Under certain
provisions of FAS 145, gains and losses related to the extinguishment of debt
should no longer be segregated on the income statement as extraordinary items
net of the effects of income taxes. Instead, those gains and losses should
be included as a component of income before income taxes. The provisions of
this statement are effective for the financial statements issued for fiscal
years beginning after May 15, 2002 with early adoption encouraged. Any gain
or loss on the extinguishment of debt that was classified as an extraordinary
item should be reclassified upon adoption. The adoption of FAS 145 is not
expected to have a material impact on our financial position or results of
operations.
In June 2002, the Financial Accounting Standards Board issued Statement No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" (FAS
146) which addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in Restructuring)." This statement requires that a liability
for a cost associated with an exit or disposal activity be recognized when
the liability is incurred. Under Issue 94-3, a liability was recognized at
the date of an entity's commitment to an exit plan. FAS 146 also establishes
that fair value is the objective for initial measurement of the liability.
The provisions of this statement are effective for exit and disposal
activities that are initiated after December 31, 2002, with early application
encouraged. The adoption of FAS 146 is not expected to have a material
impact on our financial position or results of operations.
8. COMPREHENSIVE LOSS
The Company reports comprehensive income (loss) as required by Financial
Accounting Standards Board Statement No. 130, "Reporting Comprehensive
Income," (FAS 130). FAS 130 requires that changes in fair value of the
Company's derivative instruments designated as cash flow hedges, as well as
other certain changes in stockholders' equity, be included in other
comprehensive income (loss). For the three and six months ended June 30, 2002
and 2001, comprehensive loss was as follows:
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
----------------------------------------------------------
Comprehensive loss:
Net loss ($31,289,926) ($27,613,754) ($62,477,656) ($56,562,407)
Cumulative effect of change in
accounting principle --- --- --- (716,504)
(Additions) subtractions to other
comprehensive loss for changes in
fair value of cash flow hedges (1,406,513) (44,297) 98,271 (828,134)
Reclassification from other
comprehensive loss to interest
expense for ineffective portion
and time value of cash flow hedges 106,097 (296,572) (183,733) (69,924)
------------- ------------- ------------- -------------
Comprehensive loss ($32,590,342) ($27,954,623) ($62,563,118) ($58,176,969)
============= ============= ============= =============
Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The discussion below contains certain forward-looking statements related to,
among others, but not limited to, statements concerning future revenues and
future business plans. Actual results may vary from those contained in such
forward-looking statements. The following discussion should be read in
conjunction with the Financial Statements and Notes set forth elsewhere in
this report.
LIQUIDITY, CAPITAL RESOURCES AND IMPAIRMENT CONSIDERATIONS
Financing Requirements
The current sector and economic environment in which the Company operates
has adversely affected the Company's ability to attract new customers and
expand services provided to existing customers. During the first half of
2002, the telecommunications industry experienced a series of negative
events that has caused many potential customers to delay or reduce their
purchases. Due to these factors, the Company's operating results have not
met its previous estimates and, as a result, the Company will need to raise
additional capital early in the fourth quarter of 2002. In addition, as a
result of these factors, the Company currently believes it is probable it
will not be in compliance with certain of the covenant requirements
(described below) under its debt and vendor financing facilities during the
next 12 months. If this occurs, the Company would be in default and the
lenders under these facilities would have the right to demand immediate
payment of amounts outstanding under these facilities. In addition, our
vendor would no longer be required to advance us additional funds under the
Vendor Financing Facility. The Company has retained a financial advisor,
Miller Buckfire Lewis & Co., LLC, to assist in developing a plan to amend,
restructure or refinance its existing financing facilities and to raise
additional capital. There can be no assurance that additional financing
will be available, or that the Company will be able to amend, restructure or
refinance its financing facilities. In addition, any additional financing,
if obtained, may result in substantial dilution to the Company's common
stockholders. The inability of the Company to raise the needed additional
capital would have a material adverse effect on the operations and business
of the Company. If the Company is unable to raise additional funds and
satisfactorily amend, restructure or refinance its financing facilities, the
Company would need to curtail some or all of its operations and may need to
seek protection under the Federal bankruptcy laws.
Reclassification of Debt
The Company's covenants under its debt and vendor financing facilities (see
Note 3 to the unaudited condensed consolidated financial statements)
contemplate quarterly increases in the Company's operating results
in fiscal 2002 compared with 2001. Among other things, these covenants, as
amended, require significant increases in earnings before interest, taxes,
depreciation and amortization (EBITDA), as defined in the Senior Facility
and the Vendor Financing Facility. The Company's ability to remain in
compliance with the covenants is dependent upon the Company's ability to
execute its business plan and improve its operating results. However,
notwithstanding the Company' efforts to remain in compliance by, among other
things, curtailing expenses, the Company currently believes it is probable
it will not be in compliance with certain of the covenant requirements under
its debt and vendor financing facilities during the next 12 months. If this
occurs, the Company will be in default and the lenders would have the right
to demand immediate payment of amounts outstanding under these facilities.
Accordingly, obligations under the Company's debt and vendor financing
agreements have been classified as current liabilities in the accompanying
condensed consolidated balance sheet as of June 30, 2002.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and do not
include all the information and footnote disclosures required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) necessary for the fair presentation have been
included. Operating results for the three and six months ended June 30,
2002 are not necessarily indicative of the results that may be expected for
the fiscal year ending December 31, 2002, as noted below. These statements
should be read in conjunction with the financial statements and related
notes included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2001.
The accompanying unaudited condensed consolidated financial statements have
been prepared assuming that the Company will continue as a going concern,
which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. At June 30, 2002, the Company
has experienced recurring losses from continuing operations and has negative
working capital, and, as discussed above, requires additional capital to
sustain operations and believes it is probable it will not be in compliance
with certain of the covenant requirements under its debt and vendor
financing facilities during the next 12 months. These conditions raise
substantial doubt about the Company's ability to continue as a going
concern. The accompanying unaudited condensed consolidated financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
Recoverability of Long-Lived Assets
If the Company is required to make changes to its business plan to meet the
covenants under its debt and vendor financing facilities, or if present
negative economic trends continue, the Company would be required to re-
evaluate the recoverability of its long-lived assets. The recoverability of
our long-lived assets may also be affected by the continued downward
pressure on our stock price and the evaluation of our business plans during
the capital raising process. Depending on the outcome of these evaluations,
the Company could be required to record impairment charges in future periods
(see Note 2 to the unaudited condensed consolidated financial statements).
OVERVIEW
We are a growing single-source provider of voice, data and Internet
communications services, or integrated communications provider, with 18
years of marketing, sales and service experience. We target predominantly
medium and larger-sized business customers who seek greater capacity for
voice and data traffic, a single provider for their telecommunications
requirements and improved levels of service. We have a large, experienced
sales force consisting of 149 account executives supported by 197 network
coordinators as of June 30, 2002. Our sales force is located close to our
customers in 25 sales branches primarily in the Northeast and Mid-Atlantic
states.
We are currently operating our own state-of-the-art network facilities to
carry telecommunications traffic. Our PowerPath(R) Network uses packet-
switching, a technology that transmits data in discrete packages. It uses
Internet protocol (IP), which is a method that allows computers with
different architectures and operating systems to communicate over the
Internet, and asynchronous transfer mode, or ATM, architecture, which
permits the network to transmit multiple types of media, such as voice, data
and video with various levels of Quality of Service, or QOS. The first
phase of our network, which became operational for full production mode in
January 2000, included 22 Cisco Systems, or Cisco, advanced data switches
and two network operations centers. Presently, we are interconnecting our
facilities with a combination of our owned fiber facilities and leased
transmission capacity over fiber optic cable strands from Level 3
Communications and NorthEast Optic Network. The remaining leased
transmission services will gradually be replaced by our fiber links, which
we own following our investment in fiber strands through Williams
Communications and other regional and metro fiber carriers. We have
selected Cisco to provide the Wavelength Digital Multiplexing (WDM) and
SONET technology to activate or light up the fiber and complete a highly
competitive, scalable and secure fiber transport infrastructure. Cisco has
reviewed and certified our network design and has designated our network as
a Cisco Powered Network.
In May 1999, we began testing our network with some of our customers and in
September 1999, we initiated commercial service. As of June 30, 2002 we
were servicing more than 6,000 customer locations with PowerPath(R) access
across the Northeast and Mid-Atlantic states. In December 2000, we announced
completion of a successful Class-4/5 pilot phase using a softswitch from
Telcordia Technologies. The softswitch technology integrated with our
PowerPath(R) Network allows us to deliver both local and long distance voice
services using a Voice over IP (VoIP) packet based network.
We became an integrated communications provider, or ICP, in January 1998.
Prior to that, based on agency revenues, we were the largest independent
sales agent for NYNEX Corp. and then Bell Atlantic (now Verizon). At the
end of 1997, before withdrawing from the Verizon agency program, we were
managing relationships for approximately 7,000 customers, representing over
280,000 local access lines and over $200 million in annual local
telecommunications spending. As of June 30, 2002, after only 54 months as
an integrated communications provider, we were serving over 15,000 customers
and had 615,000 access lines and equivalent circuits, or ALEs. ALEs are the
total number of voice circuits and equivalent data circuits we have in
service. Voice circuits are the actual number of voice circuits purchased by
our Customers. Equivalent data circuits represent the data transmission
capacity purchased by our customers divided by 64 kilobits per second, which
is the capacity necessary to carry one voice circuit.
Our Services
We offer the following services:
Local Telephone Services
We offer connections between our customers' telecommunications equipment and
the local telephone network which we lease from incumbent phone companies in
most instances. For large customers or customers with specific
requirements, we integrate their private systems with analog or digital
connections. We also provide all associated call processing features as well
as continuously connected private lines for voice interconnectivity between
separate facilities. We are now actively engaged in activating local dial
tone services using the Company's PowerPath(R) Network through the use of
softswitch technology developed by Telcordia Technologies. We will continue
to rollout local dial tone services market by market throughout 2002 as an
addition to our existing converged product portfolio. We also offer local
telephone services through resale of the incumbent local exchange carrier
(ILEC) service.
Long Distance Telephone Services
We offer a full range of domestic and international long distance services,
including "1+" outbound calling, inbound toll free service, and standard and
customized calling plans. We also offer related services such as calling
cards, operator assistance and conference calling.
High Speed Data Services
We offer a wide array of high-speed data services. Our portfolio includes
Frame Relay as well as point-to-point solutions from 56kbps to 45mbps.
Internet Services
We have built an extensive IP network infrastructure for our PowerPath(R)
Network. We became registered as an official Internet Service Provider, or
ISP, in 2000, which enabled us to deliver Internet access to our customers
as part of our PowerPath(R) Network converged services offering. We launched
our iMail web based email product during the summer of 2000 and plan to
further expand this offering to include unified messaging services. We
provide the necessary configuration support and other network support
services on a 24-hour, 7-day a week basis. We offer Internet access from 56k
to 45mbps to our business customers.
Hosting Solutions
We provide our customers with shared and dedicated Web Hosting services as
well as Internet/WAN Collocation services all based from our Advanced
Technology Center (ATC) in Waltham, MA. Our ATC is a multifunctional Data
Center that supports all CTC Hosting Solutions, a PowerPath(R) Supernode
configuration, and will host future PowerPath(R) Managed Services. The ATC is
a 50,000 square foot state of the art facility equipped with redundant and
fault tolerance systems that ensure ongoing service 24 hours per day, 7 days
per week, 365 days per year.
CTC currently supports over 200 Web Hosting customers and 20 Collocation
customers.
In 2002 we began to offer Storage Area Network (SAN) service and Data Tape
Backup, Archive and Recovery service and Managed Firewall service for our Web
Hosting and Collocation customers. These services have been designed and
released to support our customers' growing E-Business and Disaster Recovery
(rapid recovery/Business Continuity (continuous systems uptime) requirements.
We are also engaged in further analysis and potential development of
PowerPath(R) Managed services that would create the potential of increasing
the average revenue per PowerPath(R) user. These future services include:
managed firewall and intrusion detection, managed
router/switch/OS/applications, network attached storage, remote tape backup,
archiving and recovery, Unified Messaging and IP Telephony services.
Results of Operations - Three and Six Months Ended June 30, 2002
Compared to the Three and Six Months Ended June 30, 2001
Total revenues for the quarter ended June 30, 2002 ("2002 Quarter") were
$81,912,855, as compared to $74,512,308 for the quarter ended June 30, 2001
("2001 Quarter"), or an increase of 9.9%. Total revenues for the six months
ended June 30, 2002 ("2002 Six Months") were $164,997,799 as compared to
$142,133,452 for the six months ended June 30, 2001 ("2001 Six Months") or
an increase of 16.1%. The 2002 Quarter revenues also represented a slight
decrease of 1.4% from the revenues of $83,084,944 for the quarter ended
March 31, 2002. We have added approximately 79,600 access lines since the
quarter ending June 30, 2001 resulting in the increase in revenue due to the
addition of access line equivalents (ALEs) for both new and existing
customer relationships.
A common basis for measurement of an integrated communications provider's
progress is the growth in ALEs. ALEs are the total number of voice circuits
and equivalent data circuits we have in service. Voice circuits are the
actual number of voice circuits purchased by our customers. We calculate
our equivalent data circuits by dividing the data transmission capacity
purchased by our customers by 64 kilobits per second, which represents the
capacity necessary to carry one voice circuit. ALEs in service increased by
79,600, or approximately 14.9%, since June 30, 2001. This increase is a
result of ALEs from new customers and growth from existing customers. This
brought total ALEs in service to 615,000 at June 30, 2002.
Costs of telecommunications revenues, excluding depreciation, for the 2002
Quarter were $60,572,300, as compared to $59,852,566 for the 2001 Quarter;
and were $123,983,027 for the 2002 Six Months as compared to $115,196,751
for the 2001 Six months. As a percentage of telecommunications revenues,
cost of telecommunications revenues was 73.9% for the 2002 Quarter and 75.1%
for the 2002 Six Months, as compared to 80.3% for the 2001 Quarter and 81.0%
for the 2001 Six Months. The decrease in the percentage of the cost of the
telecommunications revenues primarily reflects the migration of new and
existing customers onto our PowerPath? Network and the increased use of our
own lower cost fiber facilities.
Selling expense consists of the costs of providing sales and other support
services for customers including salaries, commissions and bonuses to sales
force personnel. General and administrative expense consists of the costs
of the billing and information systems and personnel required to support our
operations and growth.
For the 2002 Quarter, selling, general and administrative expenses (SG&A)
decreased 3.9% to $19,789,990 from $20,587,956 for the 2001 Quarter; and for
the 2002 Six Months decreased 3.4% to $40,387,157 from $41,787,722 for the
2001 Six Months. The decrease in SG&A from the 2001 Quarter and 2001 Six
Months is due to the decision to limit our expansion and leverage our
current branch infrastructure. For the 2002 Quarter and 2002 Six Months,
SG&A expenses were 24.2% and 24.5%, respectively, of total revenue as
compared to 27.6% and 29.4% of total revenue for the 2001 Quarter and 2001
Six Months.
As of June 30, 2002, we employed 712 people including 149 account executives
and 197 network coordinators in branch locations throughout the Northeast
and Mid-Atlantic states as compared to 676 employees at June 30, 2001.
Depreciation and amortization expense increased to $24,444,941 in the 2002
Quarter from $17,094,524 for the 2001 Quarter; and increased to $48,487,312
in the 2002 Six Months from $33,728,760 for the 2001 Six Months. This
increase was a result of additional expenses associated with the equipment
and software relating to the network deployment and the upgrade of our
information systems. Network equipment and software is being depreciated
over 2-5 years, reflecting the risk of rapid technological change.
Other expense, net, increased by 82.9% to $8,395,550 for the 2002 Quarter
and increased by 83.1% to $14,617,959 for the 2002 Six Months from the same
periods in 2001. Interest expense increased due to the increase in
borrowings required in connection with the deployment of our network,
working capital requirements, funding our operating losses and issuance of
warrants. The increase is further affected by a decrease in interest income
due to lower invested cash balances throughout the quarter.
As a result of the above factors, the net losses totaled to $31,289,926 and
$62,477,656 for the 2002 Quarter and 2002 Six Months, respectively and net
losses totaled to $27,613,754 and $56,562,407 for the 2001 Quarter and 2001
Six Months, respectively.
Liquidity and Capital Resources
Working deficit at June 30, 2002 was ($291,733,900) compared to working
capital of $20,976,111, at December 31, 2001, a decrease of $312,710,011,
which was used to fund our operating losses, capital expenditures and
capital lease payments. In addition, approximately $35,287,014 of capital
lease obligations and $221,062,500 notes payable were reclassified from long
term to current liabilities as discussed in Note 1 to the unaudited condensed
consolidated financial statements. Cash balances at June
30, 2002 and December 31, 2001 totaled $27,000,035 and $66,289,140,
respectively. The Company has entered into an equipment lease financing
arrangement that restricts $7.5 million of cash as security for this
arrangement.
Since September 30, 1998, we have entered into various lease and vendor
financing agreements which provide for the acquisition of equipment and
software. As of June 30, 2002, the aggregate amount borrowed under these
agreements was approximately $157.4 million with an outstanding balance of
approximately $98.1 million.
In May 2000, the Company increased its working capital from the net proceeds
realized from a $200 million preferred stock financing with Bain Capital
Inc. ($75 million), Thomas H. Lee Partners, L.P. ($75 million) and CSFB
Private Equity ($50 million). The investment consists of 8.25% Series B
redeemable convertible preferred stock which converts into our common stock
at $50 per share at any time of the option holder. The Company may require
conversion of the preferred shares if the common stock of the Company
reaches certain levels. The Company may elect to redeem the preferred shares
on the fifth anniversary of the closing and all outstanding shares of
preferred stock must be redeemed or converted by May 2010. The net proceeds
from the sale of the Series B redeemable preferred stock are being used to
fund strategic marketing and technology initiatives of our business plan
which include the purchase of dark fiber and optronics, PowerPath(R) Network
expansion and new PowerPath(R) Network product and applications development.
In March 2000, TD Securities (U.S.) Inc. underwrote a $225 million senior
secured credit facility ("Senior Facility") to fund our base plan for
expansion of our branch sales offices and our PowerPath(R) Network. The
proceeds were used to retire the $43 million balance of a $75 million
existing credit facility and to repay in full a $25 million vendor financing
facility. The Senior Facility includes a $50 million senior secured 7-1/2
year revolving credit facility, a $100 million senior secured 7-1/2 year
delayed draw term loan and a $75 million senior secured 8 year term loan.
In March 2002, we amended the agreement covering our Senior Facility to
include new covenant levels as well as an increase in the interest rate
grids. The Senior Facility provides for certain financial and operational
covenants as described below. As of June 30, 2002, the Company is in
compliance with all the amended covenants however see Note 1
to the unaudited condensed consolidated financial statements. In connection
with the amendment, the bank syndicate will receive common stock warrants,
which could total 3.25% of our outstanding shares of common stock if
warrants to purchase common stock are issued in conjunction with the
Company's Vendor Finance Facility, as discussed below. The issuance, terms
and prices of the warrants are structured in the same manner as the warrants
issuable under the Vendor Finance Facility. As of June 30, 2002, the full
$225 million of the Senior Facility has been utilized.
As previously disclosed, we have various covenants in our debt and vendor
financing facilities. Key financial covenants at June 30, 2002 and for the
remainder of this fiscal year include:
Quarter Ended
June 2002 September 2002 December
2002
------------ -------------- ------------
- --
Minimum ALEs installed and billed 535,000 555,000 N/A
Minimum Revenue $78,000,000 $84,000,000 N/A
Minimum Consolidated EBITDA $1,500,000 $8,000,000 N/A
Maximum Total Leverage Ratio N/A 10.50:1 6.50:1
Minimum Interest Coverage Ratio N/A 1.00:1 1.50:1
Minimum Unrestricted Cash Balance $25,900,000 $13,100,000 $13,100,000
The Company reported positive EBITDA of $1,550,565 and $627,615 for the 2002
Quarter and 2002 Six Months, respectively. For the quarter ended June 30,
2002, we were in compliance with our covenants.
The Company's covenants under its debt and vendor financing facilities (see
Note 3 to the unaudited condensed consolidated financial statements)
contemplate quarterly increases in the Company's operating results
in fiscal 2002 compared with 2001. Among other things, these covenants, as
amended, require significant increases in earnings before interest, taxes,
depreciation and amortization (EBITDA), as defined in the Senior Facility
and the Vendor Financing Facility. The Company's ability to remain in
compliance with the covenants is dependent upon the Company's ability to
execute its business plan and improve its operating results. However,
notwithstanding the Company' efforts to remain in compliance by, among other
things, curtailing expenses, the Company currently believes it is probable
it will not be in compliance with certain of the covenant requirements under
its debt and vendor financing facilities during the next 12 months. If this
occurs, the Company will be in default and the lenders would have the right
to demand immediate payment of amounts outstanding under these facilities.
Accordingly, obligations under the Company's debt and vendor financing
agreements have been classified as current liabilities in the accompanying
condensed consolidated balance sheet as of June 30, 2002.
In March 2002, we entered into an agreement with a vendor ("Vendor Finance
Facility"), which an executive officer thereof is on the Board of Directors
of the Company, which restructures approximately $48 million in outstanding
capital leases. The leases have been restructured into 36-month leases
beginning in February 2002. There will be no principle or interest payments
for the first six months and the leases will then be amortized over the
remaining 30 months. In addition, subject to meeting the conditions for the
financing, we will also receive up to $40 million in capital lease financing
from the finance subsidiary of this vendor for equipment purchases in 2002
available in four separate tranches of $10 million each. These are available
quarterly on the first days of February, May, August and November 2002. For
each new tranche of capital drawn, there are no payments required for the
first six months, and then the leases will be amortized over the next 30
months. This additional capital is dependent upon our compliance with the
conditions in the agreement, including compliance with financial and
operating covenants. These covenants are virtually the same as those in the
amended Senior Facility with an additional covenant relating to minimum
unrestricted cash balance. As discussed in Note 1 to the unaudited
condensed consolidated financial statements, there are no assurances
that tranche 4 will be made available to the Company.
Prior to each tranche period, we must elect to utilize the financing tranche
for that period or decline it and the remaining tranches. If we elect to use
a tranche, we will issue warrants before the beginning of the tranche period
equal to 2% of our outstanding common stock for the first $10 million, 1% of
the then outstanding common stock for each of tranches two and three, and
2.5% of the then outstanding common stock for the fourth tranche. The number
of shares of common stock outstanding for the first tranche is determined as
of January 1, 2002. The second through fourth tranches are determined as of
the first day of the month immediately preceding the first day of the
tranche period. The initial warrants will be issued at an exercise price of
$4.10. Subsequent warrants, if issued, would be priced at the average of
our stock price for the period from the 10th to the 14th trading days of the
month during which such warrants are issued.
On February 27, 2002, the company elected to fully utilize the first $10
million tranche of the Vendor Financing Facility, resulting in the issuance
of 542,075 warrants to the vendor and 271,038 warrants to the bank
syndicate, at an exercise price of $4.10. At the date of issuance, these
warrants were valued at approximately $1,488,000 and will be recorded as
interest expense over the remaining term of the facility.
On May 1, 2002, the Company elected to fully utilize the second $10 million
tranche of the Vendor Finance Facility, resulting in the issuance of 272,067
warrants to the vendor and 136,034 to the bank syndicate, at an exercise
price of $2.408. At the date of issuance, these warrants were valued at
approximately $726,000 and will be recorded as interest expense over the
remaining term of the facility.
On August 1, 2002, the Company elected to fully utilize the third $10
million tranche of the Vendor Finance Facility, resulting in the issuance of
272,067 warrants to the vendor and 136,034 to the bank syndicate, at an
exercise price of $2.08. At the date of issuance, these warrants were
valued at approximately $126,511 and will be recorded as interest expense
over the remaining term of the facility.
The aforementioned warrants are subject to anti-dilution adjustments for
certain events.
The conversion ratio for the Series B Preferred Stock is subject to anti-
dilution adjustments for certain events. As a result of the warrants issued
associated with the first tranche of the Vendor Financing Facility, the
conversion ratio associated with the series B Preferred Stock converts into
an additional 50,000 shares of common stock. The fair value associated with
these additional shares, $2,500,000 (as determined at the commitment date),
will be accreted as additional dividends to preferred stock from the date of
issuance of the warrants to the redemption date of the Series B Preferred
Stock.
We will continue to use the balance of the proceeds realized from the Senior
Facility and the Series B redeemable convertible preferred stock financing
for general corporate purposes including, capital expenditures, working
capital and operating losses associated with the continued deployment of our
network, further penetration of our existing region throughout the Northeast
and Mid-Atlantic states. Until utilized, the net proceeds from the Senior
Facility and Series B redeemable convertible preferred stock financing are
being invested in short-term, interest-bearing instruments and other
investment-grade securities.
Please see opening section in Management's Discussion and Analysis of
Financial Condition and Results of Operations for current discussion
of Liquidity, Capital Resources and Impairment Considerations.
Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board issued Statement No.
145, "Rescission on FASB Statements 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (FAS 145). Under certain
provisions of FAS 145, gains and losses related to the extinguishment of
debt should no longer be segregated on the income statement as extraordinary
items net of the effects of income taxes. Instead, those gains and losses
should be included as a component of income before income taxes. The
provisions of this statement are effective for the financial statements
issued for fiscal years beginning after May 15, 2002 with early adoption
encouraged. Any gain or loss on the extinguishment of debt that was
classified as an extraordinary item should be reclassified upon adoption.
The adoption of FAS 145 is not expected to have a material impact on our
financial position or results of operations.
In June 2002, the Financial Accounting Standards Board issued Statement No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" (FAS
146) which addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in Restructuring)." This statement requires that a liability
for a cost associated with an exit or disposal activity be recognized when
the liability is incurred. Under Issue 94-3, a liability was recognized at
the date of an entity's commitment to an exit plan. FAS 146 also
establishes that fair value is the objective for initial measurement of the
liability. The provisions of this statement are effective for exit and
disposal activities that are initiated after December 31, 2002, with early
application encouraged. The adoption of FAS 146 is not expected to have a
material impact on our financial position or results of operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to financial risk, including changes in interest rates, relates
primarily to outstanding debt obligations. We utilize our senior secured
credit facility to fund a substantial portion of our capital requirements.
This facility bears interest at a variable interest rate, which is subject
to market changes. Our earnings are affected by changes in short-term
interest rates as a result of our borrowings under the Senior Facility. The
Senior Facility interest payments are determined by the outstanding
indebtedness and the LIBOR rate at the beginning of the period in which
interest is computed. As required under the Senior Facility, we utilize
interest rate swap and collar agreements to hedge variable rate interest
risk on 50% of the Senior Facility. All of our derivative financial
instrument transactions are entered into for non-trading purposes.
Notional amounts outstanding at June 30, 2002 subject to the interest 12.25%
and 9.67% rate collar is $33 million, with an expected maturity date in the
year 2003. The interest rate collar effectively locks $33 million of our
Senior Facility borrowings between
Notional amount outstanding at June 30, 2002 subject to the interest rate
swap is $17 million, with an expected maturity date in the year 2003. The
interest rate swap effectively caps $17 million of our Senior Facility
borrowings at 10.75%.
In December 2001 and January 2002, we entered into two additional interest
rate cap agreements of 6.5% maturing in October 2003 and September 2003 on
$12.5 million and $50 million of borrowings, respectively.
For purposes of specific risk analysis we use sensitivity analysis to
determine the impacts that market risk exposure may have on the fair value
of our outstanding debt obligations. To perform sensitivity analysis, we
assess the risk of loss in fair values from the impact of hypothetical
changes in interest rates on market sensitive instruments, considering the
hedge agreements noted above. We compare the market values for interest
risk based on the present value of future cash flows as impacted by the
changes in the rates. We selected discount rates for the present value
computations based on market interest rates in effect at June 30, 2002. We
compared the market values resulting from these computations with the market
values of these financial instruments at June 30, 2002. The differences in
the comparison are the hypothetical gains or losses associated with each
type of risk. As a result of our analysis we determined at June 30, 2002,
with respect to our variable rate debt obligations, a 10% increase in
interest rates with all other variables held constant would result in
increased interest expense and cash expenditures for interest of
approximately $368,000 for the quarter ended June 30, 2002. A 10% decrease
in interest rates would result in reduced interest expense and cash
expenditures of approximately $92,000 and for the same period taking into
consideration the interest rate collar as noted.
For purposes of specific risk analysis we use sensitivity analysis to
determine the impacts that market risk exposure may have on the fair value
of our outstanding fixed rate redeemable convertible preferred stock. To
perform sensitivity analysis, we assess the risk of loss in fair values from
the impact of hypothetical changes in dividend rates on market sensitive
instruments. We compare the market values for dividend risk based on the
present value of future cash flows as impacted by the changes in the rates.
We selected discount rates for the present value computations based on
market dividend rates in effect at June 30, 2002. We compared the market
values resulting from these computations with the market values of these
financial instruments at June 30, 2002. The differences in the comparison
are the hypothetical gains or losses associated with each type of risk. As a
result of our analysis we determined at June 30, 2002, with respect to our
fixed rate redeemable convertible preferred stock, a 10% increase in
dividend rates with all other variables held constant would result in
increased dividends of approximately $491,000 for the quarter ended June 30,
2002. A 10% decrease in dividend rates would result in reduced dividends of
approximately $491,000 for the same period.
Part II
Item 2. Changes in Securities
(c) On May 1, 2002, in connection with the Company's election to utilize the
second tranche of $10 million of the Vendor Finance Facility provided by
Cisco, we issued (i) a seven-year warrant to purchase 272,067 shares of our
common stock at an exercise price of $2.408 per share to Cisco Systems
Capital Corp. and (ii) seven-year warrants to purchase an aggregate of
136,034 shares of our common stock at an exercise price of $2.408 per share
to the Toronto Dominion (Texas) Inc. and the other Lenders under the TD
Credit Facility.
Reference is made to the disclosure set forth in the "Liquidity and Capital
Resources" section of Part I, Item 2 (Management's Discussion and Analysis
of Financial Condition And Results Of Operations) as part of this Quarterly
Report on Form 10-Q, Exhibit 10.1 filed as part of our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2002 and Exhibit 10.27 filed as
part of our Annual Report on Form 10-K for the year ended December 31, 2001
for a complete description of the transactions described above.
All of the warrants were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as
amended, as transactions by an issuer not involving a public offering.
Item 4 - Submission of Matters to a Vote of Security Holders
(a) The 2002 Annual Meeting of Stockholders of the Company was held
on May 23, 2002.
(b) Not applicable.
(c) Each nominee for Class II director received the following votes:
Name Votes For Withheld
- ---------------------------------------------------------------
Richard J. Murphy 23,859,955 127,559
Mark E. Nunnelly 23,847,154 140,359
Richard J. Santagati 23,876,419 111,094
The following table sets forth the other matters voted upon and the
respective number of votes cast for, against, number of abstentions and
broker nonvotes.
Matter Votes Votes Delivered
Voted Upon For Against Abstentions Non Voted
- ---------------------------------------------------------------------------------
To approve the amendment
to the 2000 Flexible
Stock Plan 22,152,601 1,735,786 99,126 -
To approve the amendment
to the 1999 Equity
Incentive Plan for
Non-Employee Directors 22,264,513 1,695,043 27,957 -
To approve the retention
of Ernst & Young LLP as
independent accountants 23,890,276 82,434 14,803 -
(d) Not applicable.
Item 5. Other Information
The Company has been informed by Nasdaq that its common stock will be
delisted from The Nasdaq National Market at the opening of business on August
20, 2002, due to the Company's failure to comply with the minimum bid price
for continued listing as set forth in Nasdaq Marketplace Rule 4450(b)(4).
Nasdaq has also advised the Company that it does not meet the continued
listing standard for the Nasdaq SmallCap Market in accordance with Nasdaq
Marketplace Rule 4310(c)(2)(B).
Upon the Nasdaq delisting, the Company's common stock will be traded in the
over-the-counter market in the so-called "pink sheets" or on the OTC Bulletin
Board.
Item 6 - Exhibits and Reports on Form 8-K
(a) The following exhibits are included herein:
10.1 Seven-year warrant issued May 1, 2002 to Cisco Systems Capital Corp. to
purchase 272,067 shares at $2.408 per share
99.1 Certification pursuant to Section 906 of Corporate Fraud Accountability
Act of 2002
99.2 Risk Factors
Per Instruction 2 to Item 601 of Regulation S-K and as disclosed in Part II,
Item 2 of this Report, the following Schedule sets forth the list of Warrants
we issued on May 1, 2002 pursuant to the terms of the TD Credit Facility,
which contain identical terms as the warrant filed as Exhibit 10.1 hereto
except for the name of the warrantholder and number of shares issuable upon
exercise of the warrant.
Name of Warrantholder No. of Shares Issuable Upon Exercise of Warrant
- --------------------- ------------------------------------------------
TORONTO DOMINION (TEXAS) INC. 48,367
ING (U.S.) CAPITAL LLC 15,115
CREDIT SUISSE FIRST BOSTON 24,184
LB 1 GROUP INC. 24,184
CISCO SYSTEMS, INC. 15,115
RFC CAPITAL CORPORATION 3,023
IBM CREDIT CORPORATION 6,046
(b) Reports on Form 8-K
We filed the following reports on Form 8-K during the quarter ended
June 30, 2002
Date Items Reported
------- --------------------------------------------------------
1. April 16, 2002 Announcement that over 100 customers have been
activating using our Inverse Multiplexing over
ATM solution.
2. April 24, 2002 Announcement that we have surpassed the milestone
of over 1,000,000 minutes of voice traffic per day.
3. April 30, 2002 Announcement of first quarter operating highlights.
4. May 15, 2002 Announcement of receipt of certificate of
registration for the PowerPath(R) service mark.
5. May 29, 2002 Announcement that we now offer local dial tone
service on our PowerPath(R) Network in Albany NY.
6. June 14, 2002 Report on recent presentations to stockholders
and investors.
7. June 18, 2002 Announcement that we now offer local dial tone
service on our PowerPath(R) Network in Syracuse NY.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
behalf by the undersigned thereunto duly authorized.
CTC COMMUNICATIONS GROUP, INC.
Date: August 14, 2002 /S/ ROBERT J. FABBRICATORE
----------------------------
Robert J. Fabbricatore
Chairman and CEO
Date: August 14, 2002 /S/ JOHN D. PITTENGER
-----------------------------
John D. Pittenger
Executive Vice President,
and Chief Financial
Officer