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 December 31, 1998.
Commission File Number 0-13627.
CTC COMMUNICATIONS CORP.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2731202
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
360 Second Avenue, 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 February 12, 1998, 10,306,458 shares of Common Stock were outstanding.
<PAGE>
CTC COMMUNICATIONS CORP.
FORM 10-Q
INDEX
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Part I FINANCIAL STATEMENTS PAGE NO.
Item 1. Financial Statements
Condensed Balance Sheets
as of December 31 and March 31, 1998 3
Condensed Statements of Operations
Three Months Ended December 31, 1998 and 1997 4
Condensed Statements of Operations
Nine Months Ended December 31, 1998 and 1997 5
Condensed Statements of Cash Flows
Nine Months Ended December 31, 1998 and 1997 6
Notes to Condensed Financial Statements 7-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-20
Item 3. Quantitative and Qualitative Inapplicable
Disclosures About Market Risk
Part II OTHER INFORMATION
Item 1. Legal Proceedings Inapplicable
Item 2. Changes in Securities 21
Item 3. Default Upon Senior Securities Inapplicable
Item 4. Submission of Matters to a
Vote of Security Holders 21
Item 5. Other Information Inapplicable
Item 6. Exhibits and Reports on Form 8-K 22
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In addition to historical information, this Quarterly Report on Form 10-Q
contains forward-looking statements made in good faith by the Company
pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995 including, but not limited to, those
statements regarding the successful implementation of the Company's business
plan, availability of additional financing if required, the ability to
improve operational, financial and management information systems, future
profitability, the timing and success of the expansion and deployment of
facilities, future operations and availability of capital and other future
plans, events and performance and other statements located elsewhere herein.
The forward-looking statements contained herein are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those reflected in the forward-looking statements. Factors that might
cause such a difference include, but are not limited to, those outlined in
Exhibit 99.1 filed with this Quarterly Report. Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management's analysis as of the date hereof. The Company undertakes no
obligation to publicly revise these forward-looking statements to reflect
events or circumstances that arise after the date hereof.
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CTC COMMUNICATIONS CORP.
CONDENSED BALANCE SHEETS
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<CAPTION>
December 31, March 31,
1998 1998
--------------- ---------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 2,597,116 $ 2,167,930
Accounts receivable, net 26,462,861 17,288,183
Prepaid expenses and other current assets 8,839,184 3,029,069
------------- -------------
Total Current Assets 37,899,161 22,485,182
Furniture, Fixtures and Equipment 37,889,161 13,376,970
Less accumulated depreciation (10,197,683) (6,837,683)
------------- -------------
Total Equipment 25,441,118 6,539,287
Deferred income taxes 0 1,834,000
Other assets 4,188,531 108,885
------------- -------------
Total Assets $ 67,528,810 $ 30,967,354
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Accounts payable and accrued expenses $ 29,088,014 $ 8,958,476
Accrued salaries and related taxes 2,342,299 756,159
Current portion of obligations under
capital leases 1,312,621 231,796
Current portion of note payable to bank 0 1,196,400
------------- -------------
Total Current Liabilities 32,742,934 11,142,831
Obligations under capital leases,
net of current portion 4,671,226 1,114,277
Notes payable, net of current portion 35,958,287 7,130,671
Series A redeemable convertible preferred stock 12,561,573 0
Stockholders' Equity (Deficit)
Common stock 102,911 99,806
Additional paid in capital 6,960,212 5,245,704
Deferred Compensation (238,910) (318,410)
Retained-earnings (deficit) (25,063,598) 6,688,300
------------- -------------
(18,239,385) 11,715,400
Amounts due from stockholders (165,825) (135,825)
------------- -------------
Total Stockholders' Equity (Deficit) (18,405,210) 11,579,575
------------- -------------
Total Liabilities and
Stockholders' Equity (Deficit) $ 67,528,810 $ 30,967,354
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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CTC COMMUNICATIONS CORP.
CONDENSED STATEMENTS OF OPERATIONS
Three Months Ended
December 31, December 31,
1998 1997
------------- -------------
Telecommunications revenues $ 19,024,531 $ 3,535,540
Commission revenues 0 7,620,106
-------------- -------------
Total revenues 19,024,531 11,155,646
Costs and expenses:
Cost of telecommunications revenues 16,429,094 2,940,001
Selling, general and administrative
expenses 14,303,425 7,381,233
-------------- -------------
30,732,519 10,321,234
-------------- -------------
Income (loss) from operations (11,707,988) 834,412
Other:
Interest income 12,405 29,274
Interest expense (1,207,914) (11,908)
Other 3,472 9,222
-------------- -------------
(1,192,037) 26,588
Income (loss) before income taxes (12,900,025) 861,000
Provision (benefit) for income taxes (903,000) 355,000
-------------- -------------
Net income (loss) $ (11,997,025) $ 506,000
============== =============
Net income (loss) per common share:
Basic $ (1.20) $ 0.05
============== =============
Diluted $ (1.20) $ 0.05
============== =============
Weighted average number of common shares :
Basic 10,260,932 9,917,361
============== =============
Diluted 10,260,932 11,078,771
============== =============
The accompanying notes are an integral part of these financial statements.
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CTC COMMUNICATIONS CORP.
CONDENSED STATEMENTS OF OPERATIONS
Nine Months Ended
December 31, December 31,
1998 1997
-------------- -------------
Telecommunications revenues $ 46,376,407 $ 10,078,325
Commission revenues 0 24,581,370
-------------- -------------
Total revenues 46,376,407 34,659,695
Costs and expenses:
Cost of telecommunications revenues 40,425,994 8,095,086
Selling, general and administrative
expenses 36,799,882 21,370,033
-------------- -------------
77,225,876 29,465,119
-------------- -------------
Income (loss) from operations (30,849,469) 5,194,576
Other:
Interest income 183,237 126,212
Interest expense (2,608,890) (22,135)
Other 36,473 14,348
-------------- -------------
(2,389,180) 118,425
Income (loss) before income taxes (33,238,649) 5,313,001
Provision (benefit) for income taxes (2,327,000) 2,189,000
-------------- -------------
Net income (loss) $ (30,911,649) $ 3,124,001
============== =============
Net income (loss) per common share:
Basic $ (3.15) $ 0.32
============== =============
Diluted $ (3.15) $ 0.29
============== =============
Weighted average number of common shares :
Basic 10,080,465 9,856,079
============== =============
Diluted 10,080,465 10,824,001
============== =============
The accompanying notes are an integral part of these financial statements.
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CTC COMMUNICATIONS CORP.
CONDENSED STATEMENTS OF CASH FLOWS
Nine Months Ended
December 31, December 31,
1998 1997
------------- -------------
OPERATING ACTIVITIES
Net income (loss) $(30,911,649) $ 3,124,001
Adjustments to reconcile net income to
net cash (used) by operating activities:
Depreciation and amortization 3,699,173 750,000
Stock compensation expense 79,500 0
Warrants expense 210,926 0
Changes in noncash working capital items:
Accounts receivable (9,174,678) (6,475,864)
Other current assets (3,976,115) (352,378)
Other assets (3,198,072) 3,600
Accounts payable 20,129,538 1,008,833
Accrued liabilities 1,586,140) (527,093)
Accrued taxes 0 (224,518)
Deferred revenue 0 (6,588)
------------- -------------
Net cash (used) by operating activities (21,555,237) (2,700,007)
INVESTING ACTIVITIES
Additions to equipment (17,436,552) (4,556,428)
------------- -------------
Net cash used in investing activities (17,436,552) (4,556,428)
FINANCING ACTIVITIES
Proceeds from notes payable 27,631,216 1,846,073
Proceeds from the issuance of redeemable
preferred stock 11,861,321 0
Repayments under capital leases (187,505) 0
Proceeds from the issuance of common stock 115,943 106,170
------------- -------------
Net cash provided by financing activities 39,420,975 1,952,243
Increase (decrease) in cash 429,186 (5,304,192)
Cash at beginning of year 2,167,930 6,405,670
------------- -------------
Cash and cash equivalents at end of period $ 2,597,116 $ 1,101,478
============= =============
The accompanying notes are an integral part of these financial statements.
6
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CTC COMMUNICATIONS CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The accompanying condensed 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 generally accepted accounting
principles for complete financial statements. In the opinion of management all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation have been included. Operating results for the three and nine
months ended December 31, 1998 are not necessarily indicative of the results
that may be expected for the fiscal year ending March 31, 1999. 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 March 31, 1998.
NOTE 2: COMMITMENTS AND CONTINGENCIES
(a) Pending Legal Proceedings.
Lawsuit Against Bell Atlantic. In December 1997, the Company terminated
its agency contract and filed suit against Bell Atlantic in Federal District
Court for breach of contract, including the failure of Bell Atlantic's retail
division to pay $14 million in agency commissions (approximately $11.5 million
as of December 31, 1998) owed to the Company. The Company also asserted
violations by Bell Atlantic of the antitrust laws and Telecommunications Act.
Bell Atlantic filed counterclaims asserting that the Company breached a
provision of the agency contract prohibiting the Company from selling non-Bell
Atlantic local services to certain agency customers for a one year period
following termination of the contract. Based on that provision, Bell Atlantic
obtained a TRO, which prohibited the Company from marketing certain local
telecommunications services to any Bell Atlantic customer for whom the Company
was responsible for account management, or to whom the Company sold Bell
Atlantic services in 1997. In July of 1998, the Federal District Court in
Portland, Maine ruled that the TRO was improperly issued and dissolved it.
The Company's position that it should have full access to market and sell
local services to all customers it served as an agent was affirmed by the
Court. Bell Atlantic did not appeal this decision. The Company is currently
marketing local services to those customers. Trial commenced in February 1999
with respect to the Company's law suit against Bell Atlantic for breach of
contract and violations of the Telecommunications Act and antitrust laws and
is currently in progress.
(b) State Regulatory Proceedings
In response to complaints filed by the Company, the Commonwealth of
Massachusetts, Department of Telecommunications and Energy ("DTE"), the New
York Public Service Commission, the New Hampshire Public Utilities Commission,
the Maine Public Utilities Commission and the Rhode Island Public Utilities
Commission each ruled that Bell Atlantic's rescinding of its long standing
policy of permitting resellers, including the Company, to assume the service
contracts of retail customers under contract to Bell Atlantic without contract
termination fees violates state law on contract assignment. Certain of the
states also cited violations of the resale agreement between the Company and
Bell Atlantic and Section 251 of the Telecommunications Act (which provides
that ILECs have a duty not to prohibit, and not to impose unreasonable or
discriminatory conditions or limitations on, the resale of telecommunications
service that the carrier provides at retail to subscribers who are not
telecommunications carriers).
7
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The DTE has granted Bell Atlantic a stay of its decision based on
procedural grounds and agreed to reconsider its earlier decision. Hearings on
this issue have also been held in Vermont, but to date, no decision has been
rendered.
The Company is otherwise party to suits arising in the normal course of
business which management believes are not material individually or in the
aggregate.
NOTE 3. PREFERRED STOCK
On April 10, 1998, the Company issued for investment to Spectrum Equity
Investors II, L.P. ("Spectrum") and certain other private investors (together
with Spectrum, the "Investors") an aggregate of 666,666 shares of Series A
Convertible Preferred Stock (the "Preferred Shares") for $12 million, pursuant
to the terms and conditions of a Securities Purchase Agreement among the
Company and the Investors. The Company also issued for investment to the
Investors five-year warrants to purchase an aggregate of 133,333 shares of its
Common Stock at an exercise price of $9.00 per share. Spectrum purchased
98.63% of the Preferred Shares and warrants in the private placement. On the
date of issuance, the Preferred Shares were convertible into 1,333,333 shares
of the Company's Common Stock at $9.00 per share, which conversion ratio is
subject to certain adjustments. Reference is made to the Company's Report on
Form 8-K and exhibits thereto dated and filed on May 15, 1998 for a complete
description of the transaction.
NOTE 4. CISCO VENDOR FINANCING FACILITY
On October 14, the Company obtained three-year vendor financing facility for
up to $25 million with Cisco Capital Corp. Under the terms of the agreement,
the Company has agreed to a three year, $25 million volume purchase commitment
of Cisco Systems equipment and services and Cisco Capital Corp has agreed to
advance funds as these purchases occur. In addition, a portion of the Cisco
facility can be utilized for working capital costs associated with the
integration and operation of Cisco Systems solutions and related peripherals.
Pursuant to the terms of the Cisco Vendor Financing Agreement dated as of
October 14, 1998, the Company has agreed to give the Lender a senior security
interest in all products provided to the Company by Cisco and other products
purchased with the proceeds of the first $15 million advanced under the
facility and a subordinate security interest in all other assets of the
Company. Under the terms of the facility, the Company is required to pay
interest on funds advanced under the facility at an annual rate of 12.5%. In
addition, the Company is required to pay a commitment fee of .50% per annum on
any unused amounts under the facility and certain other fees. As of February
16, 1999, the Company had borrowed $11.5 million under the facility.
Reference is made to the Company's Current Report on Form 8-K and the
agreement filed as an exhibit thereto filed on October 14, 1998 for a complete
description of the transaction.
NOTE 5 GOLDMAN SACHS/FLEET FINANCING
As of September 1, 1998, the Company as Borrower, entered into a Loan and
Security Agreement with Goldman Sachs Credit Partners L.P. and Fleet National
Bank as Lenders. Under the terms of the Loan and Security Agreement, the
Lenders have provided a three-year senior secured credit facility to the
Company consisting of revolving loans in the aggregate amount of up to $75
million (the "Credit Facility"). Advances under the facility bear interest at
1.75% over the prime rate and are secured by a first priority perfected
security interest on all of the Company's assets, provided, however, that the
Company has the ability to exclude assets acquired through purchase money
financing. In addition, the Company is required to pay a commitment fee of
8
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0.5% per annum on any unused amounts under the facility as well as a monthly
line fee of $150,000 per month. The Company may borrow $15 million
unconditionally and $60 million based on trailing 120 days accounts receivable
collections (reducing to the trailing 90 days of collections by March 31,
2000). The Company paid a one-time up front fee of $2,531,250, representing 3
3/8% of the facility. In the event that the Company wishes to prepay the
loan, the agreement provides for a prepayment penalty of 2% during the first
18 months of the term of the loan. Warrants to purchase an aggregate of
974,412 shares of the Company's common stock at an purchase price of $6.75 per
share were issued to the Lenders in connection with the transaction. The
Company has valued the Warrants at $1.3 million which is being amortized and
included in interest expense over the three-year term of the Loan and Security
Agreement. As of February 16, 1999, the Company had availability under the
Credit Facility of $42.4 million and had borrowed approximately $35 million as
of that date.
NOTE 6. NET INCOME PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share".
Statement 128 replaced the previously reported primary and fully
diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants, and convertible securities.
Diluted earnings per share is very similar to the previously reported
fully diluted earnings per share. All earnings per share amounts for
all periods have been presented, and where necessary, restated to
conform to the Statement 128 requirements.
The following table sets forth the computation of basic and diluted
net income per share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31
1998 1997 1998 1997
------------------------- --------------------------
Numerator:
<S> <C> <C> <C> <C>
Net income (loss) (11,997,025) 506,000 (30,911,649) 3,124,001
Accretion to redemption value on
redeemable preferred stock (302,200) 0 (840,252) 0
Numerator for basic net income (loss)
per share and diluted net income ------------------------ --------------------------
(loss) per share (12,299,225) 506,000 (31,751,901) 3,124,001
========================= ==========================
Denominator:
Denominator for basic net income (loss)
per share-weighted average shares 10,260,832 9,917,361 10,080,465 9,856,079
Effect of dilutive securities:
Employee stock options 0 1,161,410 0 967,922
Denominator for diluted net income ------------------------- --------------------------
(loss) per share-weighted-average shares 10,260,932 11,078,771 10,080,465 10,824,001
========================== ==========================
Basic net income (loss) per share (1.20) 0.05 (3.15) 0.32
========================== ==========================
Diluted net income (loss) per share (1.20) 0.05 (3.15) 0.29
========================== ==========================
</TABLE>
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NOTE 7 INCOME TAXES
The provision (benefit) for income taxes is less than the statutory rate
based upon management's assessment of the realizability of net operating
losses. The benefit is recognized ratably during the year based on the
relationship of amounts recoverable and management's estimate of the total
loss for the fiscal year ending March 31, 1999. The effective rate of the
benefit may vary with changes in management's estimates.
10
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Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Financial Statements and Notes set forth elsewhere in this Report.
OVERVIEW
CTC Communications Corp. (the "Company"), a Massachusetts corporation, is a
rapidly growing integrated communications provider ("ICP") with 15 years of
local telecommunications marketing, sales and service experience. The
Company offers local, long distance, Internet access, Frame Relay and other
data services on a single integrated bill. CTC currently serves
predominantly medium-sized business customers in seven Northeastern states
through its experienced 172-member direct sales force and 95 customer care
representatives located in 25 branch offices throughout the region.
Prior to becoming an ICP in January 1998, the Company was the oldest and
largest independent sales agent for Nynex Corp. (acquired by Bell Atlantic
in August 1997), selling local telecommunications services as an agent
since 1984. The Company has also offered long distance and data services
under its own brand name since 1994. In late 1997, the Company became
certified as a Competitive Local Exchange Carrier ("CLEC") in New York and
the six New England states in order to embark upon its ICP strategy and
take advantage of market opportunities created by deregulation. In
December 1997, the Company terminated its agency agreement with Bell
Atlantic and began ICP operations in January 1998. As an ICP, the Company
is utilizing its well-developed infrastructure and the same relationship-
centered sales approach that it employed as an agent without the
limitations on potential customers, services and pricing that were imposed
upon it as an agent.
Over the next three years, the Company plans to expand within its existing
markets and into six additional states in the Boston-Washington, D.C.
corridor and add network facilities.
In January 1999, the Company began deploying phase I of its state-of-the-
art, packet-switched Integrated Communications Network ("ICN"), which the
Company believes will enable it to improve margins, enhance customer
control and broaden service offerings. The ICN is an advanced Asynchronous
Transfer Mode (ATM)-based network, using Cisco Systems, Inc. ("Cisco")
BPX(r) 8600 series and MGX(tm) 8800 series IP+ATM wide-area switches, that
will deliver enhanced access services such as traditional dedicated
services, frame relay, IP, video and circuit emulation transport services.
The Company believes that its ICN will ultimately enable it to deliver
voice and data services across a single multi-service dedicated connection
that is expected to lower customers' overall telecommunications costs and
stimulate demand for new bandwidth intensive services. The phase 1
installation includes 22 switching sites in the Company's existing markets
in New York and New England and is scheduled to be completed in the Spring
of 1999 ("Phase 1"). Beginning in April 1999, the Company is scheduled to
begin transitioning selected customers on-net for full beta testing. The
Company expects that it will begin transitioning its broader customer base
on-net in the Summer of 1999.
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The Phase 1 switching hubs will be interconnected by leased transmission
facilities from Level 3 Communications, LLC ("Level 3") and NorthEast Optic
Network, Inc. ("NEON"). The initial transmission infrastructure will
consist of three self-healing SONET-based, fiber optic rings covering the
southern, western and eastern New England regions. This advanced SONET
technology, which permits full circuit redundancy and route diversity, will
allow CTC to take advantage of dense wave division multiplexing ("DWDM") to
meet increasing customer demands for reliable, high bandwidth voice, data
and video connectivity. The Company has also arranged to co-locate its
switching hubs in Level 3 and NEON points of presence buildings ("POPs")
along selected fiber routes.
The Company intends to access its customer locations with leased broadband
connectivity such as T-1, xDSL, wireless technologies or fiber optic
facilities where they are available. Initially, the Company will offer
dedicated long distance and data services over the ICN and will continue to
lease local dialtone capabilities through the existing physical connection
to the incumbent LEC until these services can be cost effectively
integrated into a packet-switched network architecture. Given the revenue
mix and size of the customers CTC is targeting for on-net services, the
Company believes that it will be capable of transitioning approximately 70%
of such average target customer's revenue stream on-net without integrating
local dialtone into its network. Based on ongoing research and development
activities at Cisco and other telecom equipment suppliers, the Company
believes that it will be able to incorporate local dialtone functionality
into its packet-switching architecture within the next 24 months. By
continuing to lease local dialtone capabilities during this interim period,
the Company will avoid the significant capital requirements associated with
circuit switching architectures and it will be able to offer ubiquitous
service in its target markets. Furthermore, this network strategy
initially will enable the Company to significantly simplify the
transitioning of existing customers on-net since a disconnection from the
incumbent LEC and reconnection to CTC will not be required. In
transitioning CTC customers on-net, the Company will simply be required to
reprogram a customer's PABX and/or WAN routers to direct long distance and
data traffic to the CTC broadband connection to the ICN. This strategy will
also allow customers to retain their existing phone numbers as well as have
the built in redundancy of the separate physical connection to the
incumbent LEC.
Prior to deploying the ICN, the Company is building its base of installed
access lines through reselling the network services of other
telecommunications carriers to targeted customers who can later be
transitioned "on-net.".
The Company bills its customers for local and long distance usage based on
the type of local service utilized, the number, time and duration of calls,
the geographic location of the terminating phone numbers and the applicable
rate plan in effect at the time of the call.
During the period in which the Company resells the services of other
telecommunications carriers prior to deploying its ICN, cost of services
includes the cost of local and long distance services charged by carriers
for recurring charges, per minute usage charges and feature charges, as
well as the cost of fixed facilities for dedicated services and special
regional calling plans. Following the deployment of the ICN, the cost of
services for "on-net" customers will include the leasing costs associated
with transmission, co-location and access facilities as well as the
depreciation charges associated with the Company's switching equipment.
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Selling expense consists of the costs of providing sales and other support
services for customers including salaries, commissions and bonuses to
salesforce personnel. General and administrative expense consists of the
costs of the billing and information systems and personnel required to
support the Company's operations and growth as well as all amortization
expenses. Depreciation is allocated throughout sales, marketing, general
and administrative expense based on asset ownership.
The Company has experienced significant growth in the past and, depending
on the extent of its future growth, may experience significant strain on
its management, personnel and information systems. To accommodate this
growth, the Company intends, subject to the availability of adequate
financing, to continue to implement and improve operational, financial and
management information systems. Since implementing its ICP strategy, the
Company has expanded its staff to include three additional senior
executives and 82 additional employees. The Company is also expanding its
information systems to provide improved recordkeeping for customer
information and management of uncollectible accounts and fraud control.
Historically, the Company's network service revenues have consisted of
commissions earned as an agent of Bell Atlantic and other RBOCs and since
1994, revenues from the resale of long distance, frame relay, Internet
access and other communications services. For the fiscal year ended March
31, 1998, agency commissions accounted for approximately 60% of network
service revenues with resale revenues accounting for 40% of such revenues.
As a result of the transition to an ICP strategy in December 1997, agency
commissions earned in the future will not be material.
13
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RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED DECEMBER 31, 1998 AS
COMPARED TO THE THREE AND NINE MONTHS ENDED DECEMBER 31, 1997.
The results for the quarter ended December 31, 1998 reflect the Company's
operations as an Integrated Communications Provider ("ICP"). In its
capacity as an independent agent for the Regional Bell Operating Companies
(RBOCs), the Company recorded revenues which represented the fees and
commissions earned by the Company for sales of products and services to
business customers. As an ICP, the Company purchases local services from
the RBOCs at a discount to the retail rate, and resells and bills these
services to business customers. The Company also resells other services
including long distance, Internet access, and various data services in
order to provide a total integrated telecommunications solution to its
customers on a single integrated bill. The Company will continue reselling
telecommunications services until the deployment of its Integrated
Communications Network ("ICN"), at which point the Company will begin
migrating customers onto its own network.
Total revenues for the third fiscal quarter were $19,025,000, as compared
to $11,156,000 for the same period of the preceding Fiscal year, or an
increase of 71%. Total revenues for the nine months ended December 31,
1998 were $46,376,000, as compared to $34,660,000, or an increase of 34%.
The December quarter revenues also represented an increase of 31% over the
September 1998 quarter revenues of $14,516,000. Revenues for local,
Internet access and data services increased a combined 55% on a sequential
quarter basis due primarily to the addition of new customer relationships.
A common basis for measurement of an ICP's progress is the growth in access
line equivalents ("ALEs"). During the quarter ended December 31, 1998, the
Company provisioned 38,878 net access line equivalents, bringing the total
lines in service to 103,272 for the Company's first year as an ICP. Net
lines provisioned during the quarter ended December 31, 1998 represented a
61% sequential increase over net lines provisioned during the quarter ended
September 30, 1998. The Company experienced the strongest growth in data
ALEs with an approximately 67% sequential increase from the quarter ended
September 1998, which brings data ALEs in service to 19,638, or 19% of
total ALEs as of December 31, 1998.
Costs of telecommunications revenues for the quarter ended December 31,
1998 were $16,429,000, as compared to $2,940,000 for the same period of the
preceding Fiscal year. For the nine months ended December 31, 1998, costs
of telecommunications revenues were $40,426,000, as compared to $8,095,000
for the same period of the preceding Fiscal year. Since substantially all
revenues since January 1, 1998 have resulted from operations as ICP,
comparative numbers on a year to year basis are not relevant. As a
percentage of telecommunications revenues, cost of telecommunications
revenues was 86% for the quarter ended December 1998, as compared to 85%
for the quarter ended September 1998. The decrease in gross margin is due
primarily to the Company's non-resale revenue declining as a percentage of
total revenue. Excluding the effects of the non-resale revenue, the gross
margin due to resale revenue remained unchanged from the quarter ended
September 1999.
For the quarter ended December 31, 1998, selling, general and
administrative expenses (SG & A) increased 94% to $14,303,000 from
$7,381,000 for the same period of the preceding fiscal year. For the nine
months ended December 31, 1998, SG & A expenses were $36,800,000, as
14
<PAGE>
compared to $21,370,000, or an increase of 72%. These increases were due
to the opening of additional branch sales offices during the nine months
ended December 31, 1998 and the associated increased number of sales and
service employees hired in connection with the transition to the ICP
platform. As of December 31, 1998, the Company employed 389 people
including 172 Account Executives and 95 Network Coordinators in 25 branch
locations throughout New England and New York. In addition, SG & A
expenses increased due to operating expenses associated with the network
build out, as well as an additional $1,400,000 of increased depreciation
expense in the third fiscal quarter and an additional $2,600,000 of
depreciation expense year-to-date associated with the investments in the
Integrated Communications Network. The final component of the increase is
related to legal and regulatory activities. Legal expenses in prosecuting
both the anti-trust action against Bell Atlantic now pending in the federal
courts and the state regulatory proceedings instituted in each of the New
England States against Bell Atlantic for discriminatory practices regarding
the Bell Atlantic policy of imposing contract termination fees on its
customers as well as the regulatory expenses incurred in obtaining
certification as a reseller in additional states, were $813,000 and
$3,444,000 respectively, for the three and nine months ended December 31,
1998.
Interest and other expense increased to $1,200,000 and $2,400,000,
respectively, for the three and nine months ended December 31, 1998. The
increase is due to increased borrowings to fund the Company's losses and
the investment in the Integrated Communications Network, the fees
associated with the Company's credit facility and vendor financing
facility, and the amortization of the interest expense associated with the
warrants issued to the Company's lenders under the credit facility.
The benefit for income taxes has been booked ratably as a percentage of the
Company's estimated pre-tax loss over each of the four quarters of the
fiscal year. The effective rate of the benefit may vary with changes in
management's estimates.
As a result of the above factors, the net loss was $11,997,000 and
$30,912,000, respectively, for the three and nine months ended December 31,
1998.
Liquidity and Capital Resources
Working capital at December 31, 1998 amounted to $5,156,000 as compared to
$11,342,000 at March 31, 1998, a decrease of 55%, due to an increase in
accounts payable resulting from approximately $8,000,000 of fixed assets
purchased during the quarter that were not yet funded under the Company's
Vendor Financing Facility. These assets were funded during the fourth
quarter of fiscal 1999, thereby reducing accounts payable and increasing
notes payable by $8,000,000. This was partially offset by a
reclassification of deferred income taxes of $1,834,000 from non-current
assets to current assets to more accurately reflect its present status.
Cash balances at December 31, 1998 and March 31, 1998 totaled approximately
$2,597,000 and $2,167,000, respectively.
15
<PAGE>
Historically, the Company funded its working capital and operating
expenditures primarily from cash flow from operations. As a result of Bell
Atlantic's failure to pay approximately $14 million in agency commissions
(currently approximately $11.5 million) that the Company believes it is
owed under its agency contract (the "Bell Atlantic Receivable"), the losses
incurred following transition to an ICP strategy, and the investment
required to implement the Integrated Communications Network, the Company
has been required to raise additional capital. Although the Company has
sued Bell Atlantic and believes the collection of the agency commissions is
probable, there is no assurance that the Company will be successful in its
collection efforts or that such collections will not be delayed. If the
Company fails to collect any of the agency commissions or if their
collection becomes less than probable, the Company would be required to
write off the uncollected amounts reflected in its financial statements or
amounts for which collection becomes less than probable. Delay in the
collection or write-off of agency commissions may adversely affect the
Company.
In April 1998, the Company completed a $12 million private placement of
Series A Convertible Preferred Stock and Warrants to Spectrum. Also, on
June 30, 1998 the Company received a commitment from Spectrum (the
"Spectrum Commitment") to purchase, at the Company's option, an additional
$5 million of preferred stock on the same terms and conditions as the
Series A Convertible Preferred Stock, which option extends until June 30,
1999.
On September 1, 1998, the Company entered into the Loan and Security
Agreement (the "Credit Facility") with Goldman Sachs Credit Partners L.P.
("GSCP") and Fleet National Bank ("Fleet") (GSCP and Fleet are together,
the "Lenders"). Under the terms of the Credit Facility, the Lenders have
provided a three-year senior secured credit facility to the Company
consisting of revolving loans in the aggregate amount of up to $75 million.
Advances under the facility bear interest at 1.75% over the prime rate and
are secured by a first priority perfected security interest on all of the
Company's assets, provided, however, that the Company has the ability to
exclude assets acquired through purchase money financing. In addition, the
Company is required to pay a commitment fee of 0.5% per annum on any unused
amounts under the facility as well as a monthly line fee of $150,000 per
month. The Company may borrow $15 million unconditionally and an
additional $60 million based on trailing 120 days accounts receivable
collections (reducing to the trailing 90 days of collections by March 31,
2000). The Company paid a one-time up front fee of $2,531,250,
representing 3 3/8% of the facility. In the event that the Company wishes
to prepay the loan, the agreement provides for a prepayment penalty of 2.0%
during the first 18 months of the term of the loan. Warrants to purchase
an aggregate of 974,412 shares of the Company's common stock at a purchase
price of $6.75 per share were issued to the Lenders in connection with the
transaction. The Company has valued the warrants at $1.3 million which is
being amortized and included in interest expense over the three-year term
of the Credit Facility. . As of February 16, 1999, the Company had
availability under the Credit Facility of $42.4 million and had borrowed
approximately $35 million as of that date.
In connection with the receipt of the commitment from Toronto Dominion
(Texas), Inc. ("TD") (described below), the Company expects that the
Lenders will agree to amend certain covenants under the Credit Facility
(the "Credit Facility Amendment"). The closing of the Credit Facility
Amendment would be subject to various conditions, including the execution
of a satisfactory intercreditor agreement with TD (as defined below).
16
<PAGE>
On October 14, 1998, the Company entered into an agreement (the "Vendor
Facility" and, together with the Credit Facility, the "Senior Facilities")
with Cisco System Capital Corporation ("Cisco Capital") for up to $25
million of vendor financing. Under the terms of the agreement, the Company
has agreed to a three year, $25 million volume purchase commitment of Cisco
equipment and services and Cisco Capital has agreed to advance funds as
these purchases occur. In addition, a portion of the Vendor Facility can
be utilized for working capital costs associated with the integration and
operation of Cisco solutions and related peripherals. Under the terms of
the Vendor Facility, the Company is required to pay interest on funds
advanced under the facility at an annual rate of 12.5%. In addition to
other amounts, the Company is required to pay a commitment fee of .50% per
annum on any unused amounts under the facility. The Company paid a closing
fee of 1% of the total Vendor Facility. As of February 16, 1999, the
Company had borrowed $11.5 million under the Vendor Facility.
Pursuant to the terms of the Senior Facilities, the Company obtained an
Intercreditor Agreement dated as of September 1, 1998 between Fleet, as
Agent, Cisco Capital and Cisco Systems, Inc. Under the Intercreditor
Agreement, the Company has agreed to give Cisco Capital a senior security
interest in all products provided to the Company by Cisco and other
products purchased with the proceeds of the first $15 million advanced
under the facility and a subordinate security interest in all other assets
of the Company.
The Company expects to utilize the proceeds of the Vendor Facility to
deploy the first phase of its data-centric ICN in 22 network hub and node
sites within the New York and New England regions.
Since September 30, 1998, the Company has entered into various lease and
vendor financing agreements which provide for the acquisition of up to
$16.2 million of equipment and software.
In order to ensure that the Company has sufficient liquidity even in the
event the Bell Atlantic Receivable is not collected or collection is unduly
delayed, on February 12, 1999, the Company obtained a commitment (the "TD
Commitment") from Toronto Dominion (Texas), Inc. ("TD") to provide an
unsecured standby credit facility for up to $30 million for capital
expenditures and other general corporate purposes (the "TD Facility"). The
closing of the TD Facility and subsequent draws under the facility are
subject to customary conditions, including the execution of definitive
documentation, receipt of the Credit Facility Amendment, and execution of a
satisfactory intercreditor agreement with the lenders under the Senior
Facilities.
Under the terms of the TD Commitment, $10 million would be immediately
available and the remaining $20 million would become available if the
Company raises an additional $5 million in proceeds from the issuance of
common or preferred equity (which could be satisfied by calling the
Spectrum Commitment), which equity requirement would be reduced by any
proceeds received as a result of the Company's litigation with Bell
Atlantic in excess of $10 million. The Company will be required to pay
certain commitment fees on closing of the TD Facility with additional
commitment fees payable if the TD Facility is still outstanding on the
dates six months, nine months and one year after the closing. In addition,
the Company would be required to pay a quarterly availability fee on
unfunded amounts as well as a funding fee for any draws. Draws under the
TD Facility would initially bear interest at 7.00% over the three-month US
17
<PAGE>
Dollar deposit LIBOR rate and would increase quarterly thereafter. The TD
Facility matures 15 months after the closing. Under the terms of the TD
Commitment, the Company would be required to repay draws with the proceeds
from subsequent issuances of equity or debt securities or from subsequent
bank financings.
Over the next three years the Company has outstanding commitments
ggregating $11.6 million to Level 3 Communications, LLC and NorthEast Optic
Network, Inc. for the leasing of transmission and co-location facilities
for its ICN pursuant to agreements entered into by the Company in January
1999.
Over the next 12 months, the Company intends to (i) further exploit its
existing markets, (ii) deploy the ICN in its existing markets, and (iii)
enhance the CTC Information System. Over the next three years, subject to
the availability of financing, the Company intends to further expand within
its existing markets and into six additional states in the New York-
Washington, D.C. corridor and continue the deployment of its ICN.
The Company believes that the net proceeds of the anticipated TD Facility
and the Spectrum Commitment, together with cash on hand and the anticipated
availability under the Senior Facilities will be sufficient to fund the
Company's capital expenditures, operating losses and working capital
requirements for its existing markets for approximately the next 12 months
even in the event the Company is unsuccessful or delayed in collecting the
Bell Atlantic Receivable. The Company expects to seek additional long-term
financing to refinance the anticipated TD Facility and further fund its
business plan within the next 3-6 months, capital markets permitting. After
the Company has raised sufficient long-term financing to further fund its
business plan, the Company expects to repay and terminate the TD Facility.
The availability of additional borrowings under the Credit Facility is
based on prior receivable collections and subject to complying with the
various covenants of such facility. There can be no assurance that
additional amounts will be available to the Company when needed or at all.
The Company will require substantial additional funding to continue its
penetration of, and deployment of its ICN in, its existing markets and to
implement the Company's planned geographic expansion of its sales presence
and ICN infrastructure into the New York-Washington D.C. corridor. The
Company's actual capital requirements may be materially affected by various
factors, including the timing and actual cost of implementing the Company's
ICN, the timing and costs of expansion into new markets, the extent of
competition and pricing of telecommunications services in its markets,
acceptance of the Company's services, technological change and potential
acquisitions.
Partly as a result of (i) Bell Atlantic rescinding its policy permitting
assignment of existing contracts to CLECs like the Company (including the
negative affect on the borrowing base under the Credit Facility which has
resulted from delays in deriving revenue from previous agency customers -
See Note 2b, "State Regulatory Proceedings"), (ii) the continuing delay in
collecting the Bell Atlantic Receivable and (iii) greater than anticipated
capital expenditures, if the TD Facility is not consummated and the Bell
Atlantic Receivable is not collected, the Company will need to obtain
additional financing, beyond the proceeds of the Spectrum Commitment, in
the first or second fiscal quarter of fiscal year 2000. If the Company
does not enter into the Credit Facility Amendment, the Company may not
remain in compliance with certain operational covenants under the Credit
18
<PAGE>
Facility, depending upon, among other factors, the Company's success in
deriving revenue from its former agency customers.
Sources of funding may include public offerings or private placements of
equity or debt securities, vendor financing, equipment lease financing and
bank loans. There can be no assurance that additional financing will be
available to the Company or, if available, that it can be obtained on a
timely basis and on terms acceptable to the Company and within the
limitations contained in the Senior Facilities and agreements governing
other debt issued by the Company from time to time. Failure to obtain
financing when needed would result in the delay or abandonment of the
Company's development and expansion plans which would in turn have a
material adverse effect on the Company.
YEAR 2000 COMPLIANCE
Currently, many computer systems and software products are coded to accept
only two digit, rather than four digit, entries in the date code field.
Date-sensitive software or hardware coded in this manner may not be able to
distinguish a year that begins with a "20" instead of a "19," and programs
that perform arithmetic operations, make comparisons or sort date fields
may not yield correct results with the input of a Year 2000 date. This
Year 2000 problem could cause miscalculations or system failures that would
affect the Company's operations.
The Company's State of Readiness
The Company has evaluated the effect of the Year 2000 problem on its
information systems and is implementing plans to ensure its systems and
applications will effectively process information necessary to support
ongoing operations of the Company in the year 2000 and beyond. The Company
believes its information technology ("IT") and non-IT systems will be Year
2000 compliant by the end of 1999.
In connection with the deployment of the Company's new Integrated
Communications Network ("ICN"), the Company has designed a new database
architecture for its computer systems which will comply with "Year 2000"
requirements. Installation of the ICN and related software is expected to
be completed in June 1999 and testing of the system, including its Year
2000 compliance, is expected to commence in May 1999. While the Company
expects that all significant IT-related systems will be Year 2000 compliant
by mid-1999, there can be no assurance that all Year 2000 problems in the
new system will be identified or that the necessary corrective actions will
be completed in a timely manner.
The Company has requested certification from its significant vendors and
suppliers demonstrating their Year 2000 compliance. To date, approximately
60% of vendors and suppliers have delivered such certifications and the
Company anticipates that it will receive the additional certifications
requested. The Company intends to continuously identify critical vendors
and suppliers and communicate with them about their plans and progress in
addressing Year 2000 problems. There can be no assurance that the systems
of these vendors and suppliers will be timely converted or that the failure
to so comply will not have an adverse effect on the Company's operations.
19
<PAGE>
The Company's Costs of Year 2000 Remediation
The Company has not incurred material costs related specifically to Year
2000 issues and does not expect to in the future. However, there can be no
assurance that the costs associated with Year 2000 problems will not be
greater than anticipated.
The Company's Year 2000 Risk
Based on the efforts described above, the Company currently believes that
its systems will be Year 2000 compliant in a timely manner. The Company has
completed the process of identifying Year 2000 issues in its IT and non-IT
systems and expects to complete any remediation efforts by mid-1999.
However, there can be no assurance that all Year 2000 problems will be
successfully identified, or that the necessary corrective actions will be
completed in a timely manner. Failure to successfully identify and
remediate Year 2000 problems in critical systems in a timely manner could
have a material adverse effect on the Company's results of operations,
financial position or cash flow.
In addition, the Company believes that there is risk relating to
significant vendors' and suppliers' failure to remediate their Year 2000
issues in a timely manner. Although the Company is communicating with its
vendors and suppliers regarding the Year 2000 problem, the Company does not
know whether these vendors' or suppliers' systems will be Year 2000
compliant in a timely manner. If one or more significant vendors or
suppliers are not Year 2000 compliant, this could have a material adverse
effect on the Company's results of operations, financial position or cash
flow.
The Company's Contingency Plans
The Company plans by mid-year 1999 to develop contingency plans to be
implemented in the event planned solutions prove ineffective in solving
Year 2000 compliance. If it were to become necessary for the Company to
implement a contingency plan, it is uncertain whether such plan would
succeed in avoiding a Year 2000 issue which may otherwise have a material
adverse effect on the Company's results of operations, financial position
or cash flow.
20
<PAGE>
Part II
Item 2. Changes in Securities
(c) During the quarter ended December 31, 1998, the Company issued a total
of 287,010 shares of Common Stock for an aggregate consideration of
$114,149 pursuant to the exercise of stock options by thirteen individuals.
The shares 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. The recipients
of the securities represented their intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were attached to the shares
certificates and stop transfer orders given to the Company's transfer
agent. All recipients had adequate access to information regarding the
Company.
Item 4 - Submission of Matters to a Vote of Security Holders
(a) The 1998 Annual Meeting of Stockholders of the Company was held
on November 16, 1998.
(b) Not applicable.
(c) Each nominee for Class I director received the following votes:
<TABLE>
<CAPTION>
Withhold
Name For Authority
- ---------------------------------------------------------------
<S> <C> <C>
Henry Hermann 10,542,047 21,957
Ralph C. Sillari 10,543,507 20,497
</TABLE>
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.
<TABLE>
<CAPTION>
Matter Votes Votes Delivered
Voted Upon For Against Abstentions Non Voted
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
To approve the 1998
Incentive Plan 7,235,345 145,991 43,835 3,138,833
To approve selection of
Ernst & Young as
accountants for the
Company for the fiscal
year ending 3/31/99
</TABLE> 10,535,255 11,524 17,225
(d) Not applicable.
21
<PAGE>
Item 6 - Exhibits and Reports on Form 8-K
(a) The following exhibits are included herein:
27 Financial Data Schedule
99.1 Risk Factors
(b) Reports on Form 8-K
On October 2, 1998 the Registrant filed a Form 8-K disclosing the existence
and terms of the Goldman Sachs Credit Partners, L.P./Fleet National Bank
$75 million credit facility.
On November 6, 1998, the Registrant filed a Form 8-K disclosing the
existence and terms of the Cisco Capital Corp. $25 million vendor financing
facility.
22
<PAGE>
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 CORP.
Date: February 16, 1999 /S/ ROBERT J. FABBRICATORE
----------------------------
Robert J. Fabbricatore
Chairman and CEO
Date: February 16, 1999 /S/ STEVEN C. JONES
-----------------------------
Steven C. Jones
Executive Vice President,
and Chief Financial
Officer
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-END> DEC-31-1998
<CASH> 2,597
<SECURITIES> 0
<RECEIVABLES> 27,335
<ALLOWANCES> 872
<INVENTORY> 0
<CURRENT-ASSETS> 37,899
<PP&E> 35,639
<DEPRECIATION> 10,198
<TOTAL-ASSETS> 67,529
<CURRENT-LIABILITIES> 32,743
<BONDS> 0
0
12,562
<COMMON> 103
<OTHER-SE> 18,302
<TOTAL-LIABILITY-AND-EQUITY> 67,529
<SALES> 19,025
<TOTAL-REVENUES> 19,040
<CGS> 16,429
<TOTAL-COSTS> 30,733
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,208
<INCOME-PRETAX> (12,900)
<INCOME-TAX> (903)
<INCOME-CONTINUING> (11,997)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,997)
<EPS-PRIMARY> (1.20)
<EPS-DILUTED> (1.20)
</TABLE>
Exhibit 99.1
Limited History as an ICP; Risks Relating to Implementation of New Strategy
Although the Company has sold integrated telecommunications services for
over 15 years, it sold local telephone services as an agent for Bell
Atlantic Corp. ("Bell Atlantic") until December 1997 and only began
offering such services as an integrated communications provider ("ICP")
under its own brand name after that time. Accordingly, stockholders have
limited historical financial and operating information under the Company's
current business strategy upon which to base an evaluation of the Company's
performance. As a result of the Company terminating its agency
relationship with Bell Atlantic, agency revenues are no longer material.
There can be no assurance that the Company's prior experience in the sale
of telecommunications services as a sales agent will result in the Company
generating sufficient cash flow to service its debt obligations or to
compete successfully under its new strategy.
The Company plans to deploy its own Integrated Communications Network.
The Company has had no experience in deploying, operating and maintaining a
telecommunications network. The Company's ability to successfully deploy
its ICN will require the negotiation of interconnection agreements with
incumbent local exchange carriers ("ILECs"), which can take considerable
time, effort and expense and which are subject to federal, state and local
regulation. There can be no assurance that the Company will be able to
successfully negotiate such agreements or to effectively deploy, operate or
maintain its facilities or increase or maintain its cash flow from
operations by deploying a network. Further, there can be no assurance that
the packet-switched design of the network will provide the expected
functionality in serving its target market or that customers will be
willing to migrate the provision of their services onto the Company's
network. The Company has engaged a network services integrator to design,
engineer and manage the buildout of the ICN in the Company's existing
markets. Any failure or inability by the network integrator to perform
these functions could cause delays or additional costs in providing
services to customers and building out the Company's ICN in specific
markets. Any such failure could materially and adversely affect the
Company's business and results of operations. The Company is purchasing
most of its network components from Cisco Systems, Inc. ("Cisco"), the
failure of such equipment to operate as anticipated or the inability of
Cisco to timely supply such equipment could materially and adversely affect
the Company's business and results of operations.
If the Company fails to effectively transition to an ICP platform, fails
to obtain or retain a significant number of customers or is unable to
effectively deploy, operate or maintain its network, such failure could
have an adverse effect on the Company's business, results of operations and
financial condition. In addition, the implementation of its new strategy
and the deployment of its network has increased and will continue to
increase the Company's expenses significantly. Accordingly, the Company
expects to incur significant negative cash flow during the next several
years as it implements its business strategy, penetrates its existing
markets as an ICP, enters new markets, deploys its ICN and expands its
service offerings. There can be no assurance that the Company will achieve
and sustain profitability or positive net cash flow.
High Leverage; Possible Inability to Service Indebtedness
The Company is highly leveraged and expects to seek to fund its business
plan with additional debt financing, including equipment leasing, which
will further increase the Company's leverage. The degree to which the
Company is leveraged could have important consequences to the Company's
future prospects, including the following: (i) limiting the ability of the
Company to obtain any necessary financing in the future for working
capital, capital expenditures, debt service requirements or other purposes;
(ii) limiting the flexibility of the Company in planning for, or reacting
to, changes in its business; (iii) leveraging the Company more highly than
some of its competitors, which may place it at a competitive disadvantage;
(iv) increasing its vulnerability in the event of a downturn in its
business or the economy generally; and (v) requiring that a substantial
portion of the Company's cash flow from operations be dedicated to the
payment of principal and interest on its debt and not be available for
other purposes.
The Company's ability to make scheduled lease payments and payments of
principal of, or to pay the interest on, or to refinance, its indebtedness,
or to fund planned capital expenditures will depend on its future
performance, which, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond its control. There can be no assurance that the Company's business
will generate sufficient cash flow from operations or that anticipated
revenue growth and operating improvements will be realized or will be
sufficient to enable the Company to service its indebtedness, or to fund
its other liquidity needs. There can be no assurance that the Company will
be able to refinance all or a portion of its indebtedness on commercially
reasonable terms or at all. If the Company does not generate sufficient
cash flow to meet its debt service and working capital requirements, the
Company may need to examine alternative strategies that may include actions
such as reducing or delaying capital expenditures, restructuring or
refinancing its indebtedness, the sale of assets or seeking additional
equity and/or debt financing. There can be no assurance that any of these
strategies could be effected on satisfactory terms, if at all.
Additional Capital Requirements; Uncertainty of Additional Financing
Over the next 12 months, the Company intends to (i) further expand its
existing markets, (ii) deploy the ICN in its existing markets, and (iii)
enhance the CTC Information System. Also, over the next three years, the
Company intends to further expand within its existing markets and into six
additional states in the New York-Washington, D.C. corridor and continue
the deployment of its ICN.
The Company believes that the net proceeds of the anticipated TD Facility
and the Spectrum Commitment, together with cash on hand and the anticipated
availability under the Senior Facilities will be sufficient to fund the
Company's capital expenditures, operating losses and working capital
requirements for its existing markets for approximately the next 12 months
even in the event the Company is unsuccessful or delayed in collecting the
Bell Atlantic Receivable. The Company expects to seek additional long-term
financing to refinance the anticipated TD Facility and further fund its
business plan within the next 3-6 months, capital markets permitting. After
the Company has raised sufficient long-term financing to further fund its
business plan, the Company expects to repay and terminate the TD Facility.
The availability of additional borrowings under the Credit Facility is
based on prior receivable collections and subject to complying with the
various covenants of such facility. There can be no assurance that
additional amounts will be available to the Company when needed or at all.
The Company will require substantial additional funding to continue its
penetration of, and deployment of its ICN in, its existing markets and to
implement the Company's planned geographic expansion of its sales presence
and ICN infrastructure into the New York-Washington D.C. corridor. The
Company's actual capital requirements may be materially affected by various
factors, including the timing and actual cost of implementing the Company's
ICN, the timing and costs of expansion into new markets, the extent of
competition and pricing of telecommunications services in its markets,
acceptance of the Company's services, technological change and potential
acquisitions.
Partly as a result of (i) Bell Atlantic rescinding its policy permitting
assignment of existing contracts to CLECs like the Company (including the
negative affect on the borrowing base under the Credit Facility which has
resulted from delays in deriving revenue from previous agency customers -
See Note 2b, "State Regulatory Proceedings"), (ii) the continuing delay in
collecting the Bell Atlantic Receivable and (iii) greater than anticipated
capital expenditures, if the facility with Toronto Dominion (Texas), Inc.
is not consummated and the Bell Atlantic Receivable is not collected, the
Company will need to obtain additional financing, beyond the proceeds of
the Spectrum Commitment, in the first or second fiscal quarter of fiscal
year 2000. If the Company does not enter into the Credit Facility
Amendment, the Company may not remain in compliance with certain
operational covenants under the Credit Facility, depending upon, among
other things, the Company's success in deriving revenue from its former
agency customers.
Sources of funding may include public offerings or private placements of
equity or debt securities, vendor financing, equipment lease financing and
bank loans. There can be no assurance that additional financing will be
available to the Company or, if available, that it can be obtained on a
timely basis and on terms acceptable to the Company and within the
limitations contained in the Senior Facilities and agreements governing
other debt issued by the Company from time to time. Failure to obtain
financing when needed would result in the delay or abandonment of the
Company's development and expansion plans which would in turn have a
material adverse effect on the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
Dependence on In-House Billing and Information System
The accurate and prompt billing of the Company's customers is essential
to the Company's operations and future profitability. The Company's
expected growth and deployment of its ICN could give rise to additional
demands on the CTC Information System, and there can be no assurance that
it will perform as expected. The failure of the Company to adequately
identify all of its information and processing needs (including Year 2000
compliance), the failure of the CTC Information System or the failure of
the Company to upgrade the CTC Information System as necessary could have a
material adverse effect on the Company and its results of operations.
Dependence on Supplier Provided Timely and Accurate Call Data Records;
Billing and Invoice Disputes
In its current business, the Company is dependent upon the timely
receipt and accuracy of call data records provided to it by its suppliers.
There can be no assurance that accurate information will consistently be
provided by suppliers or that such information will be provided on a timely
basis. Failure by suppliers to provide timely and accurate detail would
increase the length of the Company's billing and collection cycles and
adversely affect its operating results. The Company pays its suppliers
according to the Company's calculation of the charges applicable to the
Company based on supplier invoices and computer tape records of all such
calls provided by suppliers which may not always reflect current rates and
volumes. Accordingly, a supplier may consider the Company to be in arrears
in its payments until the amount in dispute is resolved. There can be no
assurance that disputes with suppliers will not arise or that such disputes
will be resolved in a manner favorable to the Company. In addition, the
Company is required to maintain sophisticated billing and reporting systems
to service the large volume of services placed over its networks. As resale
volumes increase, there can be no assurance that the Company's billing and
management systems will be sufficient to provide the Company with accurate
and efficient billing and order processing capabilities.
Dependence on Network Infrastructure and Products and Services of Others
The Company does not currently own any part of a local exchange or long
distance network and depends entirely on facilities-based carriers for the
transmission of customer traffic. After the deployment of the ICN, it will
still rely, at least initially, on others for circuit switching of local
voice calls and on fiber optic backbone transmission facilities. There can
be no assurance that such switching or transmission facilities will be
available to the Company on a timely basis or on terms acceptable to the
Company. The Company's success in marketing its services requires that the
Company provide superior reliability, capacity and service. Although the
Company can exercise direct control of the customer care and support it
provides, most of the services that it currently offers are provided by
others. Such services are subject to physical damage, power loss, capacity
limitations, software defects, breaches of security (by computer virus,
break-ins or otherwise) and other factors, certain of which have caused,
and will continue to cause, interruptions in service or reduced capacity
for the Company's customers. Such problems, although not the result of
failures by the Company, can result in dissatisfaction among its customers.
In addition, the Company's ability to provide complete
telecommunications services to its customers will be dependent to a large
extent upon the availability of telecommunications services from others on
terms and conditions that are acceptable to the Company and its customers.
There can be no assurance that government regulations will continue to
mandate the availability of some or all of such services or that the
quality or terms on which such services are available will be acceptable to
the Company or its customers.
Customer Attrition
The Company's operating results may be significantly affected by its
customer attrition rates. There can be no assurance that customers will
continue to purchase local, long distance or other services through the
Company in the future or that the Company will not be subject to increased
customer attrition rates. The Company believes that the high level of
customer attrition in the industry is primarily a result of national
advertising campaigns, telemarketing programs and customer incentives
provided by major competitors. There can be no assurance that customer
attrition rates will not increase in the future, which could have a
material adverse effect on the Company's operating results.
Ability to Manage Growth; Rapid Expansion of Operations
The Company is pursuing a new business plan that, if successfully
implemented, will result in rapid growth and expansion of its operations,
which will place significant additional demands upon the Company's current
management. If this growth is achieved, the Company's success will depend,
in part, on its ability to manage this growth and enhance its information,
management, operational and financial systems. There can be no assurance
that the Company will be able to manage any growth of its operations. The
Company's failure to manage growth effectively could have a material
adverse effect on the Company's business, operating results and financial
condition.
Potential Impact of the Lawsuit Against Bell Atlantic
In December 1997, the Company filed suit against Bell Atlantic for breaches
of its agency contract, including the failure of Bell Atlantic's retail
division to pay $14 million in agency commissions (approximately $11.5
million as of January 15, 1999) owed to the Company. The Company is
vigorously pursuing this suit. Although the Company believes the
collection of the agency commissions sought in the suit is probable, there
can be no assurance that the Company will be successful in collecting these
commissions. If the Company fails to collect any of the amounts sought or
if their collection becomes less than probable, the Company would be
required to write off the amounts reflected in its financial statements
that it is unable to collect or for which collection becomes less than
probable. Delay in the collection or write-off of the agency commissions
sought may also adversely affect the Company.
Also, Bell Atlantic has recently rescinded its policy in the New England
states of permitting resellers, including the Company, to assume the
service contracts of retail customers under contract to Bell Atlantic. The
failure of the Company's efforts to cause Bell Atlantic to cease and desist
from refusing to permit the assignment of existing contracts and to
continue its longstanding practice of allowing resellers to assume these
customer agreements, without penalty, on a resold basis could have a
material adverse effects on the Company's operating results.
In addition, the Company must use Bell Atlantic infrastructure for nearly
all of the local telephony services that it currently provides and,
although Bell Atlantic is prohibited by federal law from discriminating
against the Company, there can be no assurance that the litigation with
Bell Atlantic will not negatively affect the Company's relationships with
Bell Atlantic's wholesale division.
Dependence on Key Personnel
The Company believes that its continued success will depend to a
significant extent upon the abilities and continued efforts of its
management, particularly members of its senior management team. The loss of
the services of any of such individuals could have a material adverse
effect on the Company's results of operations. The success of the Company
will also depend, in part, upon the Company's ability to identify, hire and
retain additional key management as well as highly skilled and qualified
sales, service and technical personnel. Competition for qualified personnel
in the telecommunications industry is intense, and there can be no
assurance that the Company will be able to attract and retain additional
employees and retain its current key employees. The inability to hire and
retain such personnel could have a material adverse effect on the Company's
business.
Competition
The Company operates in a highly competitive environment and has no
significant market share in any market in which it operates. The Company
expects that it will face substantial and growing competition from a
variety of data transport, data networking and telephony service providers
due to regulatory changes, including the continued implementation of the
Telecommunications Act of 1996 (the "Telecommunications Act"), and the
increase in the size, resources and number of such participants as well as
a continuing trend toward business combinations and alliances in the
industry. The Company faces competition for the provision of integrated
telecommunications services as well as competition in each of the
individual market segments that comprise the Company's integrated approach.
In each of these market segments, the Company faces competition from
larger, better capitalized incumbent providers, which have long standing
relationships with their customers and greater name recognition than the
Company.
Regulation
The Company's local and long distance telephony service, and to a lesser
extent its data services, are subject to federal, state, and, to some
extent, local regulation.
The Federal Communications Commission (the "FCC") exercises jurisdiction
over all telecommunications common carriers, including the Company, to the
extent that they provide interstate or international communications. Each
state regulatory commission retains jurisdiction over the same carriers
with respect to the provision of intrastate communications. Local
governments sometimes impose franchise or licensing requirements on
telecommunications carriers and regulate construction activities involving
public right-of-way. Changes to the regulations imposed by any of these
regulators could adversely affect the Company.
While the Company believes that the current trend toward relaxed
regulatory oversight and competition will benefit the Company, the Company
cannot predict the manner in which all aspects of the Telecommunications
Act will be implemented by the FCC and by state regulators or the impact
that such regulation will have on its business. The Company is subject to
FCC and state proceedings, rulemakings, and regulations, and judicial
appeal of such proceedings, rulemaking and regulations, which address,
among other things, access charges, fees for universal service
contributions, ILEC resale obligations, wholesale rates, and prices and
terms of interconnection and unbundling. The outcome of these rulemakings,
judicial appeals, and subsequent FCC or state actions may make it more
difficult or expensive for the Company or its competitors to do business.
Such developments could have a material effect on the Company. The Company
also cannot predict whether other regulatory decisions and changes will
enhance or lessen the competitiveness of the Company relative to other
providers of the products and services offered by the Company. In addition,
the Company cannot predict what other costs or requirements might be
imposed on the Company by state or local governmental authorities and
whether or not any additional costs or requirements will have a material
adverse effect on the Company.
Risks Associated With Possible Acquisitions
As it expands, the Company may pursue strategic acquisitions.
Acquisitions commonly involve certain risks, including, among others:
difficulties in assimilating the acquired operations and personnel;
potential disruption of the Company's ongoing business and diversion of
resources and management time; possible inability of management to maintain
uniform standards, controls, procedures and policies; entering markets or
businesses in which the Company has little or no direct prior experience;
and potential impairment of relationships with employees or customers as a
result of changes in management. There can be no assurance that any
acquisition will be made, that the Company will be able to obtain any
additional financing needed to finance such acquisitions and, if any
acquisitions are so made, that the acquired business will be successfully
integrated into the Company's operations or that the acquired business will
perform as expected. The Company has no definitive agreement with respect
to any acquisition, although from time to time it has discussions with
other companies and assesses opportunities on an ongoing basis.
Year 2000 Compliance
Currently, many computer systems and software products are coded to
accept only two digit entries in the date code field. These date code
fields will need to accept four digit entries to distinguish 21st century
dates from 20th century dates. As a result, many companies' software and
computer systems may need to be upgraded or replaced in order to comply
with such "Year 2000" requirements. In connection with the deployment of
the Company's new ICN, it has designed new database architecture for its
computer systems that comply with the Year 2000 requirements. Installation
of the computer system and related software is expected to be completed in
June 1999 and testing of the system, including Year 2000 compliance, is
expected to take place commencing in May 1999.
There can be no assurance that the Company's new computer system will
function adequately or that all Year 2000 problems will be identified and
corrected in a timely manner. In addition, if the systems of other
companies on whose services the Company depends or with whom the Company's
systems interface are not year 2000 compliant, there could be a material
adverse effect on the Company's business, operating results and financial
condition.
Control By Principal Shareholders; Voting Agreement
As of December 31, 1998, the officers and directors and parties
affiliated with or related to such officers and directors controlled
approximately 51.4% of the Company's outstanding voting power. Robert J.
Fabbricatore, the Chairman and Chief Executive Officer of the Company,
beneficially owns approximately 26.5% of the outstanding shares of Common
Stock. Consequently, the officers and directors will have the ability to
exert significant influence over the election of all the members of the
Company's Board, and the outcome of all corporate actions requiring
stockholder approval. In addition, Mr. Fabbricatore has agreed to vote the
shares beneficially owned by him in favor of the election to the Company's
Board of Directors of up to two persons designated by the holders of a
majority of the Series A Convertible Preferred Stock.
Impact Of Technological Change
The telecommunications industry has been characterized by rapid
technological change, frequent new service introductions and evolving
industry standards. The Company believes that its long-term success will
increasingly depend on its ability to offer integrated telecommunications
services that exploit advanced technologies and anticipate or adapt to
evolving industry standards. There can be no assurance that (i) the Company
will be able to offer new services required by its customers, (ii) the
Company's services will not be economically or technically outmoded by
current or future competitive technologies, (iii) the Company will have
sufficient resources to develop or acquire new technologies or introduce
new services capable of competing with future technologies or service
offerings (iv) all or part of the ICN or the CTC Information System will
not be rendered obsolete, (v) the cost of the ICN will decline as rapidly
as that of competitive alternatives, or (vi) lower retail rates for
telecommunications services will not result from technological change. In
addition, increases in technological capabilities or efficiencies could
create an incentive for more entities to become facilities-based ICPs.
Although the effect of technological change on the future business of the
Company cannot be predicted, it could have a material adverse effect on the
Company's business, results of operations and financial condition.
Possible Volatility Of Stock Price
The stock market historically has experienced volatility which has
affected the market price of securities of many companies and which has
sometimes been unrelated to the operating performance of such companies. In
addition, factors such as announcements of developments related to the
Company's business, or that of its competitors, its industry group or its
customers, fluctuations in the Company's results of operations, a shortfall
in results of operations compared to analysts' expectations and changes in
analysts' recommendations or projections, sales of substantial amounts of
securities of the Company into the marketplace, regulatory developments
affecting the telecommunications industry or data services or general
conditions in the telecommunications industry or the worldwide economy,
could cause the market price of the Common Stock to fluctuate
substantially.
Absence Of Dividends
The Company has not paid and does not anticipate paying any cash
dividends on its Common Stock in the foreseeable future. The Company
intends to retain its earnings, if any, for use in the Company's growth and
ongoing operations. In addition, the Goldman Sachs/Fleet Loan and Security
Agreement provides that without the Lenders' prior written consent, the
Company may not make any distribution or declare any dividends in cash or
property other than stock during the three-year term of the Loan and
Security Agreement. In addition, the terms of the Series A Convertible
Preferred Stock restrict, and the terms of future debt financings are
expected to restrict, the ability of the Company to pay dividends on the
Common Stock.
Potential Effect Of Anti-takeover Provisions And Issuances Of Preferred
Stock
Certain provisions of the Company's Articles of Organization and Bylaws
and the Massachusetts Business Corporation Law may have the effect of
delaying, deterring or preventing a change in control of the Company or
preventing the removal of incumbent directors. The existence of these
provisions may have a negative impact on the price of the Common Stock and
may discourage third party bidders from making a bid for the Company or may
reduce any premiums paid to stockholders for their Common Stock. In
addition, the Company's Board of Directors has the authority without action
by the Company's stockholders to issue shares of the Company's Preferred
Stock and to fix the rights, privileges and preferences of such stock,
which may have the effect of delaying, deterring or preventing a change in
control. Certain provisions of the Company's outstanding Series A
Convertible Preferred Stock which provide for payment of the liquidation
preference in cash upon the consummation of certain transactions may have
the effect of discouraging third parties from entering into such
transactions.
