-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EqytAvgjqD1fkpWuJAZfmC+28TpQzYl4aUsxMJzf2z1PuV31XCDhbT/d5ois1w2y Jbq482qVJyzuGwLEIzlYZA== 0001056114-02-000003.txt : 20020415 0001056114-02-000003.hdr.sgml : 20020415 ACCESSION NUMBER: 0001056114-02-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CTC COMMUNICATIONS GROUP INC CENTRAL INDEX KEY: 0001092319 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 043469590 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-27505 FILM NUMBER: 02595463 BUSINESS ADDRESS: STREET 1: 220 BEAR HILL RD CITY: WALTHAM STATE: MA ZIP: 02451 BUSINESS PHONE: 7814668080 MAIL ADDRESS: STREET 1: 220 BEAR HILL RD CITY: WALTHAM STATE: MA ZIP: 02154 10-K 1 f10k4.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the year ended December 31, 2001 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) Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock. 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part IV of this Form 10-K or any amendment to this Form 10-K. [X] Based on the closing sale price on March 25, 2002, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $54,941,952. At March 22, 2002, 27,112,555 shares of the Registrant's Common Stock were outstanding. PART I GENERAL At the Annual Meeting of our Board of Directors held on July 27, 2000, we changed our fiscal year from a twelve month period ending March 31 of each year to a twelve month period ending December 31 of each year. ITEM 1. BUSINESS Overview We are a growing single-source provider of voice, data and Internet Communications services, (an integrated communications provider, or ICP) with 18 years of marketing, sales and service experience. We predominantly target medium and larger-sized business customers who seek greater capacity for voice and data traffic. We are a single provider for their telecommunications requirements and we offer improved levels of service. We became an integrated communications provider in January 1998. Prior to that, we were the largest independent sales agent for NYNEX Corp. and then Bell Atlantic (now Verizon), based on agency revenues measurements. 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 December 31, 2001, we were serving over 15,000 customers and had 589,000 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. As of December 31, 2001, our large, experienced sales force consists of 173 account executives supported by 174 network coordinators. Our sales force is located close to our customers in 26 sales and service offices principally in the Northeast and Mid-Atlantic states. We currently operate our own state-of-the-art network facilities to carry telecommunications traffic. This PowerPath(sm) Network uses packet- switching, a technology that transmits data in discrete packages and 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. This permits the network to transmit multiple types of media, such as voice, data, Internet access and video with various levels of Quality of Service, or QOS. The first phase of our network became operational for full production mode in January 2000. We interconnect our facilities over 8,000 fiber route miles on our own fiber, through fiber optic cable strands acquired over a 20-year indefeasible right of use, or IRU, from Williams Communications, and from 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 what we believe is 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. We currently utilize a combination of both leased and company-owned fiber facilities. In September 1999, we initiated commercial service and as of December 31, 2001 we were servicing more than 5,300 customer locations with our PowerPath(sm) Network 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(sm) Network allows us to deliver both local and long distance voice services using a Voice over IP (VoIP) packet based network. In 2001, the Company also introduced a suite of Hosting Solutions. These E-business and business continuity (continuous systems uptime) services consist of web hosting, Internet/WAN collocation and Data Center Storage Networking. Our 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(sm) 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(sm) 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(sm) 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 Services. We provide web hosting services via our Springfield, Massachusetts Data Center opened in early 2001 and through our Advanced Technology Center (ATC) in Waltham, Massachusetts opened in September 2001. The ATC is a 50,000 square foot state of the art data center that houses our Eastern Massachusetts Super Node for the PowerPath(sm) Network and an Internet/WAN Collocation Center. We currently offer customers hosting solutions that include shared and dedicated web hosting and web site design services, Internet/WAN collocation services and data center storage networking services. In 2002, we plan to offer network attached storage and remote data archiving services, and optical networking services for storage area networking and other high bandwidth applications. These services have been designed and released to support our customers' growing E-business and business continuity (continuous systems uptime) requirements. We currently support approximately 200 web sites for customers at our ATC in Waltham, Massachusetts. In addition, we also support 15 Internet/WAN collocations customers that utilize some or all of our complete suite of Hosting Solutions. We are also engaged in the further analysis and potential development of services such as managed firewall and monitoring service, data security, and other network operating system support services. Our Integrated Communications Network, or PowerPath(sm) Network We began deploying the first phase of our state-of-the-art, packet-switched network, the PowerPath(sm) Network, in January 1999. Today, our network is fully operational providing customers with integrated broadband services including voice, data, Internet access and access to web related services over a single connection. We offer a broad array of sophisticated services over our network including Class-4/5 switching, which provides customers with local and long distance voice calling capabilities. Our packet-based network infrastructure enables us to improve our margins, enhance network and service quality and broaden our range of product and value added service offerings. Our network services result in a more dynamic solution for our customers providing them with better performance at less cost and it has also demonstrated the ability to stimulate additional demand for new value added services. The open architecture of our PowerPath(sm) Network gives us the opportunity to integrate new and emerging technology to meet our customers' increasing demands for high capacity and reliable voice, data, Internet access and web- based services. The network utilizes Cisco ESR/GSR and Cisco BPX/MGX 8850 IP + ATM routers/switches, which we believe are the most reliable and proven method to handle all types of data, voice, Internet and video traffic. By building out our own fiber infrastructure, switches and hubs are now consolidated in major regional locations called Super Nodes. Connectivity to customers is provided over protected SONET rings that expand to serving Central Offices (COs), improving service reliability, increasing bandwidth and at the same time reducing leased circuit costs in the middle mile. T1s, multiple T1s using Inverse Multiplexing for ATM (IMA), DS3s or OCN services are then extended from the COs to customer sites covering the last mile. We believe our packet switched network is superior to the existing circuit switched network used by our competitors. The basic voice technology within the existing telephone-switching network has not changed for many years while data technology has advanced dramatically. Circuit switch technology dedicates a fixed amount of capacity for each voice line. In a packet switched environment, there is no single dedicated circuit and both voice and data information is broken apart and turned into packets that share a common facility. They are then mixed with other types of data communications and then reassembled at the end. Our ability to transmit via packets provides for superior network utilization and results in the ability to transmit more information through a similar channel. As a result, more information, i.e. voice and data, is transported at a lower cost and more efficiently with the ability to provide multiple levels of QOS. We are currently offering local dial tone (where we have elected to offer it), long distance voice, data and Internet services over our network. We introduced local dial tone in the first quarter of 2001, which will enable us to provide all of our customer services on the PowerPath(sm) Network. The customer does not have to disconnect from the local phone company and then reconnect onto our network. The transition of the customer from the local phone company's voice services to our network requires only some minor wiring at the customers location and the reprogramming of the customer's system to direct local voice service traffic to our equipment. This strategy enables customers to keep existing phone numbers and enjoy the built-in redundancy of the separate physical connection to the local phone company. Adding Our Owned Fiber to the Powerpath(sm) Network With the objective to achieve competitive transport capacity and improve time to market of our PowerPath(sm) Network and value added services, we launched a major Company owned dark fiber program in early 2000. The initial phase of the fiber program covers our current footprint in the Northeastern United States continuing through the Mid-Atlantic region. The buildout of these segments is nearing completion, with all major segments expected to be completed in the fall of 2002. Our fiber network incorporates technology that is based on carrier class optical networking equipment, specifically Cisco's ONS 15454, 15327 Synchronous Optical Network, or SONET, switches, and Cisco's ONS 15800 Dense Wave-link Multiplexing, or DWM, switches. In 2000 and early 2001, we entered into several agreements with metro and regional fiber carriers to provide connections for the middle and, where possible, last mile connections to the customer. These network build outs are a continuation of our long-haul transport infrastructure making use of the same WDM/SONET technology. Our metro and regional fiber program is designed to expand outward from the 8,300 route miles of fiber purchased from Williams Communications and connect to core ILEC CO's. By lighting the fiber closer to our customers and operating a greater percentage of the facilities on which customer traffic is routed, we are able to improve provisioning intervals, more efficiently maintain the PowerPath(sm) Network, reduce dependency on the local telephone company and improve margins. The long haul, regional and metro fiber facilities of our network will allow for consolidation of equipment and collocation resources. This cost saving measure, referred to as the Super Node program, permits centralization of service inventory spares, efficient monitoring of network elements and fewer points of failure, while maintaining robust security, redundancy and area for expansion. It also results in reduced expense associated with Point of Presence (POP) collocation and leased circuits. Sales and Customer Care We market telecommunications services by developing long-term business relationships with our customers and offering them comprehensive management of their telecommunications requirements. Each customer is supported by a dedicated local account team led by the Sales Account Executive and backed by the customer service team that includes a Network Coordinator and Branch Operations Management and a technical support team. This team works with the customer to design, implement and maintain an integrated telecommunications solution. The team also reviews the customer's services on a regular basis through on-site meetings and, based upon changes in the customer's needs or available technologies, recommends updates in order to make the best use of currently available products and services. We believe that providing localized, proactive high quality customer care promotes continued sales of new services and reduces customer churn. Sales and Service Infrastructure Our 26 branch offices are currently staffed with over 450 individuals, representing approximately 64% of our employees. As of December 31, 2001, there were 200 Sales and Sales Management, 210 Service and Service Management, 20 Field Technical Support and 20 Branch Administrators serving markets in Maine, New Hampshire, Vermont, Massachusetts, Rhode Island, Connecticut, New Jersey, New York, Pennsylvania, Maryland, Washington D.C. and Virginia. Customer Sales and Service Model At the initial meeting with a prospective customer, our Account Executives first obtain a detailed understanding of the customer's business, including their method of operations, a description of their short and long-term business plans and the communications challenges they currently face. A thorough, detailed inventory of the customer's current communications services and costs is prepared and analyzed. We then present a communications solution to our customer based on our analysis of their business and goals. We outline options and recommendations designed to eliminate unnecessary expense, implement new services to improve the functional and financial performance of their network and position them for future business or technology requirements. Account Executives also review with the customer the benefits of our comprehensive, ongoing account management program which includes timely responses to daily customer needs, and a proactive approach of keeping the customer informed of industry changes. We believe the relationship-intensive approach of assigning both Account Executives and Network Coordinators to each customer account results in high customer satisfaction and retention rates. Our Account Executives regularly participate in training programs on subjects such as solution-oriented sales, comprehensive customer care, network design and other technical features of our services. We seek to motivate and retain our Account Executives through extensive training and a commission structure that supports our relationship oriented sales and service policies and rewards on-net, on our own facilities, account growth and customer retention. Customer Care Our Network Coordinators are the first line of support for our customers. They are thoroughly trained in each of the Company's service offerings and are responsible for customer care. Network Coordinators are located in each of our sales and service branches and are responsible for customer accounts in direct support of the sales executives. Each sales representative keeps informed of the unique needs and aspects of each individual customer to whom they are assigned. Our localized, multi-step account management process provides an ongoing and comprehensive service program to our customers. This process ranges from long-term consultative planning to prompt and responsive handling of service issues. Our customer care program is designed to provide prompt action in response to customer inquiries and complaints. The local sales branches are staffed 11 hours a day, 5 days a week. At other times, incoming calls are automatically connected to a central customer care center which is staffed 24 hours a day, 7 days a week. We believe that our Network Coordinators are motivated to provide the highest level of customer care since a significant portion of their compensation is based on customer retention and satisfaction. Our Information Systems Our information systems include five central applications which fully integrate our sales and account management, customer care, provisioning, billing and financial processes. Automation of each of these processes is designed for high transaction volumes, accuracy, timely installation, accurate billing feeds and quality customer service, all done in a secure environment. Data entered in one application is generally exported into all other applications. Each branch office is connected via wide area data connections to the central processor. Our employees have online access to our information systems from their branch personal computers or laptop computers as well as remote access through our Virtual Private Network (VPN). We also installed an electronic interface to most of our major suppliers. When a sales executive wishes to place an order, our information systems electronically direct it to the appropriate supplier and monitor any delays in provisioning the order. Once the order is provisioned, our information systems automatically remove it from the in-process order file, update the customer's service inventory and network configuration, initiate billing, post the sales executive's commission and update our financial reports. Our information systems include the following applications: Account and Sales Management. Our account management application is the hub of our information systems. It stores all of our customer-related information, such as installed services location detail, contact information, transaction history and account profile. Our account management application also automatically exports data to our customized sales application. Our sales application is a fully-integrated database that provides sales personnel with access to information for pricing services, customized sales proposals, customer correspondence, sales performance, referencing methods and procedures, service descriptions, competitive information and historical profiles of our current and prospective customers. These historical profiles include details of installed services, recent transactions and billing history. Our sales system can be used both on- and off-line while maintaining a secure environment. All entries made while off-line are automatically updated to the central processor and all relevant data is simultaneously exported to the other central applications each time a salesperson connects to the network. Customer Care. Our Network Coordinators use our account care application to review installed services, make additions, changes and deletions to accounts, initiate and track repair and service work and review past billing for any customer. This closed loop application provides automatic follow up and records all transactions in a customer history file. Service orders and repair requests input in our account care application are automatically exported into our provisioning application. Provisioning. We generally direct customer orders through our provisioning application electronically to our major suppliers. We track these orders through our account care application from initiation through completion. Order information is entered by the account team at each branch and then forwarded for technical design review. When we provide PowerPath(sm) Network services to a customer, we first develop a voice and data plan for that customer's location and determine the appropriate broadband access facility (T1 or multiple T1s) necessary to accommodate all of those services. Upon design acceptance, an Access Service Request (ASR) is issued to a local service provider to provision the PowerPath(sm) Network access connection. This interval is from the local service provider and currently averages 20 days. Upon electronic receipt of the Firm Order Confirmation (FOC), the installation and services appointment is scheduled. Network Coordinators are notified of the date and they coordinate that date with the customer. Two days before installation, network addresses and services are assigned throughout the network and the Integrated Access Device (IAD) is programmed and shipped to the installation depot. On the FOC date, the access service is tested prior to acceptance. The following day, the IAD is installed and the customer's services are activated. When the IAD at the customer's location is connected to the customer's phone system, this puts voice services on our PowerPath (sm) Network and the connection of the customer routers puts data and Internet services on our network. With the use of fiber within our PowerPath(sm) network, the total interval from receipt of customer order to service activation now approaches 30 days. If any delay in the process occurs, our information system alerts the sales and service team who then have the ability to take corrective action and also notify the customer of a possible delay. Once the order has been filled the information is automatically fed to our billing application. Billing and Customer Interface. Our billing application gives us the ability to provide our customers a single bill for all the services they purchase from us. Our billing application also allows the customer to review historic bill detail, perform customized usage analyses and download information directly to their own accounting applications. Using a secure Web-based application called IntelliVIEW(sm), our customers have near real- time online access to our billing application and are able to review and analyze their bills and related information with many useful features including: Call summary Time of day analysis Call detail Day of week analysis Click-a-Bill drill down Location summary and analysis Line usage summary Group summary and analysis Expensive call breakdown e-mail notification of billing Frequent call breakdown Unlimited query capability Watchdog threshold monitoring Customer billing statements are also available for electronic download or on paper. Paper statements generated by our billing application offer our customers different management formats. Financial. Data from our billing application is electronically transferred to our financial application. Our financial application is used to track and prepare reports on sales activity, commissions, branch operations, branch profitability and cash flows. The financial application also compiles this data for our periodic financial reports. In addition, this application provides internal controls for revenue tracking and costing. The integrated nature of our information systems allows us to operate each branch as a separate cost center. Our Information Management Platform (IMP) is built on a N-Tiered Architecture. Tier One covers the Data Mart built on Oracle and EMC storage technology. Tier Two to Tier Four successively provide the Business Systems layer including the Operating Support System from Metasolv (OSS), the Network Management Systems layer (NMS), the Element Management Systems (EMS) and the Portal layer. Tier Two to Four are interconnected with Tier-One through a Tibco Data Bus. Finally Tier-Five is the client Tier, a web based client allowing our employees, partners and customers to access information with various levels of authorizations using Windows, Windows NT or web browsers. Our IMP is built on a state- of-the-art, open standard architecture providing a high level of reliability, flexibility and scalability to accommodate future growth. The IMP is fully redundant as all business critical information is mirrored between our dual data centers (Springfield and Waltham). Most systems are running on SUN-Microsystems(tm) and UNIX(tm). Furthermore, we are building flow-through provisioning capabilities integrating our packet based network with our IMP, finalizing our vision of creating an IP and web centric services platform that will ultimately allow our customers to self-serve their services activity from the Internet. Competition Competition from Single-Source Providers. We operate in a competitive environment and have a relatively small market share in each market in which we operate. We face substantial competition from a variety of data transport, data networking and telephony service providers. We face competition from single-source providers and from providers of each individual telecommunications service. Many of these competitors are larger and better capitalized than we are. Many of our competitors are incumbent providers, with long standing relationships with their customers and greater brand name recognition. Verizon is a competitor for local, voice and data services. We expect that based on regulatory developments, Verizon will increasingly be a competitor for long distance services as well. For example, Verizon was granted authority by the FCC under Section 271 to provide in-region interLATA services, including long distance services, in New York state, Massachusetts and Rhode Island. Verizon also has applications pending before the FCC to provide in-region interLATA services in Vermont, Maine, New Jersey, and New Hampshire that may be approved in 2002. SBC Communication, Inc.'s affiliate, The Southern New England Telephone Company, is a major competitor in Connecticut for local, long distance and data services. Competitors in our markets for single source solutions include Choice One and Time Warner Telecom. Competitors for our data services also include AT&T Local, Sprint and Worldcom. Our competitors for long distance services include all the major carriers such as AT&T, Worldcom and Sprint. Under the Telecommunications Act of 1996, or Telecom Act, the Regional Bell Operating Companies or the Regional Bell Operating Companies (RBOCs) are permitted to provide interLATA long distance service outside those states in which they have traditionally provided local exchange service ("out-of-region" long distance service) upon receipt of the necessary state and/or federal regulatory approvals that are otherwise applicable. The RBOCs are permitted to provide long distance service within the regions in which they traditionally provided local exchange service ("in- region" long distance service) on a state-by-state basis upon approval of the FCC and based upon a finding that the RBOC has complied with the 14- point checklist outlined in Section 271 of the Telecom Act. This 14-point checklist is designed to ensure that competitors have the ability to provide local telephone services in competition with the RBOC. Once the RBOCs are allowed to offer in-region long distance services under the terms of Section 271 of the Telecom Act, they will be in a position to offer local and long distance services similar to the services we offer and will likely become more effective competitors. Verizon was the first RBOC permitted to provide in-region long distance services when its Section 271 application for New York was approved in 1999. SBC is also permitted to offer in-region long distance services in Connecticut, because its operating subsidiary there was not part of the Bell system. Verizon and other RBOCs are expected to continue to apply for authority to provide in-region long distance services during the coming year. Although the Telecom Act and other federal and state regulatory initiatives will provide us with new business opportunities, as competition increases regulators are likely to provide the incumbent local exchange carriers with more pricing flexibility. Our revenues may be adversely affected if the ILECs elect to lower their rates and sustain these lower rates over time. We believe that we may be able to offset the effect of lower rates with the capital and operating efficiency of our network and by offering new services to our target customers, but we can provide no assurance that this will occur. In addition, if future regulatory decisions give ILECs increased pricing flexibility or other regulatory relief, such decisions could have a material adverse effect on our business. Competition for Provision of Local Exchange Services. In the local exchange market, ILECs, including RBOCs, continue to hold near-monopoly positions. We also face competition or prospective competition from one or more integrated communications providers, and from other competitive providers, including providers who do not own their own network. Many of these competitors are larger and better capitalized than we are. Some carriers have entered into interconnection agreements with ILECs and either have begun, or in the near future likely will begin, offering local exchange service in each of our markets. As of February 8, 1999, the largest long distance carriers were permitted to bundle local and long distance services. This removes one of our competitive advantages. Other entities that currently offer or are potentially capable of offering switched services include cable television companies, electric utilities, other long distance carriers, microwave carriers, and large customers who build private networks. Wireless telephone system operators are also competitors in the provisioning of local services. Cellular, personal communications service, and other commercial mobile radio services providers may offer wireless services to fixed locations, rather than just to mobile customers. This ability to provide fixed as well as mobile services will enable wireless providers to offer wireless local loop service and other services to fixed locations (e.g., office and apartment buildings) in direct competition with us and other providers of traditional fixed telephone service. In addition, the FCC has auctioned substantial blocks of spectrum for fixed use including local exchange services. Competition for Provision of Long Distance Services. The long distance market is significantly more competitive than the local exchange market. In the long distance market numerous entities compete for the same customers. In addition, customers frequently change long distance providers in response to lower rates or promotional incentives by competitors. This results in a high average rate of customer loss, or churn, in the long distance market. Prices in the long distance market have declined significantly in recent years and are expected to continue to decline. Competition in this market will further increase as RBOCs are permitted to offer in-region long distance services. Data and Internet Services. The market for high speed data services and access to the Internet is highly competitive. We expect competition in this market to continue to intensify. Our competitors in this market will include Internet service providers and other telecommunications companies, including large interexchange carriers and RBOCs. Many of these competitors have greater financial, technological and marketing resources than those available to us. Hosting Solutions. The competitive landscape for Hosting Solutions has changed over the past year. Certain Phase one Collocation Companies have failed, giving way to Telecom Services Providers, like CTC, offering E- Business and Business Continuity Services in conjunction with a powerful voice/data communication network and associated services. The main competition in this area comes from Worldcom, Sprint, AT&T, and Genuity. In addition there are other Collocation Companies that offer these services. End users are looking for single source providers of communications infrastructure services that include Web Hosting, Internet/WAN Collocation, and a variety of managed Data Storage services. End users look to their Hosting Services provider to partner with Applications Support Providers (ASP's) that can support Network Operating Systems, Client Server Desktop to Enterprise software applications, and ongoing software and help desk support. End users focus on E-business and Business Continuity is driving them to buy these services from their telecom services provider who have built their reputation and services portfolio based on doing business on the Internet and guaranteed uptime of services through Service Level Agreements (SLA's). Government Regulation The local and long distance telephony services and, to a lesser extent, the data services we provide are regulated by federal, state, and, to some extent, local government authorities. The FCC has jurisdiction over all telecommunications common carriers to the extent they provide interstate or international communications services. Each state regulatory commission has jurisdiction over the same carriers with respect to the provision of intrastate communications services. Local governments sometimes impose franchise or licensing requirements on telecommunications carriers and regulate construction activities involving public rights-of-way. Changes to the regulations imposed by any of these regulators could have a material adverse effect on our business, operating results and financial condition. In recent years, the regulation of the telecommunications industry has been in a state of flux as the United States Congress and various state legislatures have passed laws seeking to foster greater competition in telecommunications markets. The FCC and state utility commissions have adopted many new rules to implement this legislation and encourage competition. These changes, which are still incomplete, have created new opportunities and challenges for us and our competitors. The following summary of regulatory developments and legislation is not intended to describe all present and proposed federal, state and local regulations and legislation affecting the telecommunications industry. Some of these and other existing federal and state regulations are the subject of judicial proceedings, legislative hearings and administrative proposals which could change, in varying degree, the manner in which this industry operates. We cannot predict the outcome of these proceedings, or their impact on the telecommunications industry at this time. Federal Regulation Except with respect to access charges (see below), we are not subject to price cap or rate of return regulation at the federal level and we are not currently required to obtain FCC authorization for the installation, acquisition or operation of our domestic interexchange network facilities. However, we must comply with the requirements of common carriage under the Communications Act. We are subject to the general requirement that our charges and terms for our telecommunications services be "just and reasonable" and that we not make any "unjust or unreasonable discrimination" in our charges or terms. The FCC has jurisdiction to act upon complaints against any common carrier for failure to comply with its statutory obligations. Comprehensive amendments to the Communications Act were made by the Telecom Act, which was signed into law on February 8, 1996. The Telecom Act effected changes in regulation at both the federal and state levels that affect virtually every segment of the telecommunications industry. The stated purpose of the Telecom Act is to promote competition in all areas of telecommunications. The FCC is charged with establishing national guidelines to implement certain portions of the Telecom Act. The FCC issued its interconnection order on August 8, 1996. On July 18, 1997, the United States Court of Appeals for the Eighth Circuit issued a decision vacating the FCC's pricing rules, as well as certain other portions of the FCC's interconnection rules, on the grounds that the FCC had improperly intruded into matters reserved for state jurisdiction. On January 25, 1999, the Supreme Court largely reversed the Eighth Circuit's order, holding that the FCC has general jurisdiction to implement the local competition provisions of the Telecom Act. In so doing, the Supreme Court states that the FCC has authority to set pricing guidelines for unbundled network elements or UNE, to prevent ILECs from disaggregating existing combinations of network elements, and to establish "pick and choose" rules regarding interconnection agreements. The FCC's "pick and choose" rules permit a carrier seeking interconnection to "pick and choose" among the terms of service from other interconnection agreements between the ILECs and other competitive local exchange carriers. This action reestablishes the validity of many of the FCC rules vacated by the Eighth Circuit. In its July 18, 2000 decision, the United States Court of Appeals for the Eighth Circuit vacated the FCC's rule regarding the methodology for calculating the discount rate at which ILECs must resell retail telecommunications services to competitors, and remanded that rule to the FCC. That order is now final. As a result of this decision we could experience reduced margins on the ILEC services that we resell. In fact, as a result of this decision, Verizon has proposed to reduce the discount rate available to use and other resellers in Massachusetts from approximately 25% to approximately 14%. We and other resellers have challenged this proposed reduction in a proceeding before the Massachusetts Department of Telecommunications and Energy, but there is no assurance that our challenge will be successful. In the meantime, the FCC began a review in December 2001 of its rules regarding the unbundling of network elements. Some telecommunications carriers, particularly the ILECS, have argued that this list of elements should be reduced. In particular, they propose that any elements that CLECs use to provide highspeed data services should not be provided at cost-based rates. Moreover, there are some carriers, including some CLECS, who have proposed new limits on ILEC obligations to provide unbundled interoffice transport and unbundled switching in many areas. If certain network elements are no longer available, we will need to either provide these elements, which would increase costs, or forego the opportunity to provide service to certain customers, which would reduce revenues. We believe that the FCC will decide this issue sometime in 2002. There is also legislation pending in Congress that would also limit CLEC access to certain unbundled network elements, House Bill H.R. 1542 (the "Tauzin-Dingell bill") would prohibit state or federal regulation of high-speed data services, with the effect that ILECs would no longer be required to provide unbundled elements at cost-based rates (if at all) if those elements were to be used to provide high-speed data services. Votes on this bill are expected in 2002. The implications of this bill are broad and not entirely predictable at this point. Again, if certain network elements are no longer available, we will need to either provide these elements, which would increase costs, or forego the opportunity to provide service to certain customers, which would reduce revenues. In December 2001, the FCC also initiated several proceedings that together will determine the key terms and conditions under which ILECs may provide broadband services, including a review of what UNEs ILECs must make available to CLECs for provision of broadband and other services. These proceedings will examine whether ILECs should be treated as "non-dominant" in the broadband telecommunications marketplace. This proceeding will set the overall framework under which ILECs may provide broadband services while at the same time determining how CLECs will be able to provide broadband services using UNEs. If ILECs are determined to be non-dominant in the provisioning of broadband services, it is possible that they will be given more competitive pricing flexibility, which could decrease our margins on these types of services. Moreover, the ILECs may no longer provide us with UNEs for our broadband services, which may increase our costs. At this point, we cannot predict the outcome of this proceeding. The FCC has adopted rules designed to make it easier and less expensive for competitive local exchange carriers to obtain collocation at ILEC central offices by, among other things, restricting the ILECs' ability to prevent certain types of equipment from being collocated and requiring ILECs to offer alternative collocation arrangements to competitive local exchange carriers. However, the Tauzin-Dingell bill has provisions that would roll back some of these rules and would limit the types of equipment that CLECs could collocate and place restrictions on their ability to connect to other collocators. If these provisions are passed into law, we would likely experience increased costs. Under the Communications Act, ILECs have an obligation to negotiate with us in good faith to enter into interconnection agreements. Currently, we have or are concluding negotiation of interconnections throughout our footprint. However, as explained above, the FCC rules governing pricing standards for interconnection and access to the unbundled network elements of the ILECs are currently being reviewed at the Supreme Court. If the Supreme Court strikes down aspects of the FCC's pricing rules, the FCC may adopt a new pricing methodology that would require us to pay a higher price to ILECs for interconnection and unbundled network elements. This could have a detrimental effect on our business. The Telecom Act will permit RBOCS to provide long distance services in- region upon demonstrating to the FCC and state regulatory agencies that they have adhered to the Telecommunication Act's 14-point competitive checklist. Many RBOCs have subsequently filed applications with various state public utility commissions and the FCC seeking approval to offer in-region long distance service. To date, Verizon has been granted long distance authority in New York, Massachusetts, Connecticut, Rhode Island and Pennsylvania and has applications pending in Vermont, New Hampshire, Maine and New Jersey. On October 31, 1996, the FCC issued an order that required nondominant interexchange carriers, like us, to cease filing tariffs for our domestic interexchange services. This order subsequently was stayed by a federal appeals court; however, recently the court removed the stay. Accordingly, nondominant interstate services providers are no longer able to rely on the filing of tariffs with the FCC as a means of providing notice to customers of prices, terms and conditions under which they offer their domestic interstate interexchange Services. During 2001, we canceled our FCC tariffs as a result of the FCC's orders. In December 2000, the FCC released its Second Report and Order in the Matter of Numbering Resource Optimization in which the FCC adopted rules governing the utilization and forecasting of phone numbers, the guidelines for area code relief, and implementation of One-Thousand Number Block Pooling. Only carriers with number portability capable switches can participate in One-Thousand Number Block Pooling. Customers may presubscribe to various providers for their local exchange, local toll and long distance services and have the option of changing providers at any time. The FCC and some states have adopted rules designed to prevent unauthorized changes in an end-user's carrier(s) of choice. Unauthorized changes in service providers is known as "slamming". The FCC has levied substantial fines for slamming. The risk of financial damage and business reputation to slamming rules offenders of the FCC's could be significant. Over the last few years, the FCC has instituted various reforms to the existing rate structure for interstate access to the local exchange network that are designed to move access charges, over time, to more cost based rate levels and structures. These changes have reduced, and will continue to reduce, the access charges paid by long distance carriers to, ILECs and will shift charges currently based on minutes of use, to a flat-rate monthly per line charge on end users. On May 31, 2000 the FCC adopted the proposal of the Coalition for Affordable Long Distance Service ("CALLS") that significantly restructures and, reduces in some respects, the interstate access charges of the RBOCs. Among the more significant regulatory changes established by the CALLS order, the RBOCs are required to reduce switched access charges to an average of $0.0055/minute. Price cap ILECs are additionally required to eliminate the presubscribed interexchange carrier charge ("PICC") as a separate charge and fold it into an increased End-User Common Line Charge ("EUCL"). AT&T and Sprint have committed in this proceeding to pass on access charge reductions to consumers, and to eliminate minimum monthly usage charges. Although the CALLS order will not apply directly to CLECs, ILEC reductions in switched access charges may place some downward pressure on CLECs like us to reduce our own switched access charges. While we may be able to increase the EUCL rate to our customers, competitive pricing pressures may make this difficult or impossible. On April 27, 2001 the FCC released an order concerning CLEC interstate access charges specifically. The order seeks to reduce, over three years, CLEC interstate access charges to the level of the ILEC in whose territory the CLEC operates, except in the unlikely event that the IXC agrees to pay a higher rate. The FCC established a benchmark rate at or below which CLEC interstate access charges will be presumed just and reasonable and which CLECs may impose on IXCs by tariff. For new entrants such as us, the FCC set the benchmark rate at the level of the ILEC in whose territory the CLEC operates. In December 2001, the President signed into law the USA PATRIOT Act. Enacted in response to the terrorist acts of September 11, 2001, the Act (1) expands the scope of the government's pen register/trap and trace surveillance powers; (2) permits providers to disclose subscribers' communications or records related thereto to law enforcement or government entities; (3) allows nationwide surveillance under a single court order; (4) simplifies procedures for seizure of voicemail and other communications; (5) subjects cable providers to the wiretapping laws; (6) permits surveillance of computer trespassers; and (7) harmonizes the wiretapping provisions of the Foreign Intelligence Surveillance Act and the federal wiretapping laws. The PATRIOT Act allows electronic communications service providers to divulge communications to law enforcement agencies or records to governmental entities in certain circumstances, but does not provide service providers choosing to do so with liability protections. It is possible that this law will impose additional administrative burdens on us which will increase our costs. Moreover, the extent of carrier liability, if any, for divulging customer information is not clear. We may find that complying with this law exposes us to costly litigation. State Regulation To the extent that we provide telecommunications services which originate and terminate in the same state, we are subject to the jurisdiction of that state's public service commission. As our local service business and product lines expand, we will offer more intrastate service and become increasingly subject to state regulation. The Telecom Act maintains the authority of individual state public service commissions to preside over rate and other proceedings, as discussed above, and impose their own regulation of local exchange and interexchange services so long as such regulation is not inconsistent with the requirements of the Telecom Act. For instance, states may impose tariff and filing requirements, consumer protection measures and obligations to contribute to universal service, and other funds. We are subject to requirements in some states to obtain prior approval for, or notify the state commission of, any transfers of control, sales of assets, corporate reorganizations, issuances of stock or debt instruments and related transactions. Although we believe such authorizations could be obtained in due course, there can be no assurance that the FCC or state commissions would grant us authority to complete any of these transactions. We have state regulatory authority to provide competitive facilities-based local exchange services and interexchange services in 14 states. We also have state regulatory authority to provide resold interexchange services throughout the remaining continental United States. The Telecom Act generally preempts state statutes and regulations that restrict the provision of competitive local services. States, however, may still restrict competition in some rural areas. As a result of this preemption, we will be free to provide the full range of local, long distance, and data services in any state. While this action greatly increases our potential for growth, it also increases the amount of competition to which we may be subject. Local Government Regulation We may be required to obtain from municipal authorities, street opening and construction permits to install our facilities in some cities. In some of the areas where we provide service, we may be subject to municipal franchise requirements requiring us to pay license or franchise fees either on a percentage of gross revenue, flat fee or other basis. The Telecom Act requires municipalities to charge nondiscriminatory fees to all telecommunications providers, but it is uncertain how quickly this requirement will be implemented by particular municipalities in which we operate or plan to operate or whether it will be implemented without a legal challenge. Employees As of March 25, 2002, we employed 705 persons. None of our employees are represented by a collective bargaining agreement. ITEM 2. PROPERTIES Our headquarters and technology center are located in leased space in Waltham, Massachusetts. We have a back-up network operations center in Springfield, Massachusetts. We also lease offices in nine states. Although we believe that our leased facilities are adequate at this time, we expect to lease any additional facilities that may be required for future expansion. ITEM 3. LEGAL PROCEEDINGS (a) Pending Legal Proceedings. We are party to suits and regulatory proceedings arising in the normal course of business which we believe are not material individually or in the aggregate. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is listed on the Nasdaq National Market under the symbol "CPTL." Following is the range of high and low trading prices on the Nasdaq National Market for our common stock for the periods indicated. All prices reflect the March 17, 2000 three-for-two stock split. Price Range --------------- High Low ------- ------ Calendar Year 2000 First Quarter ................ $56.13 $22.67 Second Quarter ................ $45.63 $19.75 Third Quarter ................ $36.06 $13.13 Fourth Quarter ............... $20.44 $3.88 Calendar Year 2001 ............... First Quarter ................ $15.63 $4.44 Second Quarter ................ $7.73 $2.65 Third Quarter ................ $7.23 $2.93 Fourth Quarter ................ $7.95 $4.13 The last sale price of the common stock on the Nasdaq National Market on March 25, 2002 was $2.50. Our common stock was held by 481 stockholders of record. We have never paid cash dividends on our common stock and we have no plans to do so in the foreseeable future. We intend to retain earnings, if any, to develop and expand our business. In addition, the terms of our credit facility and the Series B preferred stock restrict our ability to pay cash dividends on our common stock. We also expect the terms of agreements governing any future indebtedness to restrict our ability to pay cash dividends. During the year ended December 31, 2001, we did not issue any securities which were not registered under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA At the annual meeting of directors held on July 27, 2000, we changed our fiscal year from a twelve month period ending March 31 to a twelve month period ending December 31. The consolidated financial statements include presentation of the nine months ended December 31, 2000. The following selected unaudited financial data for the year ended December 31, 2001, the nine months ended December 31, 2000 and the three years ended March 31, 2000 are derived from our consolidated financial statements. You should read the following financial data together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes. All earnings per share and weighted average share information included in the following financial data have been restated to reflect the March 17, 2000 three-for-two stock split. The following unaudited financial data for each year is presented on a pro forma basis assuming the adoption of SAB 101 as described in Note 2 and also pro forma twelve months ended December 31, 2000 and pro forma nine months ended December 31, 1999 to the consolidated financial statements to permit comparison of operating results and financial condition for all periods presented.
Fiscal Year ended March 31, ------------------------------------------------ 1998 as 1999 as previously pro forma previously pro forma reported 1998 reported 1999 ------- --------- ---------- --------- (dollars in thousands, except per share information) Statement of Operations Data: Agency revenues ...................... $ 24,775 $ 24,775 $ --- $ --- Telecommunications revenues .......... 16,172 15,962 70,964 70,046 --------- --------- --------- --------- Total revenues .................. 40,947 40,737 70,964 70,046 Cost of telecommunications revenue (excluding depreciation and amortization) ....................... 14,039 13,854 61,866 61,055 Selling, general and administrative expenses ............................ 29,488 29,472 52,521 52,451 Depreciation and amortization ........ 1,418 1,418 3,778 3,778 -------- -------- --------- --------- Loss from operations.................. (3,998) (4,007) (47,201) (47,238) Loss before extraordinary item and cumulative effect................ (2,498) (2,507) (51,238) (51,275) Loss before cumulative effect......... (2,498) (2,507) (51,238) (51,275) Net loss.............................. $ (2,498) $ (2,507) $(51,238) (51,275) ========= ========= ========== ========= Per Share Data: Loss per share before extraordinary item and cumulative effect Basic and Diluted.................... (0.17) (0.17) (3.45) (3.46) Loss per share before cumulative effect Basic and Diluted.................... (0.17) (0.17) (3.45) (3.46) Net loss per share Basic and Diluted.................... (0.17) (0.17) (3.45) (3.46) Other Financial Data: EBITDA loss........................... $ (2,405) $ (2,414) $(43,346) $(43,383) Capital expenditures .................. 6,109 6,109 36,041 36,041 Net cash used by operating activities .......................... (7,951) (7,951) (33,254) (33,254) Net cash used in investing activities 4,765 4,765 6,282 6,282 Net cash provided by financing activities ......................... 8,479 8,479 39,622 39,622 Fiscal Year Ended March 31, Nine Months Ended Year Ended December 31 December 31, ------------------- ------------------ ------------------------ 2000 as previously pro forma pro forma pro forma reported 2000 1999 2000 2000 2001 ------- --------- ---------- --------- ------------ ---------- (dollars in thousands, except per share information) Statement of Operations Data: Telecommunications revenues .......... $153,101 $147,517 $102,591 $170,353 $215,278 $299,438 Cost of telecommunications revenue (excluding depreciation and amortization) ....................... 119,586 116,984 82,076 133,196 168,103 240,519 Selling, general and administrative expenses ............................ 56,676 56,363 40,910 63,421 78,875 82,534 Depreciation and amortization ........ 18,754 18,754 11,681 34,917 41,989 77,002 -------- -------- -------- -------- --------- ----------- Loss from operations.................. (41,915) (44,584) (32,076) (61,181) (73,689) (100,617) Loss before extraordinary item and cumulative effect................ (57,073) (59,742) (43,456) (69,326) (85,611) (124,173) Loss before cumulative effect......... (59,504) (62,173) (43,456) (69,326) (88,042) (124,173) Net loss.............................. $(59,504) $(62,173) $(43,456) $(72,205) $(90,921) $(124,173) ========= ========= ========= ========= ========= =========== Per Share Data: Loss per share before extraordinary item and cumulative effect Basic and Diluted.................... $(2.89) $(3.02) $(2.30) $(3.08) $(3.84) $(5.34) Loss per share before cumulative effect Basic and Diluted.................... (3.01) (3.14) (2.30) (3.08) (3.93) (5.34) Net loss per share Basic and Diluted.................... $(3.01) $(3.14) $(2.30) $(3.19) $(4.05) $(5.34) Other Financial Data: EBITDA loss before non-recurring charge............................... $(23,153) $(25,822) $(20,395) $(23,385) $(26,390) $(23,865) EBITDA loss........................... (23,153) (25,822) (20,395) (26,264) (31,699) (23,865) Capital expenditures .................. 71,187 71,187 (41,411) 139,010 168,786 106,472 Net cash used by operating activities .......................... (36,984) (36,984) (27,562) (44,608) (56,087) (38,869) Net cash used in investing activities. 43,721 43,721 (26,155) 79,682 (95,194) (75,033) Net cash provided by financing activities ......................... $98,544 $98,544 $66,985 $184,226 $215,788 $100,162 As of March 31, ------------------------------------------------ 1998 as 1999 as previously pro forma previously pro forma reported 1998 reported 1999 ------- --------- ---------- --------- (dollars in thousands) Balance Sheet Data: Cash and cash equivalents .............$ 2,168 $ 2,168 $ 2,254 $ 2,254 Total assets .......................... 30,768 30,558 69,482 68,564 Total long-term debt, including current portion ..................... 9,673 9,673 64,858 64,858 Series A redeemable convertible preferred stock ..................... -- -- 12,672 12,672 Stockholders' equity (deficit) ........ 11,966 11,957 (37,144) (37,181) Stockholders' equity (deficit)/ preferred stock $11,966 $11,957 $(24,472) $(24,509) Fiscal Year Ended March 31, Nine Months Ended Year Ended December 31 December 31, 2000 as -------------------- ------------------------ previously pro forma 1999 2000 reported 2000 (Pro forma) 2000 (Pro forma) 2001 ------- --------- ---------- --------- ------------ ---------- (dollars in thousands, except per share information) Balance Sheet Data: Cash and cash equivalents .............$ 20,093 $ 20,093 $ 15,522 $ 80,029 $ 80,029 $ 66,289 Total assets .......................... 162,233 157,046 123,074 344,129 344,129 367,438 Total long-term debt, including current portion ..................... 129,122 129,122 85,446 184,822 184,822 324,381 Series A redeemable convertible preferred stock ..................... -- -- 13,712 -- -- -- Series B redeemable convertible preferred stock ..................... -- -- -- 203,249 203,249 222,812 Stockholders' deficit.................. (15,700) (18,369) (16,417) (96,686) (96,686) (241,049) Stockholders' deficit/Preferred stock.. $(15,700) $(18,369) $(2,705) $106,563 $106,563 $(18,237)
EBITDA consists of income (loss) before interest, income taxes, depreciation and amortization. We have provided EBITDA because it is a measure of financial performance commonly used in the telecommunications industry. Other companies may calculate it differently from us. EBITDA is not a measurement of financial performance under accounting principles generally accepted in the United States, or GAAP. We do not believe you should consider EBITDA as an alternative to net income (loss) as a measure of results of operations or to GAAP-based cash flow data as a measure of liquidity. Non-recurring charges represent a cumulative effect of change in accounting principle of $2,879,000 at December 31, 2000 and an extraordinary item for the early extinguishment of debt of $2,431,000 at March 31,2000 and. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Historically, our income consisted of agency revenues and telecommunications revenues. Agency revenues consist of commissions we formerly earned as an agent of Bell Atlantic and other Regional Bell Operating Companies, and long distance providers. Telecommunications revenues are generated by our sale of local, long distance, data communications, Internet access and other communications services. As a result of our transition to an integrated communications provider, or ICP, in January 1998, agency commissions earned after December 31, 1997 were not material. Our financial information for the year ended December 31, 2001 reflects our fourth year of operations under our new strategy. Our financial information for fiscal years ended on or before March 31, 1998 primarily reflects our operations as an agent for Verizon. Because of our transition to a new strategy and our network buildout, most of the financial information for March 31, 1998 and earlier does not reflect our current business and is not comparable to results in subsequent periods. Results of Operations Year Ended December 31, 2001 Compared to Pro forma Twelve Months Ended December 31, 2000 At the Annual Meeting of our Board of Directors held on July 27, 2000, we changed our fiscal year from a twelve month period ending March 31 of each year to a twelve month period ending December 31 of each year. As a result, the pro forma year ended December 31, 2000 is the sum of the nine month transition period ended December 31, 2000 and the quarter ended March 31, 2000. Total revenues for the year ended December 31, 2001 ("2001") were $299,438,000, an increase of 39% from $215,278,000 for the comparable twelve month period of 2000 ("2000") due to an increase in access line equivalents, or ALE's. As an integrated communications provider, revenues reflect our direct sales of local telecommunications services in addition to our direct sales of other telecommunications services, including toll and data services. 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. During the year ended December 31, 2001, voice and data ALEs in service increased by 135,700, or approximately 30%, from the year ended December 30, 2000. This increase is a result of ALE's from new customers and growth from existing customers. This brought total ALEs in service to 589,000 at December 31, 2001. Costs of telecommunications revenues, excluding depreciation and amortization, increased 43% to $240,519,000 for 2001 from $168,103,000 for 2000 as a result of the variable costs associated with increased revenues and increased leased circuits associated with our PowerPath(sm) Network. As a percentage of telecommunications revenue, costs of telecommunications revenues were 80% and 78% for 2001 and 2000, respectively, due to lower discounts and competitive pricing pressures on our off-net services offset in part by an improvement in higher margins on our PowerPath(sm) Network. Selling, general and administrative expenses increased 5% to $82,534,000 in 2001 from $78,875,000 for 2000. This increase was primarily due to the variable costs, such as commissions, associated with the increased revenues. As of December 31, 2001, we had 708 employees including 173 sales executives and 174 network coordinators in 26 branch locations throughout the Northeast and mid-Atlantic states as compared to 725 employees including 216 sales executives and 169 network coordinators in 30 branch locations at December 31, 2000. Included in SG&A, we incurred charges of $700,000 and $3,110,000 in 2001 and 2000, respectively, for the consolidation of collocation and branch office sites to reduce costs and maximize network efficiency through optimal use of fiber deployment and to realize near term operating efficiencies through our branch sites. Depreciation and amortization expense increased 83% to $77,002,000 in 2001 from $41,989,000 in 2000. This increase was a result of additional expense 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. Interest and other expense increased 98% to $23,556,000 for 2001, as compared to interest and other expense of $11,923,000 for 2000. The increase in interest expense is due to increased borrowings to fund our operating losses and the deployment of our network. Nine Months Ended December 31, 2000 Compared to Pro forma Nine Months Ended December 31, 1999 Total revenues for the nine months ended December 31, 2000 ("Transition 2000") were $170,353,000, an increase of 66% from $102,591,000 (restated for SAB 101 - see note 2 in consolidated financial statements) for the comparable nine month period of 1999 ("Transition 1999"). During the quarter ended December 31, 2000, voice and data ALEs in service increased by 46,200, or approximately 11% from the quarter ended September 30, 2000. This brought our total ALEs in service to 453,300 at December 31, 2000. Data ALEs increased by approximately 10% from the quarter ended September 30, 2000 to 98,000, or 22% of total ALEs in service as of December 31, 2000. Data ALEs at December 31, 2000 include ALEs purchased by other carriers including Internet service providers. Costs of telecommunications revenues, excluding depreciation and amortization, increased 62% to $133,196,000 for Transition 2000 from $82,076,000 (restated for SAB 101) for Transition 1999 as a result of our increase in direct sales of local telecommunications services and expenses associated with our PowerPath(sm) Network. As a percentage of telecommunications revenue, costs of telecommunications revenues were 78% and 80% for Transition 2000 and Transition 1999, respectively. Selling, general and administrative expenses increased 56% to $63,421,000 in Transition 2000 from $40,910,000 (restated for SAB 101) for Transition 1999. This increase was primarily due to the costs incurred in opening additional branch sales offices and the associated increased number of sales, service and engineering employees hired in connection with the transition to the ICP platform. As of December 31, 2000, we had 725 employees including 216 sales executives and 169 network coordinators in 30 branch locations throughout the Northeast and mid-Atlantic states as compared to 496 employees including 194 sales executives and 119 network coordinators in 28 branch locations at December 31, 1999. We incurred a charge of $3,110,000 for the consolidation of collocation and branch office sites to reduce costs and maximize network efficiency through optimal use of fiber deployment and to realize near term operating efficiencies through our branch sites. Depreciation and amortization expense increased 199% to $34,916,000 in Transition 2000 from $11,681,000 in Transition 1999. This increase was a result of additional expense 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 3-5 years, reflecting the risk of rapid technological change. Interest and other expense increased 7% to $13,081,000 for Transition 2000, as compared to interest and other expense of $12,246,000 for Transition 1999. The increase in interest expense is due to increased borrowings to fund our operating losses and the deployment of our network. There was an increase in interest income to $4,936,000 as a result of the proceeds of our Series B redeemable convertible preferred stock financing in Transition 2000, as compared to interest income of $865,000 for Transition 1999. We incurred a charge of $2,879,000 for the cumulative effect of a change in accounting principle by adopting Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). See Note 2 to consolidated financial statements. Liquidity and Capital Resources Working capital at December 31, 2001 was $21.0 million compared to $51.5 million at December 31, 2000, a decrease of $31.5 million. Cash balances at December 31, 2001 and December 31, 2000 totaled $66,289,000 and $80,029,000, respectively, excluding restricted cash. The decrease in cash at December 31, 2001 is due to cash used by operating and investing activities of $38.9 million and $75.0 million, respectively, partially offset by cash provided by financing activities of $100.2 million. Accounts Receivable increased 9% from December 31, 2000 to December 31, 2001. This increase was less than the 39% sales increase for the same period. Days sales outstanding improved from 62 days in the fourth quarter of 2000 to 54 days in the fourth quarter of 2001. During 2001, we used cash of $74.4 million to purchase property and equipment primarily to fund the continuation of the buildout of our PowerPath(sm) Network. During the year ended December 31, 2001, we entered into an equipment lease financing arrangement, which restricts $7.5 million of cash as security for this arrangement. During 2001, we borrowed the remaining $125 million under our TD Credit Facility. As of December 31, 2001, the full $225 million of the TD Credit Facility has been utilized. During 2001, we repaid $27.0 million of capital leases and notes payable. 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 December 31, 2001 and 2000, the aggregate amount borrowed under these agreements was approximately $141.1 million and $100 million, respectively. In May 2000, we completed 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 at the option of the holder. We may require conversion of the preferred shares if our common stock reaches certain levels. We 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 were used to fund strategic marketing and technology initiatives of our business plan which include the purchase of dark fiber and optronics, PowerPath(sm) Network expansion and new PowerPath(sm) Network product and applications development. In March 2000, TD Securities (U.S.) Inc. underwrote a $225 million senior secured credit facility ("TD Credit Facility") to fund our base plan for expansion of our branch sales offices and our PowerPath(sm) 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 TD Credit 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. At December 31, 2001, the Company was not in compliance with the covenants prior to the amendment signed in March 2002. However, as of December 31, 2001, the Company is in compliance with all the 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 March 2002 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 December 31, 2001, the full $225 million of the TD Credit Facility has been utilized. 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 March 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 TD Credit Facility with an additional covenant relating to minimum unrestricted cash balance. 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. We will continue to use the proceeds remaining from the TD Credit Facility and 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 and further penetration of our existing region throughout the Northeast and Mid- Atlantic states. Until utilized, the net proceeds from the TD Credit Facility and Series B redeemable convertible preferred stock financing are being invested in short-term, interest-bearing instruments and other investment-grade securities. We believe that cash on hand and the amounts expected to be available under our Vendor Finance Facility will be sufficient to fund our planned capital expenditures, working capital and operating losses for at least the next 12 months. We also believe that these sources fully fund the business plan described in our Business Overview in Item 1. We can provide no assurance that if we require funds in addition to the funds made available through the TD Credit Facility, the preferred stock financing and the Vendor Finance Facility, such financing will be available, or if available, on terms acceptable to us when needed. If we are unable to obtain such financing when needed, we may be required to postpone or abandon our development and expansion plans, which could have a material adverse effect on our business, results of operations and financial condition. The actual timing and amount of our capital requirements may be materially affected by various factors, including the timing and actual cost of the network, the timing and cost of our expansion into new markets, the extent of competition and pricing of telecommunications services by others in our markets, the demand by customers for our services, technological change and potential acquisitions. The Company's covenants under its debt and vendor financing facilities (see Note 6) contemplate improvements in the Company's operating results in fiscal 2002 over 2001. Among other things, these covenants require significant improvement in Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), as defined in the Senior Facility and the Vendor Financing Facility, (see Note 6). The Company's ability to remain in compliance with the covenants is dependent upon the Company's continued execution of its business plan which consists of the following primary initiatives; continued migration of existing offnet customers onto the Company's network, improving margins by reducing network costs of goods, (primarily by replacing leased network facilities with owned and operated fiber facilities), controlling selling, general and administrative expenses and continued revenue growth by adding new customers and selling new services. In the event that conditions arise that do not allow the Company to meet all of the primary initiatives of its business plan, management expects to take all necessary actions to remain in compliance with its required covenants which may include the reduction of certain operating expenses, migration of customers onto the Company's network and elimination of certain discretionary expenses. Management believes that if necessary, these actions could be implemented to meet its covenants, including its EBITDA covenant. Description of Senior Secured Facility TD Securities (U.S.) Inc. Facility In March 2000, we entered into a $225 million senior secured credit facility with a consortium of banks. The TD Credit Facility is comprised of a $50 million senior secured revolving credit facility (the "Revolver") with a seven and one-half year term, a $100 million senior, delayed draw term facility with a seven and one-half year term ("Term A") and a $75 million senior secured eight year term loan facility ("Term B"). As amended in March 2002, advances under the Revolver and Term A bear interest at either prime rate plus 2.25-3.5% per annum or London interbank rate ("LIBOR") plus 3.25- 4.5% per annum based upon the total leverage ratio in effect at the time. Term B borrowings bear interest at the prime rate plus 3.75% per annum or LIBOR plus 4.75% per annum. Borrowing at prime or LIBOR is at our discretion. As required by the TD Credit Facility, Term B borrowings of $75 million were drawn down in full at the closing date along with borrowings of $25 million under the Revolver. Part of the proceeds were used to pay off a $25 million vendor financing facility and the outstanding balance of the existing credit facility revolving line of credit of approximately $43 million. We paid a one-time up front fee and other closing costs, which have been capitalized as deferred financing costs and are being amortized as interest expense over the term of the TD Credit Facility. The unamortized balance of deferred financing costs associated with the previously existing credit facility were recorded as an extraordinary item in the fiscal year ended March 31, 2000. We will pay an annual commitment fee of .75-1.5% per annum, depending on the percentage of the total Senior Facility used. At December 31, 2001, the entire $225 million was outstanding. At June 30, 2003, we will begin to repay the outstanding balances of Term A and Term B on a quarterly basis through the year 2007. In September 2000, we entered into an interest rate collar agreement with a notional amount outstanding at December 31, 2000 of $33 million, with an expected maturity date in the year 2003. The interest rate collar effectively locks $33 million of the Senior Facility borrowings between 12.25% and 9.67%. In addition we have an interest rate swap which effectively caps $17 million of 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. In March 2002, we amended the agreement covering our TD Credit Facility to include new covenants as well as an increase in the interest rate grids. The bank syndicate will receive common stock warrants, which could total 3.25% of our outstanding shares of common stock. The issuance, terms and prices of the warrants are structured in the same manner as the warrants issuable under the Vendor Finance Facility. The TD Credit 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. We have also agreed, among other things, not to assume any other secured debt other than capital leases, agree to a merger, sell our assets or declare dividends without the consent of the lenders. Critical Accounting Policies Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. (See note 2 to the financial statements). We believe the following represent our critical accounting policies: Revenue Recognition We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), as amended by SAB 101A and 101B. SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured. We use historical data to estimate a provision for any sales allowances. Historically our provisions for allowances have remained relatively constant as a percentage of sales. We do not believe different assumptions would lead to materially different amounts recorded. If our experience were to change in the future, we may have to adjust our provision accordingly. Allowance for Bad Debt We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We use current evidence of collectability and historical data to estimate this provision. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Property and Equipment Property and equipment are stated at the lower of cost or fair market value less accumulated depreciation. Our policy requires capitalization of all direct costs associated with acquiring and installing an asset to perform its intended use and expensing of all costs relating to the ongoing operations and maintenance of the Powerpath(sm) Network. Significant internal resources are utilized in the buildout of our Powerpath(sm) Network and have been capitalized as a component of property and equipment. The process of providing a connection between our customers and our Powerpath(sm) Network requires that we lease a customer specific last mile circuit. We capitalize the cost of this circuit while we install it to our asset at our customer's location. Once telecommunications traffic can flow over the circuit, usually within a month, these circuit lease costs are expensed. Our policy incorporates estimates, assumptions and judgments by management relative to the capitalized costs and useful lives of all property and equipment, including the Powerpath(sm) Network and related assets. We believe the judgements and estimates we have used to date result in an accurate recording of our property and equipment. Changes in business conditions in the future may lead to changes in our judgements and estimates. Derivative Transactions We utilize derivative financial instrument transactions in the form of interest rate swap, collar and cap agreements to hedge variable rate interest risk. The effective portion of the hedge is recorded in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Changes in market conditions could impact the amount of derivative change in fair value that is recognized in earnings. The assessment of hedge effectiveness is made quarterly. Changes in market conditions could affect the assessment of hedge effectiveness. Hedges that are not deemed to be highly effective would result in changes in fair value for the entire hedging instrument to be recognized in earnings. Recent Accounting Pronouncements In July, 2001, the Financial Accounting Standards Board issued Statement No. 141, "Business Combinations" (FAS 141) and Statement No. 142, "Goodwill and Other Intangible Assets" (FAS 142). FAS 141 eliminates the pooling-of- interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. FAS 141 further clarifies the criteria to recognize intangible assets separately from goodwill. The requirements of Statement 141 are effective for any business combination accounted for by the purchase method that is completed after June 30, 2001. Under FAS 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of Statement 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, companies are required to adopt FAS 142 in their fiscal year beginning after December 15, 2001. For the intangible assets acquired on or before June 30, 2001 the intangibles will be amortized during this transition period until adoption of FAS 142. We are not expecting any material impact from the adoption FAS 141 and FAS 142 on our financial position and results of operations. In June 2001, the Financial Accounting Standards Board issued Statement No. 143, "Accounting for Asset Retirement Obligations" (FAS 143), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It also applies the legal obligations associated with the retirement of long-lived assets that result from acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The standard is effective for fiscal years beginning after June 15, 2002 (January 1, 2003 for the Company), with earlier application encouraged. We believe the adoption of FAS 143 will not have a material impact on our financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144), which addresses the financial accounting and reporting for the impairment of long-lived assets. This statement supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions for the disposal of a segment of a business of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The provisions of this statement are effective for the financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early adoption permitted. We believes that the adoption of FAS 144 will not have a material impact on our financial position or results of operations. Adoption of Staff Accounting Bulletin 101. We have revised our revenue recognition policy for certain recurring monthly fees to be consistent with applicable provisions of Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). Previously, monthly recurring fees for the next month's service were recognized at the time all of our significant performance obligations had been fulfilled and the related monthly service fee became nonrefundable based on the terms of the contract with our customers which require 60 days notice for cancellation. Since SAB 101 now indicates that nonrefundability of revenues and fulfillment of all significant performance obligations are not a basis for revenue recognition, we have determined that deferral of the monthly recurring service fees to the period in which the service is available to the customer is a preferable method of accounting. The impact of the change in recognizing recurring service fees was reported as a cumulative effect of a change in accounting principle as of April 1, 2000 in accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes". The cumulative effect of this change increased our loss by approximately $2.9 million as of April 1, 2000. This amount represents the income attributable to the deferral, as of that date, of one month's recurring service fee revenue totaling approximately $10 million. The previously reported quarterly financial information for the nine month transition period ended December 31, 2000 has been restated so that annual operating results for the transition period are presented on the new basis. There is no impact to our cash flow from operations as a result of this change. Also, the adoption of this change in accounting for the fiscal year ended March 31, 2000 or prior periods did not have a material effect on the our previously reported results of operations, financial position or cash flows for those periods. ITEM 7A. 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 TD credit facility. The TD Credit Facility interest payments are determined by the outstanding indebtedness and the prime or LIBOR rate at the beginning of the period in which interest is computed. As required under the TD Credit Facility, we utilize interest rate swap, cap and collar agreements to hedge variable rate interest risk on 50% of the TD Credit Facility. All of our derivative financial instrument transactions are entered into for non-trading purposes. Notional amounts outstanding at December 31, 2001 subject to the interest rate collar is $33 million, with an expected maturity date in the year 2003. The interest rate collar effectively locks $33 million of our TD credit facility borrowings between 12.25% and 9.67%. Notional amount outstanding at December 31, 2001 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 TD credit 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 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 December 31, 2001. We compared the market values resulting from these computations with the market values of these financial instruments at December 31, 2001. 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 December 31, 2001, 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 $1.3 million for the year ended December 31, 2001. A 10% decrease in interest rates would result in reduced interest expense and cash expenditures of approximately $85,000 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 December 31, 2001. We compared the market values resulting from these computations with the market values of these financial instruments at December 31, 2001. 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 December 31, 2001, 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 $1.9 million for the year ended December 31, 2001. A 10% decrease in dividend rates would result in reduced dividends of approximately $1.9 million for the same period. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Financial Statements, Financial Statements and Supplementary Data begin on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT* Our executive officers and directors are as follows: Name Current Office Held - ---------------------- -------------------------------------- Robert J. Fabbricatore Chairman and Chief Executive Officer Steven P. Milton President and Chief Operating Officer John D. Pittenger Executive Vice President-Finance and Administration, Chief Financial Officer, Treasurer and Secretary Thomas Fabbricatore Vice President--Business Systems Anthony D. Vermette Vice President--Sales Frederick Kunzi Vice President and Chief Technology Officer Jeffrey C. Lavin Vice President--Corporate Development Russell Oliver Vice President--Network Operations Katherine D. Courage Director Henry Hermann Director Kevin J. Maroni Director J. Richard Murphy Director Mark E. Nunnelly Director Carl Redfield Director Richard J. Santagati Director Ralph C. Sillari Director Scott M. Sperling Director Ralph S. Troupe Director Robert J. Fabbricatore, a founder of the Company and a director since its inception in 1980, became Chairman of the Board of Directors in March 1983 and served as President from October 1993 to August 1995. Robert J. Fabbricatore is the brother of Thomas Fabbricatore, Vice President-Business Systems. Steven P. Milton has been employed by the Company since 1984 and has served as President and Chief Operating Officer since August 1995. Prior to that, he held various positions within the Company including Branch Manager, District Manager, Regional Manager and Vice President--Sales and Marketing. John D. Pittenger has served as Chief Financial Officer since April 14, 1999, as Executive Vice President--Finance and Administration since April 1998 and as Treasurer and Secretary of the Company since August 1989. Mr. Pittenger served as Vice President--Finance from 1991 until April 1998, and as Chief Financial Officer from 1989 to April 1998. Thomas Fabbricatore has been employed by the Company since 1982 in a number of positions. He was named Vice President--Business Systems in 1999. Thomas Fabbricatore is the brother of Robert J. Fabbricatore. Anthony D. Vermette has been employed by the Company in a variety of positions since 1987. Mr. Vermette was named Vice President--Sales in 1996. Frederick Kunzi joined the Company as a Vice President and Chief Technology Officer in August 1998. Mr. Kunzi has over 25 years experience in information technology. From 1985 to September 1998, he was employed by Digital Equipment Corporation, most recently as Senior Manager, Global Network Services where he was responsible for Digital's worldwide enterprise network infrastructure. Jeffrey C. Lavin joined the Company in June 1998 as Vice President--Corporate Development. Mr. Lavin has 20 years of sales and operational management experience in the telecommunications industry. From December 1996 to May 1998, Mr. Lavin was Vice President of Sales, Americas/Asia Pacific for NovaSoft Systems, Inc., a software development corporation. From 1979 to 1996, Mr. Lavin was employed by Comlink Incorporated, a communications network integrator, most recently as Senior Vice President. Following the acquisition of Comlink in 1996 by Williams Communications, Mr. Lavin serve as Vice President and General Manager of Network Systems Integration. Russell Oliver joined the Company in October 1999 as Vice President--Network Operations. From 1985 to 1996, Mr. Oliver was employed by by Comlink Incorporated, a communications network integrator, most recently as Vice President of Operations, Following the acquisition of Comlink in 1996 by Williams Communications, Mr. Oliver served as Vice President of Network Systems Integration. From September 1998 to October 1999, Mr. Oliver was employed by LaVigne as Vice President of Operations, where he was responsible for network systems integration throughout North America. Mr. Oliver serves on the Board of Directors of BICSI, a non-profit association that promotes standards and education throughout the telecommunications industry. Katherine D. Courage became a director of the Company in April 1999. Ms. Courage is a managing director in the Global Telecommunications and Media Group in the Investment Banking Department of Credit Suisse First Boston, one of the underwriters of our earlier common stock offerings. Prior to joining Credit Suisse First Boston in September 1996, Ms. Courage worked at Salomon Brothers Inc. for ten years where she was a managing director in the Global Telecommunications Group. Ms. Courage currently serves as a director of NorthEast Optic Network, Inc. Credit Suisse First Boston Equity Partners, L.P., as a Series B preferred stockholder, has appointed Ms. Courage as its designee to the Company's Board of Directors. Henry Hermann, CFA, became a director of the Company in September 1996. Since November 1997, he has operated Hermann Companies, a financial services company. Mr. Hermann is registered as an Investment Advisor with the State of Texas, a Chartered Financial Analyst and, as an independent contractor, offers general securities through SWS Financial. Mr. Hermann has been a NASD Board of Arbitrators Member since 1991. Kevin J. Maroni joined the board in April 1998. Mr. Maroni is a Managing General Partner of Spectrum Equity Investors, a leading private equity firm focused on communications companies with $2.9 billion under management. Prior to Spectrum, Mr. Maroni worked at Time Warner, Inc. and Harvard Management Company. Mr. Maroni currently sits on several private company boards. He holds an MBA from Harvard University and a AB from the University of Michigan. J. Richard Murphy became a director of the Company in August 1995. Mr. Murphy is a managing director of Atlantic Management Company Incorporated (AMC), a Portsmouth, a New Hampshire valuation, investment banking and financial advisory firm that has been serving New England's business, legal and financial communities since 1968. Prior to joining AMC in January 2002, Mr. Murphy was a managing director of Baldwin & Clarke Corporate Finance, Inc., a Bedford, New Hampshire investment banking firm which he joined August 1999. Mr. Murphy was the director of the Corporate Advisory Group of Moody, Cavanaugh and Company, LLP, a North Andover, Massachusetts public accounting firm, from April 1996 to August 1999. Mark E. Nunnelly became director of the Company in June 2000 as a designee of Bain Capital, Inc. He joined Bain Capital as a General Partner in 1990 and has served as Managing Director since April 1993. Mr. Nunnelly also serves on the Board of Directors of Domino's, DoubleClick, Modus Media International, and Eschelon Telecom. Mr. Nunnelly received an M.B.A. from Harvard Business School and a B.A. from Centre College. Carl Redfield became a director of the Company in January 1999. He has been Senior Vice President, Manufacturing and Logistics of Cisco since February 1997. From September 1993 to February 1997 he was Vice President of Manufacturing. Mr. Redfield also is a director of VA Linus Systems, Inc., iBasis Inc. and Broadwing, Inc. Richard J. Santagati became a director of the Company in September 1991. He has been the President of Merrimack College in North Andover, Massachusetts since 1994. From March 1992 to February 1994, Mr. Santagati was the Chairman of the Board, Chief Executive Officer and President of Artel Communications Corp., a publicly held data communications firm located in Hudson, Massachusetts. Mr. Santagati also serves as a director of Celerity Solutions, Inc., a software company. Ralph C. Sillari became a director of the Company in October 1997. Since 1991, Mr. Sillari has been employed by Fleet National Bank where he is currently an Executive Vice President, Manager of Regional Banking. Scott M. Sperling became a director of the Company in May 2000 as a designee of Thomas H. Lee Company. He has been a Managing Director of Thomas H. Lee Company since July 1994 and is also President of TH Lee, Putnam Capital, Trustee of THL Equity Trust III and Managing Director of THL Equity Advisors IV, LLC. Mr. Sperling is currently a Director of Fisher Scientific International, Inc., GenTek, Inc., Safelite Glass Corp., LiveWire Systems LLC, Wyndham International, GoodHome.com and several private companies. He holds an MBA degree from Harvard University and a B.S. from Purdue University. Ralph S. Troupe became a director of the Company in May 1999. In October 1999, Mr. Troupe co-founded Callisma (formerly known as Rt.1 Solutions), a network services company focusing on all key aspects of complex network planning, design and implementation, and serves as its President and Chief Executive Officer. From January 1993 to October 1999, Mr. Troupe was employed by International Network Services, most recently as Vice President of North American Field Operations, East. Mr. Troupe holds a B.S. degree from Northeastern University and is a 1998 graduate of the Harvard Business School Advanced Management Program for International Senior Managers. ITEM 11. EXECUTIVE COMPENSATION* ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT* ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS* *The balance of the information required by Item 10 of Part III of this Annual Report, and Items 11 through 13 of Part III of this Annual Report are incorporated by reference to the corresponding items in our definitive proxy statement to be filed with the Securities and Exchange Commission in April 2002. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Operations for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000. Consolidated Statements of Stockholders' Equity (Deficit) for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000 Consolidated Statements of Cash Flows for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000 Notes to Consolidated Financial Statements (2) Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts Financial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the required information, where material, is shown in the financial statements or notes. (3) Exhibits: The following Exhibits are either filed herewith or have heretofore been filed with the Securities and Exchange Commission and are referred to and incorporated herein by reference to such filings.
Exhibit No. Title - ------------ ----- 3.1 Restated Articles of Incorporation (11) 3.2 Certificate of Designation for Series B Convertible Preferred Stock (5) 3.3 Amended and Restated By-Laws (11) 4.1 Form of Common Stock Certificate (3) 10.1 1996 Stock Option Plan, as amended (1) 10.2 1993 Stock Option Plan (3) 10.3 Employee Stock Purchase Plan (2) 10.4 Lease for premises at 360 Second Ave., Waltham, MA (3) 10.5 Sublease for premises at 360 Second Ave., Waltham, MA (3) 10.6 Lease for premises at 110 Hartwell Ave., Lexington, MA (3) 10.7 Lease for premises at 120 Broadway, New York, NY (3) 10.8 Agreement dated February 1, 1996 between NYNEX and CTC Communications Corp. (3) 10.9 Agreement dated May 1, 1997 between Pacific Bell and CTC Communications Corp. (3) 10.10 Agreement dated January 1, 1996 between SNET America, Inc. and CTC Communications Corp. (3) 10.11 Agreement dated June 23, 1995 between IXC Long Distance Inc. and CTC Communications Corp., as amended (3) 10.12 Agreement dated August 19, 1996 between Innovative Telecom Corp. and CTC Communications Corp. (3) 10.13 Agreement dated October 20, 1994 between Frontier Communications 10.14 Agreement dated January 21, 1997 between Intermedia Communications Inc. and CTC Communications Corp. (3) 10.16 Securities Purchase Agreement dated April 10, 1998 among CTC Communications Corp. and the Purchasers named therein (4) 10.17 Registration Rights Agreement dated April 10, 1998 among CTC Communications Corp. and the Holders named therein (4) 10.18 Form of Warrant dated April 10, 1998 (4) 10.19 Loan and Security Agreement dated as of September 1, 1998 by and between CTC Communications Corp., Goldman Sachs Credit Partners L.P. and Fleet National Bank (6) 10.20 Agreement with Cisco Systems Capital Corp. dated as of October 14, 1998 (7) 10.21 Warrant dated July 15, 1998 issued to Spectrum (8) 10.22 Lease for premises at 220 Bear Hill Rd., Waltham, MA (8) 10.23 Warrant dated September 1, 1998 issued to Goldman Sachs & Co. (8) 10.24 Warrant dated September 1, 1998 issued to Fleet National Bank (8) 10.25 1998 Incentive Plan, as amended (1) 10.26 Loan Agreement dated as of March 15, 1999 by and between CTC Communications Corp, TD Dominion (Texas), Inc. & TD Securities(USA), Inc.(9) 10.27 Warrant dated March 24, 1999 issued to Toronto Dominion (Texas), Inc. (9) 10.28 1999 Equity Incentive Plan for Non-Employee Directors (1) 10.29 Series B Preferred Stock Purchase Agreement dated as of March 22, 2000. (5) 10.30 Series B Preferred Stock Registration Rights Agreement dated as of March 22, 2000. (5) 10.31 Amendment No. 1 to Loan and Security Agreement dated as of September 30, 1999 among CTC Communications Corp., Fleet National Bank and Goldman Sachs Credit Partners L.P. (12) 10.32** Dark Fiber IRU Agreement between Williams Communications, Inc. and CTC Communications Corp. dated as of March 31, 2000 (13) 10.33** Carrier Services Agreement between Williams Communications, Inc. and CTC Communications Corp. dated as of March 31, 2000 (13) 10.34 $225 Million Credit Agreement with TD Securities (USA) Inc. and the other parties to the agreement dated as of March 30, 2000 (14) 10.35 Lease for premises at 115-125 Bear Hill Rd., Waltham MA 02451(14) 10.36 2000 Flexible Stock Plan (13) 10.37 Fourth Amendment dated as of February 27, 2002 to Credit Agreement with TD Securities (USA) Inc. and the other parties to the agreement dated as of March 30, 2000 (++) 23 Consent of Ernst & Young LLP (++) 27 Financial Data Schedule (++) 99 Risk Factors (++) - ------------------ ++ Filed herewith. (1) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-8 (File No. 333-93735). (2) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-8 (File No. 33-44337). (3) Incorporated by reference to an Exhibit filed as part of the Registrant's Annual Report on Form 10-K for the Fiscal Year Ended March 31, 1997. (4) Incorporated by reference to an Exhibit filed as part of the Registrant's Current Report on Form 8-K dated May 15, 1998. (5) Incorporated by reference to an Exhibit filed as part of the Registrant's Current Report on Form 8-K dated April 19, 2000. (6) Incorporated by reference to an Exhibit filed as part of the Registrant's Current Report on Form 8-K dated October 2, 1998. (7) Incorporated by reference to an Exhibit filed as part of the Registrant's Current Report on Form 8-K dated November 6, 1998. (8) Incorporated by reference to an Exhibit filed as part of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. (9) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-1 (File No. 333-77709). (10) Incorporated by reference to an Appendix filed as part of the Registrant's Schedule 14A (Amendment No. 2) filed on June 4, 1999. (11) Incorporated by reference to an Exhibit filed as part of the Registrant's Current Report on Form 8-K dated October 1, 1999. (12) Incorporated by reference to an Exhibit filed as part of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. (13) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-8 (File No. 333-44002). (14) Incorporated by reference to an exhibit filed as part of the Registrant's Annual Report on Form 10-K for the nine months ended December 31, 2001. ** PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT
(4) Reports on Form 8-K The Company filed the following reports on Form 8-K during the quarter ended December 31, 2001: Date Items Reported - ---- -------------- October 2, 2001. Announcement that Fiber Access and Packet Based Dial Tone and Voice Services Available to Maine Customers October 23, 2001. Announcement that (1) we have applied for a U.S. patent on our Intergrated Communications System, or PowerPath(sm) network and (2) the Wall Street Transcript has published an in-depth interview with Robert J. Fabbricatore, our Chairman and CEO. October 31, 2001 Announcement of results for the quarter ended September 30, 2001. SIGNATURES SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED ON THIS 31st DAY OF MARCH, 2002. CTC Communications Group, Inc. By: /s/ Robert J. Fabbricatore ---------------------------------------- Robert J. Fabbricatore, Chairman and Chief Executive Officer PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT IN THE CAPACITIES AND ON THE DATES INDICATED: SIGNATURE TITLE DATE --------- ----- ---- Chairman of the Board March 31, 2002 /s/Robert J. Fabbricatore and Chief Executive Robert J. Fabbricatore Officer, Director Chief Financial Officer March 31, 2002 /s/ John D. Pittenger and Chief Accounting John D. Pittenger Officer /s/ Katherine D. Courage Katherine D. Courage Director March 31, 2002 /s/ Henry Hermann Henry Hermann Director March 31, 2002 /s/ Kevin J. Maroni Kevin J. Maroni Director March 31, 2002 /s/ J. Richard Murphy J. Richard Murphy Director March 31, 2002 /s/ Mark E. Nunnelly Mark E. Nunnelly Director March 31, 2002 /s/ Carl Redfield Carl Redfield Director March 31, 2002 /s/ Richard J. Santagati Richard J. Santagati Director March 31, 2002 /s/ Ralph C. Sillari Ralph C. Sillari Director March 31, 2002 /s/ Scott M. Sperling Scott M. Sperling Director March 31, 2002 /s/ Ralph S. Troupe Ralph S. Troupe Director March 31, 2002 CTC COMMUNICATIONS GROUP, INC. Index to Financial Statements
Audited Consolidated Financial Statements Management's responsibility for financial statements......................... F-1 Report of Independent Auditors............................................... F-2 Consolidated Balance Sheets as of December 31, 2001 and 2000................. F-3 Consolidated Statements of Operations for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000... F-4 Consolidated Statements of Stockholders' Equity (Deficit) for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000................... F-5 Consolidated Statements of Cash Flows for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000........................................... F-7 Notes to Consolidated Financial Statements................................... F-8
- ------------------------------ MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information for CTC Communications Group, Inc. appearing in this report. Management believes that the consolidated financial statements fairly reflect the form and substance of transactions and that the consolidated financial statements reasonably present CTCCommunications Group, Inc.'s financial position and results of operations in conformity with accounting principles generally accepted in the United States. Management has also included in the consolidated financial statements amounts that are based on estimates and judgments which it believes are reasonable under the circumstances. The independent auditors audit the consolidated financial statements in conformity with accounting principles generally accepted in the United States and provide an objective, independent review of the fairness of reported operating results and consolidated financial position. The Board of Directors of CTC Communications Group, Inc. has an Audit Committee composed of four non-management directors. The Committee meets periodically with financial management and the independent auditors to review accounting, control and financial reporting matters applicable to CTC Communications Group, Inc. F-1 Report of Independent Auditors The Board of Directors and Stockholders CTC Communications Group, Inc. We have audited the accompanying consolidated balance sheets of CTC Communications Group, Inc., as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CTC Communications Group, Inc. at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Boston, Massachusetts February 15, 2002, except for Note 6 and the last paragraph of Note 7, as to which the date is March 6, 2002 F-2 CTC COMMUNICATIONS GROUP, INC. CONSOLIDATED BALANCE SHEETS
December 31, 2001 2000 ----------- ------------ ASSETS Current assets: Cash and cash equivalents $66,289,140 $80,029,442 Restricted cash - current 550,000 - Accounts receivable, less allowance for doubtful accounts of $6,915,598 and $4,501,672 in December 2001 and 2000, respectively 47,059,065 43,137,423 Prepaid commissions 2,200,000 2,518,995 Prepaid expenses and other current assets 1,186,850 1,030,603 Notes receivable from executives 1,217,281 6,375,135 Amounts due from employees 158,561 212,304 ------------- ------------- Total current assets 118,660,897 133,303,902 Property and equipment: Property and equipment 366,087,446 259,615,413 Accumulated depreciation and amortization (135,762,149) (63,873,598) ------------- ------------- Total property and equipment, net 230,325,297 195,741,815 Restricted cash - noncurrent 6,950,000 - Deferred financing costs, net of amortization 6,124,749 6,403,413 Other assets 5,377,382 8,679,463 ------------- ------------- Total assets $367,438,325 $344,128,593 ============== ============== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable and accrued expenses $56,657,154 $48,716,754 Accounts payable to related party 1,641,525 744,796 Accrued salaries and related taxes 2,995,383 3,282,079 Current portion of obligations under capital leases 33,036,325 27,055,850 Current portion of notes payable 3,354,399 1,983,984 ------------- ------------- Total current liabilities 97,684,786 81,783,463 Long term liabilities: Obligations under capital leases, net of current portion 60,324,538 52,763,576 Notes payable, net of current portion 225,000,000 103,018,589 Other 2,665,710 - ------------- ------------- Total long term liabilities 287,990,248 155,782,165 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 December 31, 2001 and 2000, respectively (liquidation preference $255,546,343 at December 31, 2001) 222,812,360 203,249,272 Stockholders' deficit: Common stock, par value $.01 per share; authorized 100,000,000 shares, 27,103,730 and 26,582,137 shares issued and outstanding at December 31, 2001 and 2000, respectively 271,037 265,821 Additional paid-in capital 95,528,040 93,300,483 Deferred compensation - (26,910) Other accumulated comprehensive loss (2,886,424) - Retained deficit (333,961,722) (190,225,701) ------------- -------------- Total stockholders' deficit (241,049,069) (96,686,307) ------------- -------------- Total liabilities and stockholders' deficit $367,438,325 $344,128,593 ============== ============== The accompanying notes are an integral part of these consolidated financial statements.
F-3 CTC COMMUNICATIONS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Year Ended Months Ended Year Ended December 31, December 31, March 31, 2001 2000 2000 ---------------- ----------- ------------ Telecommunications revenues $299,438,481 $170,352,695 $153,100,934 Operating costs and expenses: Cost of telecommunications revenues (excluding depreciation and amortization) 240,518,899 133,196,099 119,585,548 Selling, general and administrative expenses 82,534,316 63,421,022 56,676,773 Depreciation and amortization 77,002,257 34,916,209 18,753,667 ----------------------------------------- Total operating costs and expenses 400,055,472 231,533,330 195,015,988 ----------------------------------------- Loss from operations (100,616,991) (61,180,635) (41,915,054) Other income (expense): Interest income 2,873,314 4,935,575 996,283 Interest expense (26,179,255) (13,081,070) (16,162,835) Other income (expense) (250,000) - 8,519 ----------------------------------------- Total other expense (23,555,941) (8,145,495) (15,158,033) ----------------------------------------- Loss before extraordinary item and cumulative effect of change in accounting principle (124,172,932) (69,326,130) (57,073,087) Extraordinary item - early extinguishment of debt - - (2,430,456) ----------------------------------------- Loss before the cumulative effect of change in accounting principle (124,172,932) (69,326,130) (59,503,543) Cumulative effect of change in accounting principle - (2,878,949) - ----------------------------------------- Net loss ($124,172,932) ($72,205,079) ($59,503,543) ========================================== Net loss available to common stockholders ($143,736,021) ($83,722,079) ($61,112,894) ========================================== Loss per common share excluding extraordinary item and cumulative effect of change in accounting principle Basic and Diluted ($5.34) ($3.08) ($2.89) Loss per common share before cumulative effect of change in accounting principle: Basic and Diluted ($5.34) ($3.08) ($3.01) Cumulative effect of change in accounting principle - (0.11) - ----------------------------------------- Net loss per common share: Basic and Diluted ($5.34) ($3.19) ($3.01) Weighted average number of shares used in computing ========================================== net loss per common share: Basic and Diluted 26,903,518 26,249,173 20,320,626 ========================================== Pro forma amounts assuming the accounting change is applied retroactively: Loss before extraordinary item ($124,172,932) ($69,326,130) ($57,914,190) Net loss ($124,172,932) ($69,326,130) ($60,344,646) Net loss per common share ($5.34) ($3.08) ($3.05) The accompanying notes are an integral part of these consolidated financial statements.
F-4 CTC Communications Group, Inc. Consolidated Statements of Stockholders' Equity (Deficit)
Common Stock Additional Retained Amount --------------------- Paid-In Deferred Earnings Treasury Due From Shares Par Value Capital Compensation (Deficit) Stock Stockholders Total ---------- --------- ---------- ------------ ------------ -------- ------------ ----------- Balance at March 31, 1999................... 10,352,513 $103,525 $8,386,816 $(212,410) $(45,390,732) -- $(31,025) $(37,143,826) Issuance of stock pursuant to employee stock purchase plan... 16,875 169 183,465 -- -- -- -- 183,634 Exercise of employee stock options......... 1,339,979 13,400 7,179,737 -- -- -- -- 7,193,137 Issuance of common stock................. 4,025,000 40,250 61,758,528 -- -- -- -- 61,798,778 Issuance of common stock due to stock split................. 7,740,882 77,408 (77,408) -- -- -- -- -- Noncash stock compensation.......... 10,503 105 2,456,934 -- -- -- -- 2,457,039 Acquisition of treasury stock................. -- -- -- -- -- $(3,494,121) -- (3,494,121) Retirement of treasury stock................. (88,834) (888) (3,493,233) -- -- 3,494,121 -- -- Deferred compensation.. -- -- -- 106,000 -- -- 106,000 Receipt of amounts due from stockholders..... -- -- -- -- -- -- 31,025 31,025 Accretion of offering costs related to Series A convertible preferred stock....... -- -- -- -- (112,000) -- -- (112,000) Accretion of warrants related to Series A convertible preferred stock................. -- -- -- -- (296,888) -- -- (296,888) Preferred stock dividend.............. -- -- -- -- (1,200,459) -- -- (1,200,459) Conversion of Series A convertible preferred stock to common stock 2,376,660 23,767 14,257,181 -- -- -- -- 14,280,948 Net loss............... -- -- -- -- (59,503,543) -- -- (59,503,543) ---------- -------- ---------- --------- ------------ --------- --------- ------------ Balance at March 31, 2000......... 25,773,578 257,736 90,652,020 (106,410) (106,503,622) -- -- (15,700,276) Issuance of stock pursuant to employee stock purchase plan... 5,689 57 135,341 -- -- -- -- 135,398 Exercise of employee stock options......... 938,733 9,387 4,499,809 -- -- -- -- 4,509,196 Acquisition of treasury stock................. -- -- -- -- -- (1,988,046) -- (1,988,046) Retirement of treasury stock................. (135,863) (1,359) (1,986,687) -- -- 1,988,046 -- -- Deferred compensation.. -- -- -- 79,500 -- -- 79,500 Accretion of offering costs related to Series B redeemable convertible preferred stock . -- -- -- -- (1,033,466) -- -- (1,033,466) Preferred stock dividend.............. -- -- -- -- (10,483,534) -- -- (10,483,534) Net loss.............. -- -- -- -- (72,205,079) -- -- (72,205,079) ---------- -------- ---------- --------- ------------ --------- --------- ------------ Balance at December 31, 2000...... 26,582,137 $265,821 $93,300,483 $ (26,910) $(190,225,701) -- -- $(96,686,307) ========== ======== =========== ========= ============== ======== ========== ============== (table continued on next page) F-5 CTC Communications Group, Inc. Consolidated Statements of Stockholders' Equity (Deficit) (table continued) Common Stock Additional Retained Other --------------------- Paid-In Deferred Earnings Treasury Comprehensive Shares Par Value Capital Compensation (Deficit) Stock Income Total ---------- --------- ---------- ------------ ------------ -------- ------------ ----------- Balance at December 31, 2000...... 26,582,137 $265,821 $93,300,483 $(26,910) $(190,225,701) -- -- $(96,686,307) Issuance of stock pursuant to employee stock purchase plan... 132,120 1,321 401,169 -- -- -- -- 402,490 Exercise of employee stock options......... 404,062 4,041 1,817,775 -- -- -- -- 1,821,816 Acquisition of treasury stock................. -- -- -- -- -- $(91,533) -- (91,533) Retirement of treasury stock................. (14,589) (146) (91,387) -- -- 91,533 -- -- Deferred compensation.. -- -- -- 26,910 -- -- 26,910 Stock options issued to outside consultant -- -- 100,000 -- -- -- -- 100,000 Accretion of offering costs related to Series B convertible preferred stock....... -- -- -- -- (1,653,546) -- -- (1,653,546) Preferred stock dividend.............. -- -- -- -- (17,909,543) -- -- (17,909,543) Unrealized loss on derivative instruments -- -- -- -- -- -- (2,886,424) (2,886,424) Net loss............... -- -- -- -- (124,172,932) -- -- (124,172,932) ------------- Comprehensive loss..... -- -- -- -- -- -- -- (127,059,356) ---------- -------- ---------- --------- ------------ -------- ------------ ------------- Balance at December 31, 2001...... 27,103,730 $271,037 $95,528,040 -- $(333,961,722) -- $(2,886,424) $(241,049,069) The accompanying notes are an integral part of these consolidated financial statements.
F-6 CTC COMMUNICATIONS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Year Ended Months Ended Year Ended December 31, December 31, March 31, 2001 2000 2000 ---------------- ------------ ------------ Operating Activities: Net loss $(124,172,932) $(72,205,079) $(59,503,543) Adjustments to reconcile net loss to net cash provided by (used in)operating activities: Extraordinary item-early extinguishment of debt - - 2,430,456 Depreciation and amortization 77,002,257 34,916,209 18,753,667 Interest related to warrants and certain fees 679,312 704,671 2,754,556 Provision for doubtful accounts 4,123,921 2,950,521 1,528,564 Stock-based compensation 126,910 79,500 2,563,039 Gain on sale of property and equipment - (247,740) - Changes in operating assets and liabilities: Accounts receivable (8,045,563) (6,122,609) (22,292,968) Prepaid commissions 318,995 (478,513) 459,518 Prepaid expenses and other current assets (156,247) 406,448 (414,853) Amounts due from employees 53,743 (113,804) (42,928) Income taxes receivable - - 2,313,070 Deferred financing costs and other assets 2,650,231 (8,429,466) (5,247,944) Accounts payable and accrued expenses 8,837,129 3,132,793 18,889,269 Accrued salaries and related taxes (286,696) 799,279 826,433 -------------------------------------------- Net cash used by operating activities (38,868,940) (44,607,790) (36,983,664) Investing Activities: Additions to property and equipment (74,425,034) (73,554,572) (41,667,211) Restricted cash (7,500,000) - - Proceeds from dispositions of property and equipment 1,734,115 247,740 - Deposits for property and equipment - - (2,053,900) Repayments of notes receivable from stockholders 5,414,676 - - Notes receivable from stockholders (256,822) (6,375,135) - -------------------------------------------- Net cash used in investing activities (75,033,065) (79,681,967) (43,721,111) Financing Activities: Proceeds from the issuance of Series B Redeemable Convertible Preferred Stock, net of offering costs - 191,732,271 - Proceeds from the issuance of common stock 2,132,773 2,656,548 65,681,228 Amounts due from stockholders, net - - 31,025 Borrowings under notes payable 125,000,000 25,000,000 185,165,892 Repayment of notes payable (1,697,618) (26,074,674) (147,996,587) Repayment of capital lease obligations (25,273,452) (9,088,102) (4,337,885) -------------------------------------------- Net cash provided by financing activities 100,161,703 184,226,043 98,543,673 -------------------------------------------- Increase in cash and cash equivalents (13,740,302) 59,936,286 17,838,898 Cash and cash equivalents at beginning of year 80,029,442 20,093,156 2,254,258 -------------------------------------------- Cash and cash equivalents at end of period $66,289,140 $80,029,442 $20,093,156 ============================================ Supplemental disclosure of cash flow information: Cash paid for interest $24,285,376 $11,617,264 $13,408,279 Cash received for income taxes - - $(2,463,571) Noncash investing and financing activities: Receipt of common stock in exercise of stock options $91,533 $1,988,046 $3,494,121 Network and related equipment acquired under capital leases $41,103,288 $65,463,006 $16,547,964 Network and related equipment acquired under notes payable - $362,615 $12,972,029 Conversion of Series A Redeemable Convertible Preferred Stock to common stock - - $14,280,948 The accompanying notes are an integral part of these consolidated financial statements.
F-7 CTC Communications Group, Inc. Notes to Consolidated Financial Statements December 31, 2001 1. Nature of Business The Company CTC Communications Group, Inc., through its wholly-owned operating subsidiary, CTC Communications Corp. (the "Company") is an integrated communications provider ("ICP"), which offers voice and data services predominantly to medium and larger-sized business customers in the Northeast and Mid-Atlantic states. Prior to becoming an ICP in January 1998, the Company, since 1984, had been a sales agent for Verizon (formerly Bell Atlantic). The Company has also offered long distance and data services under its own brand name since 1994. In January 1999, the Company began deploying a packet-switched network in its existing markets. The Company operates in a single industry segment providing telecommunication service to medium and larger-sized business customers. As the Company continues to deploy its network, further penetrates its existing region and expands into new markets throughout the Boston- Washington, D.C. corridor, the Company will need significant amounts of additional capital. The Company believes that proceeds available from the preferred stock financing described in Note 9, the senior secured facility described in Note 6, cash on hand and the amounts expected to be available under its bank and lease financing arrangements will be sufficient to fund its planned capital expenditures, working capital and operating losses for at least the next 12 months. We also believe that the above noted sources fully fund our business plan. During this period the Company may seek to raise additional capital through the issuance of debt or equity securities, the timing of which will depend on market conditions. The Company may also seek to raise additional capital through vendor financing, equipment lease financing or bank loans. There can be no assurance that additional financing will be available on terms acceptable to the Company when needed or if at all. The agreements governing its existing indebtedness limit its ability to obtain debt financing. If the Company is unable to obtain financing when needed, it may delay or abandon its development and expansion plans which could have a material adverse effect on its business, results of operations and financial condition. The actual timing and amount of its capital requirements may be materially affected by various factors, including the timing and actual cost of the network, the timing and cost of its expansion into new markets, the extent of competition and pricing of telecommunications services by others in its markets, the demand by customers for its services, technological change and potential acquisitions. The Company's covenants under its debt and vendor financing facilities (see Note 6) contemplate improvements in the Company's operating results in fiscal 2002 over 2001. Among other things, these covenants require significant improvement in Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), as defined in the Senior Facility and the Vendor F-8 Financing Facility, (see Note 6). The Company's ability to remain in compliance with the covenants is dependent upon the Company's continued execution of its business plan which consists of the following primary initiatives; continued migration of existing offnet customers onto the Company's network, improving margins by reducing network costs of goods, (primarily by replacing leased network facilities with owned and operated fiber facilities), controlling selling, general and administrative expenses and continued revenue growth by adding new customers and selling new services. In the event that conditions arise that do not allow the Company to meet all of the primary initiatives of its business plan, management expects to take all necessary actions to remain in compliance with its required covenants which may include the reduction of certain operating expenses, migration of customers onto the Company's network and elimination of certain discretionary expenses. Management believes that if necessary, these actions could be implemented to meet its covenants, including its EBITDA covenant. 2. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include the accounts of CTC Communications Group, Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain amounts in the prior years have been reclassified to conform to current year presentation. At the Annual Meeting of the Company's Board of Directors held on July 27, 2000, the Company changed its fiscal year from a twelve month period ending March 31 of each year to a twelve month period ending December 31 of each year. The consolidated financial statements include presentation of the nine month transition period beginning April 1, 2000 and ending December 31, 2000. The following table presents certain financial information for the twelve months ended December 31, 2001, December 31, 2000 (restated for SAB 101 as discussed below), and March 31, 1999, respectively.
Twelve months ended December 31, March 31, 2001 2000 2000 ------------ ------------ --------- (Unaudited) Telecommunications revenue $299,438,481 $215,278,467 $153,100,934 Costs of telecommunications revenue 240,518,899 168,103,119 119,585,548 (excluding depreciation and amortization) Loss from operations (100,616,991) (73,688,504) (41,915,054) Net loss (124,172,932) (90,920,874) (59,503,543) Net loss per share, basic and diluted $(5.34) $(4.05) $(3.01) ============ ============ ============
F-9 Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less as cash equivalents. The Company has entered into an equipment lease financing arrangement which restricts $7.5 million of cash as security for this arrangement. At December 31, 2001, other non-current assets include $6.9 million of this restricted cash and the balance of $550,000 is reflected as current restricted cash. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Property and Equipment Property and equipment are stated at the lower of cost or fair market value less accumulated depreciation and amortization. The Company accounts for internal use software under the provisions of AICPA Statement of Position 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). Capitalization of costs commences when the preliminary project stage, as defined under SOP 98-1, is completed. Amortization on a straight-line basis, commences at the point that the software components have been subjected to all significant testing phases and are substantially complete and ready for their intended use. The Company also capitalizes certain external and internal costs associated with the installation of network equipment. A significant portion of the network and related equipment costs is subject to the risk of rapid technological change. Accordingly, the Company's useful lives reflect this risk. Depreciation and amortization is provided using the straight-line method over the following estimated useful lives: Furniture, fixture, vehicles and equipment................ 3-7 years Network and related equipment............................. 2-5 years Fiber-related equipment .................................. 3-5 years Building ................................................. 14 years Fiber .................................................... 15 years Leasehold improvements and assets under capital leases are amortized over the lesser of the lease term or the useful life of the property, usually 3-5 years. 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 F-10 probability that future undiscounted net cash flows will be less than the carrying amount of the assets. Impairment is measured at fair value. Collocation Agreements The Company annually reviews its collocation agreements based on its current fiber deployment strategy and in 2000 concluded that it no longer required all of the collocation sites originally planned enabling a consolidation of collocation sites. Consequently, the collocation consolidation resulted in a $700,000 and $2.4 million accrual of collocation termination costs and write-off of deposits as a component of general and administrative expenses for the year ended December 31, 2001 and the nine months ended December 31, 2000, respectively. 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. Retroactive to April 1, 2000, the Company revised its revenue recognition policy for certain recurring monthly fees to be consistent with applicable provisions of Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). Previously, monthly recurring fees for the next month's service were recognized at the time all of the Company's significant performance obligations had been fulfilled and the related monthly service fee became nonrefundable based on the terms of the Company's contract with its customers. The new method of accounting defers recognition of monthly recurring service fees to the period in which the service is available to the customer. The cumulative effect of the change resulted in a charge to income of $2,879,000 which is included in the net loss for the nine months ended December 31, 2000. The effect of the change on the nine months ended December 31, 2000 was to increase the loss before the cumulative effect of the accounting change by $1,018,000 ($0.04 per share). For the three months ended June 30, 2000, the Company recognized $9,649,000 in revenue that was included in the cumulative effect adjustment as of April 1, 2000. The effect of that revenue in the first quarter of 2000 was to increase income by $2,506,000 during that period. Deferred Financing Costs In connection with certain financing arrangements, the Company capitalized $719,527, $3,971,577 and $3,099,424 of financing costs during the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, respectively. These costs represent professional and debt origination fees. The financing arrangements are being amortized over the lives of the agreements. Due to the early extinguishment of the fiscal 1999 financing arrangements, the unamortized balance of the deferred financing costs and unamortized value of the warrants relating to those agreements were recognized as an extraordinary expense item in the fiscal year ended March 31, 2000. For the year ended December 31, 2001, the nine months ended December 31, 2000, and the year ended March 31, 2000, the Company recorded amortization, excluding the extraordinary expense item, of F-11 $998,191, $667,588 and $1,743,958, respectively, related to deferred financing costs associated with the various financing arrangements. Income Taxes The Company provides for income taxes under the liability method prescribed by SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred income taxes are recognized for the future tax consequences of differences between the tax and financial accounting bases of assets and liabilities at each year end. Deferred income taxes are based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income (loss). Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Income (Loss) Per Share The Company's income (loss) per share information is prepared in conformity with SFAS No. 128 "Earnings per Share" ("SFAS No. 128"). SFAS No. 128 replaced the calculation of 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 similar to the previously reported fully diluted earnings per share. Concentration of Credit Risk Financial instruments which potentially subject the Company to a concentration of credit risk principally consist of cash, cash equivalents and accounts receivable. Until utilized, the net proceeds from the TD credit facility and Series B redeemable convertible preferred stock financing are being invested in short-term, interest-bearing instruments and other investment-grade securities which minimizes the concentration of credit risk with respect to cash and cash equivalents. Concentration of credit risk with respect to accounts receivable at December 31, 2001 and 2000 was minimized by the large number of customers across New England and New York State. The Company reduces its risk of loss through periodic review of customer creditworthiness and generally does not require deposits. From a supplier standpoint, the Company has a large concentration of recurring expenditures to Verizon primarily as a result of resale services. Fair Value of Financial Instruments The Company is required to disclose the fair value of financial instruments. At December 31, 2001 and 2000, the Company's financial instruments consist of cash, cash equivalents, accounts receivable, accounts payable and accrued expenses, notes payable and interest rate swap and collar agreements. The fair value of these financial instruments, excluding the notes payable and interest rate swap and collar agreements, approximates their cost due to the short-term maturity of these financial instruments. Of the $228,354,399 total notes payable, the carrying value of $225,000,000 approximates fair value due to the variable interest rates on the Note. The carrying value of F-12 the remaining notes payable of $3,354,399 are not materially different than their estimated fair value. The fair value of the interest rate swap and collar represent liabilities to the Company of $1,196,201 and $1,469,509, respectively, at December 31, 2001. The fair value of the cap at December 31, 2001 is immaterial. Significant Estimates and Assumptions The financial statements have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made by management affect the Company's allowance for doubtful accounts and certain accrued expenses. Actual results could differ from those estimates. Accounting for Stock Options The Company grants stock options for a fixed number of shares to employees with an exercise price at least equal to the fair value of the shares at the date of the grant. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations in accounting for its employee stock options. Under APB No. 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Stock options and other stock-based awards to non-employees are accounted for based on the provisions of SFAS No. 123 and EITF 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services". During the year ended December 31, 2001, the Company granted stock options to outside consultants to purchase an aggregate of 40,000 shares of its common stock. These options have exercise prices ranging from $3.06 to $4.28. As of December 31, 2001, 30,000 of these options have vested and a cost of $100,000 has been recorded to the general and administrative expense for the year ended December 31, 2001. Leases Leases, in which the Company is the lessee and which transfer substantially all of the risks and benefits of ownership to the Company, are classified as capital leases. Accordingly, assets and liabilities are recorded at amounts equal to the lesser of the present value of the minimum lease payments or the fair value of the leased property or equipment at the beginning of the respective lease terms. Interest expense relating to the lease obligations is recorded to effect constant rates of interest over the terms of the lease. Leases which do not meet capital lease criteria are classified as operating leases and the related rentals are charged to expense as incurred. F-13 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 12). Cash Flow Hedging Strategy As required by the Company's credit facility with TD Securities (US) Inc. (the TD Credit Facility), the Company maintains an interest rate collar and an interest rate swap. These instruments hedge the variable rate of interest due on the TD Credit Facility. The interest rate collar effectively locks $33 million of the TD Credit Facility borrowings between 12.25% and 9.67%. The interest rate swap effectively caps $17 million of the TD Credit 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 TD Credit Facility borrowings, respectively. All of these instruments have been entered into for non-trading purposes. During the year ended December 31,2001, the Company recorded a loss of $(716,504) in other comprehensive income (loss) as a cumulative effect adjustment in connection with the adoption of FAS 133, effective January 1, 2001. During the year ended December 31,2001, the Company recorded a loss of $(1,949,206) in other comprehensive income (loss) for the change in fair value of the collar, swap and cap outstanding at December 31, 2001. Furthermore, during the year ended December 31, 2001, the Company reclassified out of other comprehensive income (loss) to interest expense a loss of $(29,937) related to the ineffective portion of the collar and the swap and gain of $250,651 for the same period related to the time value deterioration on the collar, (see Note 12). For the period from January 1, 2002 to December 31, 2002, the Company expects to reclassify approximately $(1,840,000) of losses on the collar, the swap and interest cap agreements from accumulated other comprehensive income (loss) to interest expense due to the payment of variable interest associated with the TD Credit Facility. F-14 Segment Information The Company operates in a single industry segment and manages its business as one operating segment. Recent Accounting Pronouncements In July, 2001, the Financial Accounting Standards Board issued Statement No. 141, "Business Combinations" (FAS 141) and Statement No. 142, "Goodwill and Other Intangible Assets" (FAS 142). FAS 141 eliminates the pooling-of- interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. FAS 141 further clarifies the criteria to recognize intangible assets separately from goodwill. The requirements of Statement 141 are effective for any business combination accounted for by the purchase method that is completed after June 30, 2001. Under FAS 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of Statement 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, companies are required to adopt FAS 142 in their fiscal year beginning after December 15, 2001. For the intangible assets acquired on or before June 30, 2001 the intangibles will be amortized during this transition period until adoption of FAS 142. The Company is not expecting any material impact from the adoption FAS 141 and FAS 142 on its financial position and results of operations. In June 2001, the Financial Accounting Standards Board issued Statement No. 143, "Accounting for Asset Retirement Obligations" (FAS 143), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It also applies the legal obligations associated with the retirement of long-lived assets that result from acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The standard is effective for fiscal years beginning after June 15, 2002 (January 1, 2003 for the Company), with earlier application encouraged. The Company believes the adoption of FAS 143 will not have a material impact on the Company's financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144), which addresses the financial accounting and reporting for the impairment of long-lived assets. This statement supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions for the disposal of a segment of a business of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." F-15 The provisions of this statement are effective for the financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early adoption permitted. The Company believes that the adoption of FAS 144 will not have a material impact on the Company's financial position or results of operations. 3. Property and Equipment Property and equipment, at cost, and related accumulated depreciation and amortization balances are as follows: December 31, 2001 2000 ----------- ------------ Furniture, fixtures, vehicles and equipment.........$ 11,497,228 $ 5,922,131 Network and related equipment....................... 149,680,055 115,141,984 Leasehold improvements.............................. 40,187,598 21,170,502 Fiber and related equipment......................... 28,412,779 17,627,621 Assets under capital lease ......................... 136,309,786 99,753,175 ------------ ------------ 366,087,446 259,615,413 Less accumulated depreciation and amortization...... 135,762,149 63,873,598 ----------- ------------ $230,325,297 $195,741,815 ============ ============ Assets under capital lease principally consist of $93,482,053 of network and related equipment, $27,043,528 of fiber related equipment, $4,098,152 of furniture and fixtures, and $11,686,053 of building and leasehold improvements. Amortization expense of capital lease assets is included in depreciation expense. Capitalized interest of $5,172,698 and $3,659,000 were recorded in the year ended December 31, 2001 and the nine months ended December 31, 2000, respectively. 4. Related-Party Transactions The installation of certain telecommunications equipment and certain related activities are generally subcontracted to a company in which the Chairman of the Company is the major shareholder. In addition, equipment is purchased from this company. Amounts paid to this company for hardware and services, based on fair market value, aggregated $11,374,050, $3,928,713 and $1,361,430 during the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, respectively. Amounts payable to this company were $1,641,525 and $744,796 at December 31, 2001 and 2000, respectively. The Company leases office space from a trust in which the Chairman is a beneficiary. Rent expense for these facilities aggregated $51,584, $38,688 and $51,584 during the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, respectively. The lease expires during fiscal 2002. F-16 The Company subleases space to a company controlled by the Chairman of the Company. Terms of the sublease are identical to those included in the Company's lease. Sublease rental income totaled $131,073, $100,862 and $108,326 during the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, respectively. In May 2000, the Company entered into a 15 year lease for approximately 71,250 feet from a limited liability company in which two executive officers, including the Chairman, own a majority of membership interests, and in which three executive officers each own a minority membership interest. The payments under this lease were $1,933,508 and $1,162,982 for the year ended December 31, 2001 and the nine months ended December 31, 2000. The Company has funded a security deposit of $889,050 as of December 31, 2001. During the nine months ended December 31, 2000, the Company funded an escrow account guarantee for this lease in the sum of $2.5 million which was repaid with interest to the Company during the year ended December 31, 2001. This lease has been accounted for as a capital lease. The Company has recorded capital lease obligations to this related party of $10.0 million at December 31, 2001 and 2000. The limited liability company has a mortgage on the building at December 31, 2001 of $9,233,575. As of December 31, 2001 and 2000, the Company had advanced funds to certain stockholders, who are executives and officers, amounting to $1,217,281 and $6,375,135, respectively, evidenced by fully secured promissory notes. These notes bear interest at 10.75%. During March 2001, $5,414,676 was repaid together with interest due. In February 2002, the Company advanced $545,243 to two executives that have been secured fully by promissory notes bearing interest at 10.75%. 5. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses consist of the following: December 31, 2001 2000 ----------- ---------- Trade accounts payable and accrued telecommunication costs......................... $51,137,700 $41,174,477 Sales tax payable................................. 4,789,078 7,209,500 Other accrued expenses............................ 2,371,901 1,077,573 ----------- ----------- $58,298,679 $49,461,550 =========== =========== F-17 6. Financing Arrangements In September 1998, the Company entered into an agreement providing for a revolving line of credit agreement (the "Revolving Line of Credit") with a consortium of lenders, providing for a three year senior secured credit facility of up to $75,000,000. Advances under the Revolving Line of Credit were subject to interest at the prime rate plus 1.75% per annum. The outstanding debt was secured by all the Company's assets excluding those acquired through purchase money financing. The Company paid a one-time up front fee which was capitalized as a deferred financing cost and amortized as interest expense over the term of the Revolving Line of Credit. Warrants to purchase an aggregate of 1,461,618 shares of the Company's common stock at an exercise price of $4.50 per share were issued to the lenders in connection with the transaction. The fair value of the warrants of $1,909,848 was amortized and included in interest expense over the term of the Revolving Line of Credit. Borrowings under the Revolving Line of Credit were repaid from the senior secured credit facility obtained in March 2000 and described below. The unamortized balance of deferred financing costs associated with the Revolving Line of Credit were recognized as an extraordinary item for the fiscal year ended March 31, 2000. In March 2000, the Company entered into a $225 million senior secured credit facility (the "Senior Facility") with a consortium of banks. This Senior Facility is comprised of a $50 million senior secured revolving credit facility (the "Revolver") with a seven and one-half year term, a $100 million senior, delayed draw facility with a seven and one-half year term ("Term A") and a $75 million senior secured eight year term loan facility ("Term B"). This facility is secured by all assets of the Company excluding those assets used to secure other notes payables and capital leases. As amended in March 2002, advances under the Revolver and Term A bear interest at either prime rate plus 2.25-3.5% per annum or London interbank rate ("LIBOR") plus 3.25-4.5% per annum based upon the total leverage ratio in effect at the time. Term B borrowings bear interest at the prime rate plus 3.75% per annum or LIBOR plus 4.75% per annum. Borrowing at prime or LIBOR is at our discretion. As required by the Senior Facility, Term B borrowings of $75 million were made at the closing date along with borrowings of $25 million under the Revolver. The proceeds were used to pay off an existing $25 million vendor financing facility and the outstanding balance of the revolving line of credit approximating $43 million. The Company paid a one-time up front fee and other closing costs at the closing, which have been capitalized as deferred financing costs and are being amortized as interest expense over the term of the Senior Facility. We will pay an annual commitment fee of .75-1.5% per annum, depending on the percentage of the total Senior Facility used. At December 31, 2001, the entire $225 million was outstanding. At June 30, 2003, we will begin to repay the outstanding balances of Term A and Term B on a quarterly basis through the year 2007. F-18 In September 2000, we entered into an interest rate collar agreement with a notional amount outstanding at December 31, 2000 of $33 million, with an expected maturity date in the year 2003. The interest rate collar effectively locks $33 million of the Senior Facility borrowings between 12.25% and 9.67%. In addition we have an interest rate swap which effectively caps $17 million of 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. These interest rate collar, swap and cap agreements expose the Company to losses in the event the counter party is unable to perform under the contracts. The risk of nonperformance is low due to the credit worthiness of the counter party. 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. At December 31, 2001, the Company was not in compliance with the covenants prior to the amendment signed in March 2002. However, as of December 31, 2001, the Company is in compliance with all the 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 March 2002 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. 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 March 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 cash balance. 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 F-19 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. Notes payable, net of the unamortized discount of related warrants, consisted of the following: December 31, 2001 2000 ------------ ------------ Senior facility................................ $225,000,000 $100,000,000 Notes payable for network and related equipment 3,354,399 5,002,573 ------------ ------------ $228,354,399 $105,002,573 Less current portion........................... (3,354,399) (1,983,984) ------------ ------------ $225,000,000 $103,018,589 ============ ============ Long-term debt matures as follows: Year ending December 31: 2002................................................... 3,354,399 2003................................................... 11,812,500 2004................................................... 27,000,000 2005................................................... 36,375,000 2006................................................... 43,875,000 2007................................................... 82,312,500 2008................................................... 23,625,000 ------------ $228,354,399 ============ 7. Leases The Company leases office facilities under long-term lease agreements classified as operating leases. The following is a schedule of future minimum lease payments, net of sublease income, for operating leases as of December 31, 2001: Sublease Operating Rental Leases Income Net ---------- --------- ----------- Year ending December 31: 2002.................................... 3,499,567 (144,933) 3,354,634 2003.................................... 2,961,084 (109,212) 2,851,872 2004.................................... 2,252,200 (81,909) 2,170,291 2005.................................... 1,122,295 - 1,122,295 2006.................................... 1,019,362 - 1,019,362 Thereafter.............................. 2,609,095 - 2,609,095 ----------- --------- ----------- Net future minimum lease payments........$13,463,603 $(336,054) $13,127,549 =========== ========= =========== F-20 Rental expense for operating leases aggregated $4,591,838, $2,918,127 and $2,470,340 for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, respectively. Sublease rental income amounted to $131,073, $100,862 and $108,326 for the year ended December 31, 2001, the nine months ended December 31, 2000 and the year ended March 31, 2000, respectively. For the nine months ended December 31, 2000, the Company reserved $700,000 for future lease obligations of branch locations that were consolidated to achieve near term operating efficiencies. As of December 31, 2001, the Company has a reserve balance of $269,092 outstanding. The Company leases certain assets, principally network and related equipment, fiber related equipment and buildings, under capital leases. At December 31, 2001 and 2000, the Company has capitalized leased equipment totaling $136,309,786 and $99,753,175, respectively, with related accumulated amortization of $28,935,304 and $18,767,228 for the year ended December 31, 2001 and the nine months ended December 31, 2000, respectively. As of December 31, 2001, obligations under capital leases mature as follows: Year ending December 31: 2002.....................................................$ 43,351,581 2003...................................................... 36,524,216 2004...................................................... 17,301,459 2005...................................................... 4,342,288 2006...................................................... 3,949,090 Thereafter................................................ 47,517,226 ----------- 152,985,860 Less amount representing interest..........................(59,624,997) ----------- Present value of minimum lease payments.................... 93,360,863 Less current portion of obligations under capital leases...(33,036,325) ----------- Obligations under capital leases, net of current portion...$60,324,538 =========== In March 2002, we entered into an agreement with a vendor, (see note 6) which restructures a portion of the above capital leases outstanding. We expect this restructuring to reduce our cash outflow in 2002 by approximately $7.5 million for the leases outstanding at December 31, 2001. This restructuring is not included in the table above. Under the agreement, these payments will now be due during the years ending December 31, 2003, 2004 and 2005. 8. Telecommunications Agreements On October 20, 1994, the Company entered into a four-year non-exclusive agreement with a long-distance service provider for the right to provide long distance service to the Company's customers at fixed prices during the term of the agreement. On September 6, 2000, the Company entered into an amendment that extended the initial term of the agreement through April 2003. In December 2001, the Company entered into an amendment which reduced its minimum aggregate usage commitment to $36 million. Based upon existing F-21 and expected usage, these provisions had no effect on the financial statements for the twelve months ended December 31, 2001. Through December 31, 2001, the Company had incurred expenditures of approximately $54.8 million under these agreements. On January 8, 1999, the Company entered into agreements with two communications companies for the provision of transmission and collocation facilities for the Company's initial network build-out in New England and New York State. The agreements, which total $11.6 million of expenditures by the Company over three years, provide for connectivity between the Company's 22 network hub sites and two fully redundant network operations centers. Through the year ended December 31, 2001, the Company had incurred expenditures of approximately $18.5 million under these agreements. In fiscal years 1999 and 2000, the Company entered into an amendment that revised the original terms of the Company's resale agreements with a supplier of local services. The Amendment provides for several additional discounts on various resold services if certain term and volume commitment levels associated with access lines and Minutes of Use (MOUs) are maintained. While the Company exceeded its commitment levels in fiscal year 2001 relative to the number of access lines and MOUs, there is currently some uncertainty as to whether the Company met a commitment level in certain jurisdictions associated with one of the smaller discount percentages under the agreement. The Company and its suppliers are currently considering revising the terms associated with this discount percentage. On March 31, 2000, the Company entered into a 20 year agreement to purchase an exclusive, indefeasible right of use of optical dark fibers from a fiber optic engineering and construction company. The agreement also includes collocation facilities at points of presence and transmission site locations and ongoing fiber maintenance services provided by the supplier. The Company's total estimated commitment is approximately $115 million. Through December 31, 2001, the Company had incurred expenditures of approximately $12 million under this agreement. On May 9, 2000, the Company entered into an agreement with a professional services company for the "softswitch" and related software required to support local services of the Company for a total commitment of approximately $26 million through the end of 2005. Through December 31, 2001, the Company had incurred costs of $15.1 million. During the year ended December 31, 2001, the Company finalized negotiations of a local interconnection agreements which the Company intends to execute in all states within its footprint. It is the Company's current intention to use the negotiated agreement in new markets within its footprint and as a replacement agreement for expiring agreements in Connecticut, Maine, Massachusetts, New Hampshire, New York, Rhode Island and Vermont. These agreements enable the Company to interconnect with the public switched telephone network (PSTN), obtain access to unbundled network elements (UNEs), collocate in the incumbent local provider's central offices, and purchase other miscellaneous additional services also provided by the incumbent for purposes of providing local dial tone and associated local services over the Company's network facilities. F-22 9. Stockholders' Equity (Deficit) In connection with the reorganization of the Company into a holding company structure in September 1999, each share of Common Stock, $.01 par value, and each share of Series A Convertible Preferred Stock, $1.00 par value, of CTC Communications Corp., was converted into one share of Common Stock, $.01 par value, and one share of Series A Convertible Preferred Stock, $1.00 par value, of CTC Communications Group, Inc. ("CTC Group"). CTC Group is authorized to issue up to 100 million shares of common stock, $.01 par value, and 10 million shares of preferred stock, $1.00 par value. As a result of the reorganization, CTC Communications Corp. became a wholly-owned subsidiary of CTC Group. On March 17, 2000, the Company effected a three-for-two stock split for stockholders of record as of March 6, 2000. All common stock information presented in Note 9 herein has been adjusted to reflect the stock split. At December 31, 2001, 14,178,735 shares of common stock are reserved for future issuance upon exercise of outstanding stock options and common stock purchase warrants and conversion of outstanding preferred stock. Preferred Stock The dividends, Liquidation Preference, voting rights and other rights of each series of preferred stock, when issued, are to be designated by the Board of Directors prior to issuance. In May 2000, the Company completed a $200 million preferred stock financing with Bain Capital Inc., Thomas H. Lee Partners, L.P. and CSFB Private Equity, consisting of 8.25% Series B redeemable convertible preferred stock which converts into common stock at $50 per share. The 8.25% dividends are cumulative and are payable in cash or upon conversion or redemption, at the Company's option, as discussed below. Bain Capital and Thomas H. Lee each invested $75 million and CSFB Private Equity has invested $50 million. The Company may require conversion of the preferred shares, into the Company's common stock, if the average market price of the common stock of the Company equals or exceeds 200% of the conversion price for a period of 30 consecutive trading days or if there are outstanding fewer than 15% of the number of shares issued on the closing date. In the event the Company elects to require conversion of the preferred stock under this provision, the Company is required to convert the principal and cumulative dividends that would otherwise have been payable through the third anniversary ($55.5 million or $13.89 per share) or through the date of conversion, whichever is greater (the "Liquidation Preference"), at $50 per share. The value ($55 million) related to this contingent conversion is recognizable at the time the conversion occurs. The Company may elect to redeem the preferred shares on or after the fifth anniversary of the closing. The redemption price per share is equal to the greater of the Liquidation Preference or the current market value of the number of shares of common stock into which a share of preferred stock could be converted by the holder on the redemption date. F-23 To the extent the Company has funds available, on the tenth anniversary of the closing date the Company is required to redeem all outstanding shares of the Series B Preferred Stock, if any, at a redemption price per share equal to the greater of (a) the Liquidation Preference as of that date, and (b) the current market value of the number of shares of Common Stock into which a share of Preferred Stock could be converted by the holder as of that date. The redemption price is payable, at the Company's option, in cash or in shares of Common Stock, which shares are to be valued at 95% of the average market price, as defined, if redeemed for cash and 100% of the average market price, as defined, if redeemed for stock. The holders of the shares of Series B Preferred Stock have the right at any time and from time to time, at the holder's option, to convert any or all outstanding shares (and fractional shares) of Series B Preferred Stock plus cumulative dividends into fully paid and non-assessable shares of Common Stock. Holders of Series B stock are entitled to a number of votes equal to the whole number of common stock they would receive if they converted their Series B stock. Dividends The Company has never paid cash dividends on our common stock and does not plan to do so in the foreseeable future. The Company intends to retain earnings, if any, to develop and expand its business. In addition, the terms of its credit facility and the Series B preferred stock restrict its ability to pay cash dividends on the common stock. The Company also expects the terms of agreements governing any future indebtedness to restrict its ability to pay cash dividends. Common Stock Purchase Warrants As of December 31, 2001, the Company had outstanding warrants in connection with the issuance of the Series A and the financing arrangements disclosed in Note 6 to purchase an aggregate of 515,489 shares of common stock at exercise prices ranging from $4.50 to $7.87 with exercise periods extending through March 2009. The values of the warrants range from $1.96 to $4.76 and were determined using a Black-Scholes pricing methodology. Significant assumptions include an interest rate of 5.21%, an expected volatility of 50% and an expected life of the warrants of 2.5 to 3 years. Employee Stock Purchase Plan The Company has an employee stock purchase plan (the "ESPP") which enables participating employees to purchase Company shares at 85% of the lower of the market prices prevailing on two valuation dates as defined in the ESPP. Individuals can contribute up to 5% of their base salary. The Company made no contributions to the ESPP during the year ended December 31, 2001, the nine months ended December 31, 2000 and the fiscal year ended March 31, 2000. Set forth below is a summary of shares of common stock purchased under the ESPP. F-24 Date Shares Purchased Purchase Price - ------------- ------------------ --------------- July 2001 87,632 $ 2.57 February 2001 44,488 $ 3.98 July 2000 5,689 $23.80 February 2000 10,533 $10.38 July 1999 14,779 $ 5.03 February 1999 11,945 $ 4.46 Stock Option Plans Under the terms of its 1993 Incentive Stock Option Plan, 1996 Stock Option Plan, 1998 Incentive Plan and 2000 Flexible Stock Plan, (collectively, the "Plans"), the Company may grant qualified and non-qualified incentive stock options for the purchase of common stock to all employees and, except for the 1993 Stock Option Plan and 2000 Flexible Stock Plan, to members of the Board of Directors. The Plans generally provide that the option price will be fixed by a committee of the Board of Directors but for qualified incentive stock options will not be less than 100% (110% for 10% stockholders) of the fair market value per share on the date of grant. Non-qualified options are granted at no less than 85% (110% for 10% stockholders) of the fair market value per share on the date of grant. The 2000 Flexible Stock Plan also provides for benefits in the form of stock appreciation rights, performance shares, cash awards and other common stock based awards. The stock appreciation rights represent the fair market value per share on the date of grant. The performance shares are equal to the fair market value of the stock on the date all the restrictions are satisfied. No options have a term of more than ten years and options to 10% stockholders may not have a term of more than five years. In the event of termination of employment, other than by reason of death, disability or with the written consent of the Company, all options granted to employees are terminated. Vesting is determined by the Board of Directors. Under the terms of the 1999 Equity Incentive Plan for Non-Employee Directors, at each annual meeting at which a non-employee director is reelected or is continuing as a director, he or she will be granted a five-year, non- discretionary, option to purchase 10,000 shares of common stock, at an exercise price equal to 100% of the fair market value of the common stock on the day before the date of the grant. The options are exercisable on the grant date. In addition to the foregoing options, the plan administrator also has the authority to award options to eligible directors in amounts and on terms as it determines. These options are referred to as discretionary options. The exercise price of discretionary options will be set by the administrator and will become exercisable and expire as the administrator determines, but no options will expire later than 10 years from the date of grant. If a director dies, or otherwise ceases to be a director, all options, including those issued under the 1993, 1996, 1998, 1999 and 2000 Plans, not then exercisable will immediately terminate, unless the board of directors otherwise determines. Any exercisable options will remain exercisable for a period of one year following death or three months following other termination of the individual's status as a director, but in no event beyond F-25 the fifth anniversary of the date of grant in the case of non- discretionary options and beyond the tenth anniversary of the date of the grant in the case of discretionary options. Upon a merger or consolidation, which results in a 50% change in ownership, a transfer of all or substantially all of the Company's assets, or a dissolution or liquidation of the Company, all options, including the 1993, 1996, 1998, 1999 and 2000 plans, not then exercisable will become exercisable and all unexercised options will terminate upon the consummation of the transaction. However, in lieu of termination, the board of directors may cause the acquiring or surviving corporation to assume all options outstanding under the plan or provide replacement options on substantially the same terms, with any necessary adjustments. Stock Based Compensation Pro forma information regarding net loss and net loss per common share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options granted under the Plans and shares issued pursuant to the ESPP under the fair value method of SFAS No. 123. The fair value for these options and shares issued pursuant to the ESPP was estimated at the dates of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
Options ESPP December 31, March 31, December 31, March 31, ------------- -------- ----------- ---------- 2001 2000 2000 2001 2000 2000 ----- ----- ----- ----- ----- ---- Expected life (years)................. 4.00 3.73 3.69 0.50 0.50 0.50 Interest rate......................... 5.73% 5.75% 6.12% 5.56% 5.85% 6.08% Volatility............................ 95.11% 93.25% 84.12% 105.60% 136.54% 82.73% Dividend yield........................ 0.00 0.00 0.00 0.00 0.00 0.00
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the expense related to estimated fair value of the options is recognized over the options' vesting period. The Company's pro forma net loss and loss per common share, which has been adjusted to reflect the March 17, 2000 three-for-two stock split, are as follows: F-26 December 31, March 31, ---------------------------------------- 2001 2000 2000 ------------ ------------ ----------- Pro forma net loss attributable to Common shareholders............... $(155,463,241)$(91,918,300)$(66,276,203) Pro forma net loss per common share (Basic and diluted)............... $ (5.78) $ (3.50) $ (3.26) The effects on the year ended December 31, 2001, the nine months ended December 31, 2000 and the fiscal year ended March 31, 2000 pro forma net loss and loss per common share of expensing the estimated fair value of stock options and shares issued pursuant to the ESPP are not necessarily representative of the effects on reporting the results of operations for future years as the periods presented only include the effects of option grants under the Company's plans since 1997. A summary of the Company's stock option activity, and related information for the nine months ended December 31, 2000 and the fiscal years ended March 31, 1999 and 1998, which has been adjusted to reflect the March 17, 2000 three- for-two stock split, follows:
December 31, 2001 December 31, 2000 March 31, 2000 ------------------- -------------------- ------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price --------- -------- ---------- -------- --------- -------- Outstanding at beginning of year................ 6,352,005 $ 9.97 5,906,373 $ 8.91 5,423,714 $ 4.70 Options granted....... 2,818,148 5.47 1,292,750 16.01 2,137,569 15.08 Options terminated.... (779,093) 12.86 (221,100) 33.60 (411,950) 4.67 Options exercised..... (418,062) 4.51 (626,018) 4.96 (1,242,960) 3.37 --------- ---------- --------- Outstanding at end of year................... 7,972,998 $8.42 6,352,005 $9.97 5,906,373 $8.91 ========== ========== ========= Exercisable at end of year................... 3,546,327 2,286,752 1,630,865 Weighted-average fair value of options granted during the year................... $ 3.81 $ 10.35 $ 8.87
F-27
The following table presents weighted-average price and life information about significant option groups outstanding at December 31, 2001: Options Outstanding Options Exercisable --------------------------------------------------------------------------- Weighted Average Remaining Weighted Weighted Range of Contractual Average Average Exercise Prices Outstanding Life--Years Exercise Price Exercisable Exercise Price --------------- ----------- ---------------- -------------- ----------- ------------------- $ 0.00-5.35............. 2,376,961 3.6 $ 4.45 1,833,398 $ 4.39 5.35-10.70............ 3,586,616 6.3 6.76 888,600 7.85 10.70-16.05............ 1,216,322 3.1 11.65 579,334 11.48 16.05-21.40............ 442,200 4.6 18.32 94,065 18.11 21.40-26.75............ 196,650 4.0 24.24 127,080 24.07 26.75-32.10............ 71,749 4.5 28.38 8,850 28.49 32.10-37.45............ 49,000 4.3 34.93 8,300 34.91 37.45-42.80............ 5,500 4.2 38.90 1,100 38.90 42.80-48.15............ 21,500 5.7 46.22 4,300 46.22 48.15-53.50............ 6,500 5.4 53.38 1,300 53.38 --------- --------- 7,972,998 3,546,327 ========= =========
10. Benefit Plans Defined Contribution Plan (the "401(k) Plan") The Company maintains a defined contribution plan (the "401(k) Plan") which covers all employees who meet certain eligibility requirements and complies with Section 401(k) of the Internal Revenue Code ("IRC"). Participants may make contributions to the 401(k) Plan up to 15% of their compensation, as defined under the terms of the 401(k) Plan, up to the maximum established by the IRC. The Company may make a matching contribution of an amount to be determined by the Board of Directors, but subject to a maximum of 6% of compensation contributed by each participant. Company contributions vest ratably over three years. Company contributions to the 401(k) Plan were $963,302, $527,724 and $486,434 in the year ended December 31, 2001, the nine months ended December 31, 2000, and the fiscal year ended March 31, 2000, respectively. F-28 11. Loss Per Share Loss per common share has been calculated as follows:
December 31, March 31, 2001 2000 2000 ------------ ----------- ----------- Numerator: Loss before extraordinary item and cumulative effect of change in accounting principle ........... $(124,172,932) $(69,326,130) $(57,073,087) Extraordinary item-early extinguishment of debt.............. - - (2,430,456) Loss before cumulative effect of --------------- ------------- ------------- change in accounting principle..... (124,172,932) (69,326,130) (59,503,543) Cumulative effect of change in accounting principle............... - (2,878,949) - --------------- ------------- ------------- Net loss (124,172,932) (72,205,079) (59,503,543) Less preferred stock dividends and accretion to redemption value of preferred stock...................... (19,563,089) (11,517,000) (1,609,351) -------------- ----------- ------------- Equals: numerator for Basic and Diluted loss per common share........ $(143,736,021) $(83,722,079) $(61,112,894) Denominator: ============== ============= ============= Denominator for Basic and Diluted loss per common share-weighted average shares............................... 26,903,518 26,249,173 20,320,626 -------------- ------------ ------------ Basic and diluted loss per common share. $ (5.34) $ (3.19) $ (3.01) ============== ============= ============ Basic and diluted loss per common share- cumulative effect of change in accounting principle.................. $ - $ (0.11) $ - ============== ============= ============ Basic and diluted loss per common share- extraordinary item.................... $ - $ - $ (0.12) ============== ============= ============ Basic and diluted loss per common share- before extraordinary item and cumulative effect of change in accounting principle.................. $ (5.34) $ (3.08) $ (2.89) ============== ============= ============
12. Comprehensive Loss The Company reports comprehensive 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 comprehensive loss. For the year ended December 31, 2001 the nine months ended December 31, 2000 and the year ended March 31, 2000, comprehensive loss was $(127,059,356), $(72,205,079) and $(59,503,543) respectively, as follows: F-29
Year ended Nine Months Year ended December 31, ended March 31, 2001 December 31, 2000 2000 ------------------------------------------- Comprehensive loss: Net loss $(124,172,932) $(72,205,079) $(59,503,543) Cumulative effect of change in accounting principle (716,504) -- -- Additions to comprehensive loss for changes in fair value of cash flow hedges (1,949,206) -- -- Reclassification of gain from comprehensive loss line as offset to interest expense for ineffective portion and time value of cash flow hedges (220,714) -- -- ----------------------------------------- Comprehensive loss $(127,059,356) $(72,205,079) $(59,503,543) ==========================================
13. Income Taxes Significant components of the Company's deferred tax assets and liabilities as of December 31, 2001 and 2000, are as follows:
December 31, 2001 2000 ------------ ------------ Deferred tax assets: Bad debt allowance.................................$ 2,801,000 $ 1,823,000 Accruals and allowances, other..................... 4,420,000 1,965,000 Stock option expense............................... 41,000 - Net operating loss carryforward.................... 105,607,000 71,514,000 Depreciation ..................................... 13,873,000 2,606,000 ------------ ------------ Total deferred tax asset............................. 126,742,000 77,908,000 Deferred tax liability: Other expenses..................................... (220,000) (117,000) - ------------ ----------- Total deferred tax liability......................... (220,000) (117,000) ------------ ----------- Net deferred tax asset before valuation allowance.... 126,522,000 77,791,000 Valuation allowance..................................(126,522,000) (77,791,000) ------------ ----------- Net deferred tax asset............................... $ - $ - ============ ============
Management has provided a full valuation allowance against deferred tax assets due to the uncertainty that the Company will realize these assets. The Company believes that, based upon a number of factors, the available objective evidence creates sufficient uncertainty regarding the realization of the deferred tax assets such that a full valuation allowance has been recorded. The Company will continue to assess the realization of the deferred tax assets based on actual and forecasted operating results. At F-30 December 31, 2001, the Company had federal and state net operating loss carryforwards of approximately $260,800,000 which may be used to reduce future income tax liabilities, and expire ratably through 2020. Changes in the Company's ownership will subject the net operating loss carryforwards to limitations pursuant to Sections 382 of the Internal Revenue Code. The income tax expense is different from that which would be obtained by applying the enacted statutory federal income tax rate to loss before income taxes. The items causing this difference are as follows: December 31, March 31, 2001 2000 2000 ------------ ----------- ---------- Tax (benefit) at U.S. statutory rate $ (42,219,000)$ (24,550,000) $(20,231,000) State income taxes, net of federal benefit............ (8,071,000) (4,693,000) (3,867,000) Unbenefitted losses and other....... 50,290,000 29,243,000 24,098,000 -------------- ------------- ------------ $ - $ - $ - ============= ============= ============ 14. Quarterly Information (Unaudited) A summary of operating results and net loss per share for the quarterly periods in the year ended December 31, 2001, the nine months ended December 31, 2000 (restated for SAB 101), and the fiscal year ended March 31, 2000 is set forth below:
Quarter Ended ------------------------------------------------------------------- March 31 June 30 September 30 December 31 Total ----------- ------------ ------------ ------------ ------------ Year ended December 31, 2001 Revenues................ $67,621,144 $ 74,512,308 $ 78,166,156 $ 79,138,873 $299,438,481 Cost of telecommunications revenues (excluding depreciation and amortization).......... 55,344,185 59,852,566 61,989,987 63,332,161 240,518,899 Net loss................ (28,948,653) (27,613,754) (30,226,603) (37,383,922) (124,172,932) Net loss per share - Basic and diluted...... (1.26) (1.21) (1.30) (1.57) (5.34)
F-31
Quarter Ended ----------------------------------------------------------- June 30, 2000 September 30, as 2000 December 31, restated as restated 2000 Total ------------- ------------ ------------ ------------ Nine months ended December 31, 2000 Total revenues........ $51,052,832 $56,993,993 $62,305,870 $170,352,695 Cost of telecommunications revenues (excluding depreciation and amortization) 39,178,593 44,386,041 49,631,465 133,196,099 Loss before cumulative effect.... (18,176,697) (21,901,440) (29,247,993) (69,326,130) Net loss.............. (21,055,646) (21,901,440) (29,247,993) (72,205,079) Loss per common share -before cumulative effect............... (0.79) (1.01) (1.28) (3.08) Net loss per common share......... (0.90) (1.01) (1.28) (3.19) Quarter Ended ------------------------------------------------------------------- June 30 September 30 December 31 March 31 Total ----------- ------------ ------------ ------------ ------------ Year ended March 31, 2000 Total revenues.......... $31,046,851 $ 35,109,155 $ 40,369,021 $ 46,575,907 $153,100,934 Cost of telecommunications revenues (excluding depreciation and amortization) 26,089,184 27,398,259 30,409,039 35,689,066 119,585,548 Loss before extra- ordinary item.......... (15,118,813) (12,293,504) (14,216,531) (15,444,239) (57,073,087) Net loss................ (15,118,813) (12,293,504) (14,216,531) (17,874,695) (59,503,543) Loss per common share before extraordinary item (.99) (.61) (.67) (.69) (2.89) Net loss per share - Basic and diluted...... (.99) (.61) (.67) (.80) (3.01)
F-32 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS CTC COMMUNICATIONS GROUP, INC.
Col. A Col. B Col. C Col. D Col. E ---------- ---------- ---------- ---------- ---------- Additions Balance at Charged to Charged to Balance at Beginning Costs and Other End of Description of Period Expenses Accounts Deductions(a) Period ----------- ---------- ---------- ---------- ------------- ---------- Year ended December 31, 2001: Allowance for doubtful accounts............. $4,501,672 $4,123,921 - $1,709,995 $6,915,598 Nine months ended December 31, 2000: Allowance for doubtful accounts............. $2,000,000 $2,950,521 - $ 448,849 $4,501,672 Year ended March 31, 2000: Allowance for doubtful accounts............. $1,717,000 $1,528,564 - $1,245,564 $2,000,000 - --------- (a) Bad debts written off, net of collections. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. EX-10 3 ex10.txt EXHIBIT 10.37 [EXECUTION COPY] FOURTH AMENDMENT TO CREDIT AGREEMENT This FOURTH AMENDMENT TO CREDIT AGREEMENT, dated as of February 27, 2002 (this "Amendment"), to the Existing Credit Agreement (as defined below) is made by CTC COMMUNICATIONS CORP., a Massachusetts corporation (the "Borrower"), CTC COMMUNICATIONS GROUP, INC., a Delaware corporation (the "Parent"), and certain of the Lenders (such capitalized term and other capitalized terms used in this preamble and the recitals below to have the meanings set forth in, or are defined by reference in, Article I below). W I T N E S S E T H: WHEREAS, the Borrower, the Parent, the Lenders, Toronto Dominion (Texas), Inc., as the Administrative Agent, Lehman Brothers, as the Syndication Agent, Credit Suisse First Boston, as the Documentation Agent, and TD Securities (USA) Inc., as the Arranger, are all parties to the Amended and Restated Credit Agreement, dated as of August 15, 2000, as amended by the First Amendment to Credit Agreement, dated as of September 30, 2000, the Second Amendment to Credit Agreement, dated as of November 14, 2000, and the Third Amendment to Credit Agreement, dated as of November 1, 2001 (the "Existing Credit Agreement", and as amended by this Amendment and as the same may be further amended, supplemented, amended and restated or otherwise modified from time to time, the "Credit Agreement"); WHEREAS, the Borrower desires to modify certain provisions of the Existing Credit Agreement and the Lenders are willing to so modify the Existing Credit Agreement on the terms and subject to the conditions set forth herein; NOW, THEREFORE, in consideration of the premises and of the mutual agreements contained herein, the parties hereto hereby covenant and agree as follows: ARTICLE I DEFINITIONS SECTION I.1. Certain Definitions. The following terms when used in this Amendment shall have the following meanings (such meanings to be equally applicable to the singular and plural forms thereof): "Amendment" is defined in the preamble. "Borrower" is defined in the preamble. "Cisco Lease Documents" means the Amended and Restated Master Agreement to Lease Equipment, dated as of February 27, 2002, between Cisco Systems Capital Corporation, as lessor, and the Borrower, as lessee, together with all annexes, schedules, appendices and exhibits thereto, and all documents executed in connection therewith, including all documents relating to the Cisco Warrants. "Cisco Warrants" is defined in Section 5.1. "Credit Agreement" is defined in the first recital. "Existing Credit Agreement" is defined in the first recital. "Parent" is defined in the preamble. "Fourth Amendment Effective Date" is defined in Article III. SECTION I.2. Other Definitions. Terms for which meanings are provided in the Credit Agreement are, unless otherwise defined herein or the context otherwise requires, used in this Amendment with such meanings. ARTICLE II AMENDMENTS TO CREDIT AGREEMENT Effective on (and subject to the occurrence of) the Fourth Amendment Effective Date, the provisions of the Existing Credit Agreement referred to below are hereby amended in accordance with this Article II. Except as expressly so amended, the Existing Credit Agreement shall continue in full force and effect in accordance with its terms. SECTION II.1. Modification of Article I. Article I of the Existing Credit Agreement is hereby amended as follows: SECTION II.1.1. Section 1.1 of the Existing Credit Agreement is hereby amended by inserting the following definition in such Section in the appropriate alphabetical sequence: "Amendment No. 4" means the Fourth Amendment to Credit Agreement, dated as of February 27, 2002, to this Agreement. SECTION II.1.2. Section 1.1 of the Existing Credit Agreement is hereby amended by amending the definition of "Applicable Margin" appearing therein by: (a) deleting the grid appearing in clause (b) thereof and inserting the following grid in replacement therefor:
Total Leverage Ratio Applicable Margin For Applicable Margin For Base Rate Loans LIBO Rate Loans Greater than or equal to 8.00:1 3.50% 4.50% Greater than or equal to 6.00:1 but less than 8.00:1 3.00% 4.00% Greater than or equal to 5.00:1 but less than 6.00:1 2.75% 3.75% Greater than or equal to 4.00:1 but less than 5.00:1 2.50% 3.50% Less than 4.00:1 2.25% 3.25%
(b) deleting the amounts "3.25%" and "4.25%" appearing in clause (c) thereof and inserting "3.75%" and "4.75%", respectively, in replacement therefor. SECTION II.2. Modification of Article VII. Article VII of the Existing Credit Agreement is hereby amended as follows: SECTION II.2.1. Section 7.1.1 of the Existing Credit Agreement is hereby amended by (a) inserting the parenthetical "(or, if earlier, the date required under any lease agreement between the Borrower, as lessee, and Cisco Systems Capital Corporation, as lessor)" immediately following the words "Fiscal Year" appearing in the second line of each of clauses (b) and (c) thereof; and (b) renumbering clause (n) thereof as clause (o) and inserting a new clause (n) in its place as follows: (n) until such time as the Total Leverage Ratio is less than 5.00:1 as set forth in the most recent Compliance Certificate delivered pursuant to clause (d) above, no later than the first and fifteenth day of each month, a bi-weekly report setting forth the delivery of new line additions, total number of power paths, new power path additions/conversions and revenues on and off-net, in each case with comparisons to the budget; and SECTION II.2.2. Section 7.2.2 of the Existing Credit Agreement is hereby amended by: (a) deleting the proviso to clause (e) thereof in its entirety and inserting the proviso "provided, that the aggregate amount of Indebtedness at any time outstanding pursuant to this clause shall not exceed $130,000,000" in replacement therefor; and (b) deleting clause (l) thereof in its entirety. SECTION II.2.3. Clause (a) of Section 7.2.4 of the Existing Credit Agreement is hereby amended by deleting the date "March 31, 2002" appearing in the second line thereof and inserting the date "September 30, 2002" in replacement therefor. SECTION II.2.4. Clause (a)(i) of Section 7.2.4 of the Existing Credit Agreement is hereby amended by deleting the reference to "60%" appearing therein and inserting "55%" in replacement therefor. SECTION II.2.5. Clause (a)(ii) of Section 7.2.4 of the Existing Credit Agreement is hereby amended and restated to read in its entirety as follows: (ii) Minimum ALEs Installed and Billed. Neither the Borrower nor the Parent will permit the aggregate number of ALEs installed and billed as of the last day of any Fiscal Quarter set forth below to be less than the amount set forth opposite such Fiscal Quarter: Fiscal Quarter ALEs March 31, 2000 260,000 June 30, 2000 300,000 September 30, 2000 350,000 December 31, 2000 390,000 March 31, 2001 430,000 June 30, 2001 470,000 September 30, 2001 530,000 December 31, 2001 530,000 March 31, 2002 530,000 June 30, 2002 535,000 September 30, 2002 555,000 SECTION II.2.6. Clause (a)(iii) of Section 7.2.4 of the Existing Credit Agreement is hereby amended and restated to read in its entirety as follows: (iii) Minimum Revenue. Neither the Borrower nor the Parent will permit the revenue received by the Consolidated Group as of the last day of any Fiscal Quarter set forth below to be less than the amount set forth opposite such Fiscal Quarter: Fiscal Quarter Revenue March 31, 2000 $40,000,000 June 30, 2000 $47,500 ,000 September 30, 2000 $49,500,000 December 31, 2000 $53,100,000 March 31, 2001 $59,800,000 June 30, 2001 $67,700,000 September30, 2001 $76,900,000 December 31, 2001 $73,100,000 March 31, 2002 $74,000,000 June 30, 2002 $78,000,000 September 30, 2002 $84,000,000 SECTION II.2.7. Clause (a)(iv) of Section 7.2.4 of the Existing Credit Agreement is hereby amended and restated to read in its entirety as follows: (iv) Minimum Consolidated EBITDA. Neither the Borrower nor the Parent will permit the Consolidated EBITDA as of the last day of any Fiscal Quarter set forth below to be less than the amount set forth opposite such Fiscal Quarter: Period Consolidated EBITDA March 31, 2000 ($5,400,000) June 30, 2000 ($5,700,000) September 30, 2000 $9,500,000) December 31, 2000 ($11,800,000) March 31, 2001 ($10,300,000) June 30, 2001 ($6,400,000) September 30, 2001 ($4,400,000) December 31, 2001 ($6,500,000) March 31, 2002 ($3,500,000) June 30, 2002 $1,500,000 September 30, 2002 $8,000,000 SECTION II.2.8. Clause (b)(i) of Section 7.2.4 of the Existing Credit Agreement is hereby amended and restated to read in its entirety as follows: (i) Maximum Total Leverage Ratio. Neither the Parent nor the Borrower will permit the Total Leverage Ratio as of the last day of any Fiscal Quarter occurring during any period set forth below to be greater than the ratio set forth opposite such period: Period Total Leverage Ratio 07/01/01 through (and including) 06/30/02 n/a 07/01/02 through (and including) 09/30/02 10.50:1 10/01/02 through (and including) 12/31/02 6.50:1 01/01/03 through (and including) 03/31/03 4.50:1 04/01/03 and thereafter 3.00:1 SECTION II.2.9. Clause (b)(ii) of Section 7.2.4 of the Existing Credit Agreement is hereby amended and restated to read in its entirety as follows: (ii) Minimum Pro Forma Debt Service Coverage Ratio. Neither the Parent nor the Borrower will permit the Pro Forma Debt Service Coverage Ratio as of the last day of any Fiscal Quarter occurring during any period set forth below to be less than the ratio set forth opposite such period: Period Total Leverage Ratio 07/01/01 through (and including) 03/31/03 n/a 04/01/03 through (and including) 06/30/03 1.00:1 07/01/03 and thereafter 1.10:1 SECTION II.2.10. Clause (b)(iii) of Section 7.2.4 of the Existing Credit Agreement is hereby amended and restated to read in its entirety as follows: (iii) Minimum Interest Coverage Ratio. Neither the Parent nor the Borrower will permit the Interest Coverage Ratio as of the last day of any Fiscal Quarter occurring during any period set forth below to be less than the ratio set forth opposite such period: Period Interest Coverage Ratio 07/01/01 through (and including) 06/30/02 n/a 07/01/02 through (and including) 09/30/02 1.00:1 10/01/02 through (and including) 12/31/02 1.50:1 01/01/03 through (and including) 03/31/03 2.00:1 04/01/03 and thereafter 3.00:1 SECTION II.2.11. Clause (b) of Section 7.2.7 of the Existing Credit Agreement is hereby amended by deleting the grid appearing therein and inserting the following grid in replacement therefor: Fiscal Year Capital Expenditure Amount 2000 $175,000,000 2001 $130,000,000 2002 $100,000,000 2003 $100,000,000 2004 $100,000,000 2005 $100,000,000 2006 and thereafter $100,000,000 ARTICLE III CONDITIONS TO EFFECTIVENESS This Amendment and the amendments contained herein shall become effective on the date (the "Fourth Amendment Effective Date") when each of the conditions set forth in this Article III shall have been fulfilled to the satisfaction of the Administrative Agent. SECTION III.1. Counterparts. The Administrative Agent shall have received counterparts hereof executed on behalf of the Borrower, the Parent and the Required Lenders. SECTION III.2. Amendment Fee. The Administrative Agent shall have received, for the account of each Lender executing this Amendment, an amendment fee in an amount equal to 0.50% of such Lender's portion of the Total Exposure Amount. SECTION III.3. Cisco Leases. The Administration Agent shall have received executed copies of the Cisco Lease Documents, each in form and substance satisfactory to the Administrative Agent. SECTION III.4. Legal Details, etc. All documents executed or submitted pursuant hereto shall be satisfactory in form and substance to the Administrative Agent and its counsel. The Administrative Agent and its counsel shall have received all information and such counterpart originals or such certified or other copies or such materials as the Administrative Agent or its counsel may reasonably request, and all legal matters incident to the transactions contemplated by this Amendment shall be satisfactory to the Administrative Agent and its counsel. ARTICLE IV REPRESENTATIONS AND WARRANTIES In order to induce the Lenders to enter into this Amendment, the Borrower and the Parent hereby represent and warrant as follows: SECTION IV.1. Representations and Warranties. In order to induce the Lenders to execute and deliver this Amendment, the Borrower and the Parent represent and warrant to the Agents, the Lenders and the Issuer that, after giving effect to the terms of this Amendment, the following statements are true and correct: (a) the representations and warranties set forth in Article VI of the Existing Credit Agreement and in the other Loan Documents are true and correct on the Fourth Amendment Effective Date as if made on the Fourth Amendment Effective Date (unless stated to relate solely to an earlier date, in which case such representations and warranties were true and correct in all material respects as of such earlier date); and (b) no Default has occurred and has been continuing. SECTION IV.2. Validity, etc. This Amendment constitutes the legal, valid and binding obligation of the Borrower and the Parent, enforceable in accordance with its terms, subject to the effect of any applicable bankruptcy, insolvency, moratorium or similar laws affecting creditors' rights generally and subject to general principles of equity, regardless of whether considered in a proceeding in equity or at law. SECTION IV.3. Restrictive Covenants. The covenants and obligations contained in the agreements relating to the other Indebtedness of the Borrower and its Subsidiaries, other than those set forth in the Cisco Lease Documents, are no more restrictive or more burdensome on the Borrower or such Subsidiaries than those contained in the Loan Documents. ARTICLE V COVENANTS In order to induce the Lenders to enter into this Amendment, the Borrower and the Parent hereby agree as follows: SECTION V.1. Warrants. The Borrower shall provide the Lenders, pro rata in accordance with their portion of the Total Exposure Amount, with warrants to acquire Capital Securities of the Borrower in an amount equal to 50% of the warrants provided to Cisco Systems Capital Corporation or any of its affiliates in connection with the Cisco Lease Documents (the "Cisco Warrants"), in each case on the dates any Cisco Warrants are provided and containing identical terms as the Cisco Warrants, including as to exercise price, term and the inclusion of registration rights and anti-dilution protection, such warrants to be otherwise in form and substance satisfactory to the Administrative Agent. ARTICLE VI MISCELLANEOUS SECTION VI.1. Cross References. References in this Amendment to any article or section are, unless otherwise specified, to such article or section of this Amendment. SECTION VI.2. Loan Document Pursuant to Credit Agreement. This Amendment is a Loan Document executed pursuant to the Existing Credit Agreement and shall be construed, administered and applied in accordance with all of the terms and provisions of the Existing Credit Agreement. SECTION VI.3. Successors and Assigns. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. SECTION VI.4. Counterparts. This Amendment may be executed by the parties hereto in several counterparts, all of which shall be deemed to be an original and which shall constitute together but one and the same agreement. SECTION VI.5. Expenses. The Borrower hereby agrees to pay to or reimburse the Administrative Agent, upon demand, all of its reasonable expenses in connection with the development, negotiation, preparation, execution and closing of this Amendment, including all reasonable fees and other charges of Mayer, Brown & Platt in connection therewith. SECTION VI.6. Governing Law. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers hereunder duly authorized as of the date and year first above written. CTC COMMUNICATIONS CORP. By:_____________________________ Title: CTC COMMUNICATIONS GROUP, INC. By:_____________________________ Title: TORONTO DOMINION (TEXAS), INC., as Lender By:_____________________________ Title: CREDIT SUISSE FIRST BOSTON, as Lender By:_____________________________ Title: By:_____________________________ Title: LEHMAN COMMERCIAL PAPER INC., as Lender By:_____________________________ Title: SYNDICATED LOAN FUNDING TRUST, as Lender By:_____________________________ Title: ING (U.S.) CAPITAL LLC, as Lender By:_____________________________ Title: By:_____________________________ Title: CISCO SYSTEMS, INC., as Lender By:_____________________________ Title: RFC CAPITAL CORPORATION, as Lender By:_____________________________ Title: IBM CREDIT CORPORATION, as Lender By:_____________________________ Title: 17039707 EX-23 4 ex23.txt EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-44337, 333-17613, 333-68767, 333-93735, 333-44002, and 333-68208) of CTC Communications Group, Inc. of our report dated February 15, 2002, except for Note 6 and the last paragraph of Note 7, as to which the date is March 6, 2002, with respect to the consolidated financial statements and schedule of CTC Communications Group, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2001. /s/ Ernst & Young LLP Boston, Massachusetts March 27, 2002 EX-99 5 ex99.txt EXHIBIT 99 RISK FACTORS From time to time we have, and may in the future make, forward-looking statements, based on our then-current expectations, including statements made in Securities and Exchange Commission filings, in press releases and oral statements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All forward-looking statements involve risks and uncertainties, and actual results could differ materially from those expressed or implied in the forward- looking statements for a variety of reasons. These reasons include, but are not limited to, factors outlined below. We do not undertake to update or revise our forward-looking statements publicly even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized. THE DECLINE IN THE NATIONAL ECONOMY AND THE EFFECT OF RECENT TERRORIST ATTACKS MAY NEGATIVELY AFFECT OUR OPERATIONS The continued decline in our national economy and the effect of the September 11, 2001 terrorist attacks in New York City and Washington D.C. could have an adverse effect on our revenues, results of operations, and financial condition. At the time of the attacks, the demand by businesses for communications services had been experiencing weakness. Economic and political uncertainly resulting from general economic conditions and these attacks could result in further declines. We do not know what effect the government's attempts to bolster the economy, or effects of the war on terrorism, could have on our business, revenues, or results of operations. If businesses decide to cut back, defer or cancel purchases of new communications services, our revenues could be adversely affected, which could have an adverse effect on our results or operations and could have an adverse effect on our financial condition. BECAUSE OUR REVENUES PRIOR TO JANUARY 1998 RESULTED FROM A BUSINESS STRATEGY WE ARE NO LONGER PURSUING, YOU MAY HAVE DIFFICULTY EVALUATING US. We began offering local services under our own brand name in January 1998 and began providing network services to customers since September 1999. As a result, we can only provide limited historical operating and financial information about our current business strategy for you to evaluate. IF WE DO NOT SUCCESSFULLY EXECUTE OUR NEW BUSINESS STRATEGY, WE MAY BE UNABLE TO COMPETE EFFECTIVELY. Our business strategy is complex and requires that we successfully complete many tasks, a number of which we must complete simultaneously. If we are unable to effectively implement or coordinate the implementation of these multiple tasks, we may be unable to compete effectively in our markets and our financial results may suffer. OUR INCURRENCE OF NEGATIVE CASH FLOWS AND OPERATING LOSSES DURING THE NEXT SEVERAL YEARS MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK. During recent periods we have experienced substantial net losses, operating losses and negative cash flow. Our expenses have increased significantly, and we expect our expenses to continue to increase as we deploy our network and implement our business plan. Accordingly, we expect to incur significant operating losses, net losses and negative cash flow during the next year, which may adversely affect the price of our common stock. IF OUR NETWORK DOES NOT FUNCTION PROPERLY, WE WILL BE UNABLE TO PROVIDE THE TELECOMMUNICATIONS SERVICES ON WHICH OUR FUTURE PERFORMANCE WILL IN LARGE PART DEPEND. Because the design of our network has not been widely deployed, we cannot assure you that our network will provide the functionality that we expect. We also cannot be sure that we will be able to incorporate local dial tone capabilities into our network because this technology has not been widely implemented. Without this capability we will not be able to provide on our network all of our target customers' fixed line telecommunications services. IF WE DO NOT OBTAIN INTERCONNECTION AGREEMENTS WITH OTHER CARRIERS, WE WILL BE UNABLE TO PROVIDE ENHANCED SERVICES ON OUR NETWORK. Negotiation of interconnection agreements with incumbent local exchange carriers, or ILECs, can take considerable time, effort and expense, and these agreements are subject to federal, state and local regulation. We may not be able to effectively negotiate the necessary interconnection agreements. Without these interconnection agreements, we will be unable to provide enhanced connectivity to our network and local dial tone services and to achieve the financial results we expect. BECAUSE OF OUR LIMITED EXPERIENCE, WE MAY NOT BE ABLE TO PROPERLY OR TIMELY DEPLOY, OPERATE AND MAINTAIN OUR NETWORK, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR FINANCIAL RESULTS. The failure of our network equipment and fiber to operate as anticipated or the inability of equipment suppliers to timely supply such equipment could materially and adversely affect our financial results. Because we have limited experience operating and maintaining telecommunications networks, we may not be able to deploy our network properly or do so within the time frame we expect. In addition, we may encounter unanticipated difficulties in operating and maintaining our network. If network implementation does not occur in a timely and effective manner, our financial results could be adversely affected. OUR HIGH LEVERAGE CREATES FINANCIAL AND OPERATING RISK THAT COULD LIMIT THE GROWTH OF OUR BUSINESS. We have a significant amount of indebtedness. As of December 31, 2001, we had approximately $321.7 million of total indebtedness outstanding. We have incurred substantial debt financing to fund our business plan. Our high leverage could have important consequences to us, including, . limiting our ability to obtain necessary financing for future working capital, capital expenditures, debt service, or refinancing requirements or other purposes; . limiting our flexibility in planning for, or reacting to, changes in our business; . placing us at a competitive disadvantage to competitors with less leverage; . increasing our vulnerability in the event of a downturn in our business or the economy generally; . requiring that we use a substantial portion of our cash flow from operations for debt service and not for other purposes. WE MAY BE UNABLE TO OBTAIN THE ADDITIONAL CAPITAL WE WILL REQUIRE TO FUND OUR OPERATIONS AND FINANCE OUR GROWTH ON ACCEPTABLE TERMS OR AT ALL, WHICH COULD CAUSE US TO DELAY OR ABANDON OUR DEVELOPMENT AND EXPANSION PLANS. We will need significant additional capital to expand our business plan. We cannot assure you that capital will be available to us when we need it or at all. If we are unable to obtain capital when we need it, we may delay or abandon our expansion plans. That could have a material adverse effect on our business and financial condition. OUR MARKET IS HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY, ESPECIALLY AGAINST ESTABLISHED COMPETITORS WITH GREATER FINANCIAL RESOURCES AND MORE EXPERIENCE. We operate in a highly competitive environment. We have no significant market share in any market in which we operate. We will face substantial and growing competition from a variety of data transport, data networking, telephony service and integrated telecommunications service providers. We also expect that the incumbent local exchange carriers ultimately will be able to provide the range of services we currently offer. Many of our competitors are larger and better capitalized than we are, are incumbent providers with long-standing customer relationships, and have greater name recognition. We may not be able to compete effectively against our competitors. OUR INFORMATION SYSTEMS MAY NOT PRODUCE ACCURATE AND PROMPT BILLS WHICH COULD CAUSE A LOSS OR DELAY IN THE COLLECTION OF REVENUE AND COULD ADVERSELY AFFECT OUR RELATIONS WITH OUR CUSTOMERS. We depend on our information systems to bill our customers accurately and promptly. Because of the deployment of our network and our expansion plans, we are continuing to upgrade our information systems. Our failure to identify all of our information and processing needs or to adequately upgrade our information systems could delay our collection efforts, cause us to lose revenue and adversely affect our relations with our customers. WE MAY NOT RECEIVE TIMELY AND ACCURATE CALL DATA RECORDS FROM OUR SUPPLIERS WHICH COULD CAUSE A LOSS OR DELAY IN THE COLLECTION OF REVENUE AND COULD ADVERSELY AFFECT OUR RELATIONS WITH OUR SUPPLIERS. Our billing and collection activities are dependent upon our suppliers providing us with accurate call data records. If we do not receive accurate call data records in a timely manner, our collection efforts could suffer and we could lose revenue. In addition, we pay our suppliers according to our calculation of the charges based upon invoices and computer tape records provided by these suppliers. Disputes may arise between us and our suppliers because these records may not always reflect current rates and volumes. If we do not pay disputed amounts, a supplier may consider us to be in arrears in our payments until the amount in dispute is resolved, which could adversely affect our relations with our suppliers. WE DEPEND ON THE NETWORKS AND SERVICES OF THIRD PARTY PROVIDERS TO SERVE OUR CUSTOMERS AND OUR RELATIONSHIPS WITH OUR CUSTOMERS COULD BE ADVERSELY AFFECTED BY FAILURES IN THOSE NETWORKS AND SERVICES. We depend on other carriers for the switching and transmission of our customer traffic. After we complete deploying our network, we will still rely to some extent on others for switching and transmission of customer traffic. We cannot be sure that any third party switching or transmission facilities will be available when needed or on acceptable terms. Although we can exercise direct control of the customer care and support we provide, most of the services we currently offer are provided by others. The availability of these services are subject to work stoppages, lack of available facilities, physical damage, power loss, capacity limitations, software defects, breaches of security and other factors which may cause interruptions in service or reduced capacity for our customers. These problems, although not within our control, could adversely affect customer confidence and damage our relationships with our customers. INCREASES IN CUSTOMER ATTRITION RATES COULD ADVERSELY AFFECT OUR OPERATING RESULTS. Our customers may not continue to purchase local, long distance, data or other services from us. Because we have been selling voice and data telecommunications under our own brand name for a short time, our customer attrition rate is difficult to evaluate. We could lose customers as a result of national advertising campaigns, telemarketing programs and customer incentives provided by major competitors as well as for other reasons not in our control as well as a result of our own performance. Increases in customer attrition rates could have a material adverse effect on our results of operations. WE MAY BE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH, WHICH COULD MATERIALLY ADVERSELY AFFECT ALL ASPECTS OF OUR BUSINESS. We are pursuing a business plan that will result in rapid growth and expansion of our operations if we are successful. This rapid growth would place significant additional demands upon our current management and other resources. Our success will depend on our ability to manage our growth. To accomplish this we will have to train, motivate and manage an increasing number of employees. Our failure to manage growth effectively could have a material adverse effect on our business, results of operations and financial condition. WE MAY BE UNABLE TO RETAIN OR REPLACE OUR SENIOR MANAGEMENT OR HIRE AND RETAIN OTHER HIGHLY SKILLED PERSONNEL UPON WHICH OUR SUCCESS WILL DEPEND. We believe that our continued success will depend upon the abilities and continued efforts of our management, particularly members of our senior management team. The loss of the services of any of these individuals could have a material adverse effect on our business, results of operations and financial condition. Our success will also depend upon our ability to identify, hire and retain additional highly skilled sales, service and technical personnel. Demand for qualified personnel with telecommunications experience is high and competition for their services is intense. If we cannot attract and retain the additional employees we need, we will be unable to successfully implement our business strategy. CHANGES TO THE REGULATIONS APPLICABLE TO OUR BUSINESS COULD INCREASE OUR COSTS AND LIMIT OUR OPERATIONS. We are subject to federal, state, and local regulation of our local, long distance, and data services. The outcome of the various administrative proceedings at the federal and state level and litigation in federal and state courts relating to this regulation as well as federal and state legislation may increase our costs, increase competition and limit our operations. RAPID TECHNOLOGICAL CHANGES IN THE TELECOMMUNICATIONS INDUSTRY COULD RENDER OUR SERVICES OR NETWORK OBSOLETE FASTER THAN WE EXPECT OR REQUIRE US TO SPEND MORE THAN WE CURRENTLY ANTICIPATE. The telecommunications industry is subject to rapid and significant changes in technology. Any changes could render our services or network obsolete, require us to spend more than we anticipate or have a material adverse effect on our operating results and financial condition. Advances in technology could also lead to more entities becoming our direct competitors. Because of this rapid change, our long-term success will increasingly depend on our ability to offer advanced services and to anticipate or adapt to these changes, such as evolving industry standards. We cannot be sure that: . we will be able to offer the services our customers require; . our services will not be economically or technically outmoded by current or future competitive technologies; . our network or our information systems will not become obsolete; . we will have sufficient resources to develop or acquire new technologies or introduce new services that we need to effectively compete; or . our cost of providing service will decline as rapidly as the costs of our competitors. WE MAY PURSUE ACQUISITIONS WHICH COULD DISRUPT OUR BUSINESS AND MAY NOT YIELD THE BENEFITS WE EXPECT. We may pursue strategic acquisitions as we expand. Acquisitions may disrupt our business because we may: . experience difficulties integrating acquired operations and personnel into our operations; . divert resources and management time; . be unable to maintain uniform standards, controls, procedures and policies . enter markets or businesses in which we have little or no experience; and find that the acquired business does not perform as we expected. OUR EXISTING PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS CONTROL A SUBSTANTIAL AMOUNT OF OUR VOTING SHARES AND WILL BE ABLE TO SIGNIFICANTLY INFLUENCE ANY MATTER REQUIRING SHAREHOLDER APPROVAL. Our officers and directors and parties related to them now control approximately 29.7% of the voting power of our outstanding capital stock. Robert J. Fabbricatore, our Chairman and Chief Executive Officer, controls approximately 9.8% of our voting power. Therefore, the officers and directors are able to significantly influence any matter requiring shareholder approval. FLUCTUATIONS IN OUR OPERATING RESULTS COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK. Our annual and quarterly revenue and results could fluctuate as a result of a number of factors, including: . variations in the rate of timing of customer orders, . variations in our provisioning of new customer services, . the speed at which we expand our network and market presence, . the rate at which customers cancel services, or churn, . costs of third party services purchased by us, and . competitive factors, including pricing and demand for competing services. Also, our revenue and results may not meet the expectations of securities analysts and our stockholders. As a result of fluctuations or a failure to meet expectations, the price of our common stock could be materially adversely affected. OUR STOCK PRICE IS LIKELY TO BE VOLATILE. The trading price of our common stock is likely to be volatile. The stock market in general, and the market for technology and telecommunications companies in particular, has experienced extreme volatility. This volatility has often been unrelated to the operating performance of particular companies. Other factors that could cause the market price of our common stock to fluctuate substantially include: . announcements of developments related to our business, or that of our competitors, our industry group or our customers; . fluctuations in our results of operations; . hiring or departure of key personnel; . a shortfall in our results compared to analysts' expectations and changes in analysts' recommendations or projections; . sales of substantial amounts of our equity securities into the marketplace; . regulatory developments affecting the telecommunications industry or data services; and . general conditions in the telecommunications industry or the economy as a whole. -----END PRIVACY-ENHANCED MESSAGE-----