-----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, Qm5wsdyxZHpQguuX9k6V3yy/n5MCqmUxp8JMlR7aASke9Wxo6aWcHxkAsNw3sbjx s+NxfbvBR7bzanR/BKZcig== 0000927016-98-002672.txt : 19980717 0000927016-98-002672.hdr.sgml : 19980717 ACCESSION NUMBER: 0000927016-98-002672 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980716 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CTC COMMUNICATIONS CORP CENTRAL INDEX KEY: 0000764841 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 042731202 STATE OF INCORPORATION: MA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-13627 FILM NUMBER: 98667033 BUSINESS ADDRESS: STREET 1: 360 SECOND AVE CITY: WALTHAM STATE: MA ZIP: 02154 BUSINESS PHONE: 7814668080 MAIL ADDRESS: STREET 1: 360 SECOND AVENUE CITY: WALTHAM STATE: MA ZIP: 02154 FORMER COMPANY: FORMER CONFORMED NAME: COMPUTER TELEPHONE CORP DATE OF NAME CHANGE: 19920703 10-K405 1 FORM 10-K405 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 fiscal year ended March 31, 1998. Commission File Number 0-13627. CTC COMMUNICATIONS CORP. (Exact name of registrant as specified in its charter) Massachusetts 04-2731202 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 360 Second Avenue, Waltham, Massachusetts 02154 (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] The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $38,228,190, on July 10, 1998, based on the closing sale price of the registrant's Common Stock as reported on the Nasdaq National Market as of such date. At July 10, 1998, 9,978,142 shares of the Registrant's Common Stock, $.01 par value, were outstanding. 1 PART I Certain statements regarding the Company contained in this Annual Report on Form 10-K including, without limitation, certain statements under the headings "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" relating to the Company's business plan, future profitability, expansion, deployment of facilities, future operations and availability of capital and other future plans, events and performance and other statements located elsewhere herein, are forward-looking statements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. No assurance can be given that the future results covered by the forward looking statements will be achieved. 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 in Exhibit 99.1 filed with this Annual Report on Form 10-K. The Company does not undertake to update or revise its 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. ITEM 1. BUSINESS OVERVIEW CTC Communications Corp. ("CTC" or the "Company"), a Massachusetts corporation, is a rapidly growing integrated communications provider ("ICP") with 14 years of local telecommunications marketing, sales and service experience. The Company offers local, long distance, Internet access, Frame Relay and other data services on a single integrated bill. CTC currently serves small to medium-sized business customers in seven Northeastern states through its experienced 181-member direct sales force and 85 customer care representatives located in 16 branch offices throughout the region. As of March 31, 1998, after only three months as an ICP, the Company had sold 21,613 local access lines of which 17,637 lines had already been provisioned. Prior to becoming an ICP in January 1998, the Company was the oldest and largest independent sales agent for Bell Atlantic Corp. ("Bell Atlantic"), selling local telecommunications services as an agent since 1984. The Company has also offered long distance and data services under its own brand name since 1994. As an agent, the Company managed relationships with approximately 7,000 customers who purchased in excess of $200 million of annual local telecommunications services for calendar year 1997, representing an estimated 280,000 local access lines at year end. In December 1997, the Company left the Bell Atlantic agency program to become an ICP using its well-developed franchise and infrastructure to capitalize on market opportunities created by deregulation. As an ICP, the Company is utilizing the same relationship-centered sales approach that it employed as an agent without the limitations on potential customers, services and pricing that were imposed upon it as an agent. The Company plans to expand geographically and add facilities assuming the availability of financing. The Company intends to expand within its existing markets and into six additional states in the Boston-Washington, D.C. corridor, plans to open more than 20 new branch offices and hire more than 200 additional sales personnel. In addition, beginning in late 1998, the Company intends to deploy a state-of-the-art, data centric, packet-switched Integrated Communications Network ("ICN"), initially in the Company's existing markets and in new markets as customer demand and concentrations warrant. INTERIM CREDIT FACILITY COMMITMENT. The Company has obtained a commitment for an interim credit facility (the "Interim Facility") from the lender under the Company's existing credit facility (the "Credit Facility"). The Interim Facility, which would mature on June 30, 1999, would provide secured revolving loans of up to $20 million to refinance the Credit Facility, to fund capital expenditures and operating losses and for general corporate purposes. Borrowing for capital expenditures in excess of $1 million would be limited to the extent of collection of the Bell Atlantic agency commissions under dispute and by financial covenants. The commitment, which is subject to certain conditions, extends to September 30, 1998. The Company also agreed to reduce availability under the Credit Facility to $9 million, and the lender has extended its waiver of existing covenant defaults through September 30, 1998. The Company paid fees in connection with obtaining this commitment and waiver of $500,000 and an additional fee of $300,000 would be payable if the Company draws on the Interim Facility. If the Interim Facility is outstanding at various dates from October 31, 1998 through June 30, 1999, the Company has agreed to issue to the lender warrants to purchase in the aggregate up to 5% of the Company's outstanding Common Stock on a fully diluted basis at exercise prices equal to the market value on the respective dates of issuance. SPECTRUM COMMITMENT. To satisfy a condition of the Interim Facility, the Company has obtained a commitment from Spectrum Equity Investors II L.P. ("Spectrum") that at any time prior to June 30, 1999, Spectrum will upon the request of the Company, purchase an additional $5 million in Preferred Stock, which would have the same terms as the Series A Convertible Preferred Stock (the "Interim Spectrum Financing"). In consideration of this commitment, the Company has agreed to issue to Spectrum five-year warrants to purchase 55,555 shares of Common Stock, exercisable at $9 per share. SERVICES The Company offers the following services: LOCAL TELEPHONE SERVICES. The Company's services include the connections between customers' telecommunications equipment and the local telephone network and/or multiple company locations. For customers with multiple locations served from the same central office, the Company offers a wide array of Centrex products and services. For large customers or customers with specific requirements, the Company integrates customer-owned Private Branch Exchange ("PBX") systems with analog or digital PBX trunks. In addition to providing standard dial tone services, the Company provides all associated call processing features as well dedicated private lines for both voice and data applications. LONG DISTANCE SERVICES. The Company offers a full range of domestic (interLATA and intraLATA) and international long distance services including "1+" outbound calling, inbound toll free service, standard and customized calling plans and related services such as calling cards, operator assistance, and conference calling. HIGH SPEED DATA SERVICES. The Company offers a wide array of dedicated and switched high speed digital data services. Dedicated services include DDS, DS-1 (T-1), Fiber Distributed Data Interface ("FDDI") and DS-3. Switched or virtual digital services include Integrated Services Digital Network ("ISDN"), Frame Relay and ATM. INTERNET SERVICES. The Company offers dedicated high speed Internet access and services via DDS, Frame Relay, T-1 and T-3 connections. In addition, the Company offers switched digital access to the Internet via ISDN. In support of these connections, the Company provides the necessary communications hardware, configuration support, domain registration as well as other support services on a 24-hour, 7-day a week basis. WHOLESALE SERVICES TO ISPS. The Company supplements its core end user product offerings by providing a full array of local services to Internet Service Providers ("ISPs"), including telephone numbers and switched and dedicated access to the Internet. POSSIBLE FUTURE SERVICES. Once its ICN is deployed, the Company plans to offer systems integration, consulting and network monitoring services, customized Virtual Private Networks ("VPNs") utilizing IP, data network product packages and voice over IP services. SALES AND CUSTOMER CARE SALES AND SERVICE INFRASTRUCTURE. The Company markets telecommunications services by seeking to develop long-term business relationships with its customers and offering them comprehensive management of their telecommunications requirements. Each customer of the Company is assigned a local dedicated Company team consisting of a sales executive and a customer care coordinator. This team provides a single point of contact for the customer's needs, working together to design, implement and maintain an integrated telecommunications solution. The team also reviews and updates the customer's services on a regular basis. The Company's services are currently provided through 181 sales executives and 85 customer care coordinators located in 16 branch sales offices servicing markets throughout Connecticut, Maine, Massachusetts, New Hampshire, New York, Rhode Island and Vermont. In addition, the Company maintains an agency office in California with an additional five sales and service personnel. CUSTOMER SALES AND SERVICE MODEL. Sales executives meet with prospective customers to understand their business and telecommunications requirements and analyze their current usage and costs. Sales executives outline the range of services and potential savings offered by the Company, discuss the benefits of the Company's comprehensive customer care program and develop Account Telemanagement Plans for potential customers designed to balance network expense and utility. Sales executives work with their existing customers through regular telephone calls and meetings to review the customers' telecommunications usage and requirements and to update their suite of services and network design. This relationship-centered sales approach assists sales executives in monitoring customers' demands and selling additional services into customers' consumption patterns. Sales executives regularly participate in training programs on subjects such as solution-oriented sales, comprehensive customer care, network design and other technical features of the Company's services. The Company seeks to motivate and retain its sales executives through extensive training as well as a commission structure which -2- currently bases approximately 45% of a sales executive's compensation on annualized billing revenues and 25% on customer satisfaction. CUSTOMER CARE. Customer care coordinators trained in the Company's service offerings work in direct support of sales executives in each branch location. The Company's reiterative, multi-step customer care process provides an ongoing and comprehensive service program ranging from long-term consultative planning to day-to-day handling of service issues. CTC's customer care program is designed to provide prompt action in response to customer inquiries and complaints and a dedicated team approach to sales and service. The local branch offices are staffed 12 hours a day, 5 days a week. At other times, incoming calls automatically roll over to a central customer care center which is staffed 24 hours a day, 7 days a week. If the customer care coordinator assigned to a particular account is not available, the customer's request is accommodated by another customer service representative. The Company believes that its customer care coordinators are motivated to provide the highest level of customer care as a significant portion of their compensation is based on customer satisfaction. THE CTC INFORMATION SYSTEM The CTC Information System is comprised of five central applications which fully integrate the Company's sales and account management, customer care, provisioning, billing and financial processes. Automation of each of these processes is designed to provide for high volume and accurate throughput, timely installation, accurate billing feeds and quality customer service. Data entered in one application is simultaneously exported into all other applications. Each branch office is served by a LAN connected via Frame Relay to the central processor. From their branch desktops or docking stations, the Company's employees have online access to all of the Company's operational systems and applications. The system also interfaces with the Company's network suppliers for ordering, repair, status reporting and billing feeds. When an order is placed by a sales executive, the CTC Information System electronically directs it to the appropriate supplier(s) and monitors and reports any delays in the provisioning. Once the order is completed, the CTC Information System automatically removes it from the in-process order file, updates the customer's service inventory and network configuration, initiates billing, posts the sales executive's commission and updates the branch office, area and Company financial reports. Sales and Account Management. The CTC Account Management System, the hub of the CTC Information System, stores all customer-related information, such as location detail, contact information, transaction history and account profile. The CTC Account Management System also feeds CTC's Customized Sales System, a fully-integrated database which provides sales personnel with access to information for pricing services, generating customized proposals and customer correspondence, tracking sales performance, referencing methods and procedures, service descriptions, competitive information and historical profiles, which include details of installed services, recent transactions and billing history, for current and prospective customers. The CTC Customized Sales System can be used both on- and off-line, and 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 laptop is reconnected to the network. Customer Care. Through the CTC Account Care System, customer care coordinators can 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 the customer history file. The orders and repair requests input through the CTC Account Care System are automatically fed into the CTC Provisioning System. Provisioning. Through the CTC Provisioning System, customer orders are directed electronically to the Company's suppliers via file transfer or electronic data interchange. All orders are tracked through the CTC Account -3- Care System from initiation through completion, and an exception is noted when an order or process has not been fulfilled in the estimated time frame. The proactive nature of the system affords the sales executive or customer care coordinator the opportunity to get the installation process back on track, or at least notify the customer of the delay. Once the order has been fulfilled, the information is automatically fed to the CTC Billing System to initiate billing for the newly provisioned services. Billing and Customer Interface. The CTC Billing System is a fully- convergent system, billing all of the services the Company provides to its customers on a single bill. The CTC Billing System, available to customers on both diskette and CD-Rom with accompanying software, allows the customer to review historic bill detail, perform customized usage analyses and download information directly to their own accounting applications. Through the IntelliVIEW application, a secure Web-based application, customers have near real-time online access to the CTC Billing System via the Internet and are able to review and analyze their bills online. Paper statements generated by the CTC Billing System offer the Company's customers different telemanagement formats. The CTC Billing System was launched in October 1997, billing long distance services and subsequently Internet access, private data services and Frame Relay services and began billing local services in January 1998 when the Company began operations as an ICP. Financial. Data from the CTC Billing System is automatically exported to the CTC Financial System. Through its integration with the other applications, the CTC Financial System tracks and prepares reports on sales activity, commissions, branch operations, branch profitability, cash flows and compiles all of this data in preparing the Company's periodic financial reports. The system also provides for internal controls for revenue tracking and costing. The integrated nature of the CTC Information System allows the Company to operate each branch as a separate profit and loss center. THE CTC INTEGRATED COMMUNICATIONS NETWORK The Company's ICN is being designed as a state-of-the-art digital network with data and long distance services The ICN is expected to be comprised of data and long distance switches capable of handling Asynchronous Transfer Mode ("ATM"), Internet Protocols ("IP"), and Ethernet and Frame Relay protocols interconnected by leased transmission facilities. The ICN is being designed to provide customers with dedicated DS-1 or other broadband access and to bundle a variety of voice and data services on one digital platform. The data services planned for the ICN include point-to-point private line, Frame Relay, Internet access and virtual private network services for on-net data traffic as well as network-to-network interface points to other data carrier networks and Internet service providers for traffic which must travel off-net. The Company plans to lease local dialtone services until these services can be fully integrated into a packet-switched network architecture. During the initial phase of network deployment, CTC intends to deploy a network operations center and data and long distance toll switching equipment in hub and node locations in the New England and New York region where the Company has an established customer base. As the Company expands into new markets, it plans to deploy its network as customer demand and concentrations warrant. In May 1998, the Company signed agreements with a network services integrator to design, engineer and manage the buildout of the ICN in the Company's existing markets. Under the terms of the agreements, the network integrator will (i) provide an initial evaluation of the Company's proposed network, (ii) create a detailed network design, (iii) assist the Company in acquiring network components and network operations center system components, (iv) develop the appropriate software interfaces to the Company's Operational Support System, and (v) supervise construction, testing and validation of the ICN in the Company's existing markets, primarily on a fixed fee basis. COMPETITION The Company operates in a highly competitive environment and has no significant market share in any market in which it operates. The Company expects that it will face substantial and growing competition from a variety of data -4- transport, data networking and telephony service providers due to regulatory changes, including the continued implementation of the Telecommunications Act of 1996 (the "Telecommunications Act"), and the increase in the size, resources and number of such participants as well as a continuing trend toward business combinations and alliances in the industry. The Company faces competition for the provision of integrated telecommunications services as well as competition in each of the individual market segments that comprise the Company's integrated approach. In each of these market segments, the Company faces competition from larger, better capitalized incumbent providers, which have long standing relationships with their customers and greater name recognition than the Company. Competition for Provision of Integrated Telecommunications Services. The current regulatory trend toward fostering competition and opening markets, as well as the continued consolidation of telecommunication service providers, has increased the number of competitors able to provide integrated telecommunications services similar to those provided by the Company. Many facilities-based ICPs and long distance carriers have committed substantial resources to building their networks or to purchasing ICPs or Interexchange Carriers ("IXCs") with complementary facilities. By building or purchasing a network or entering into interconnection agreements or resale agreements with Incumbent Local Exchange Carriers ("ILECs"), including Regional Bell Operating Companies ("RBOCs"), a facilities-based provider can offer single source local and long distance services similar to those offered or to be offered by the Company. Such additional alternatives may provide such competitors with greater flexibility and a lower cost structure than the Company. In addition, some of these ICPs and other facilities-based providers of local exchange service are acquiring or being acquired by IXCs that are not subject to joint marketing restrictions. Once the RBOCs are allowed to offer widespread in-region long distance services under the terms of Section 271 of the Telecommunications Act, both they and the largest IXCs will be in a position to offer single-source local and long distance services similar to those offered by the Company. Currently, no RBOC is permitted to provide in-region long distance services, although there is no assurance that this will continue to be the case. The availability of broad- based local resale and introduction of facilities-based local competition are required before the RBOCs may provide in-region interLATA long distance services. In 1997, the FCC denied the applications of several RBOCs for in- region interLATA long distance authority. Further FCC rulings may be complicated by a Texas Federal District Court ruling on December 31, 1997 (the "Wichita Falls Decision") that Section 271 of the Telecommunications Act is unconstitutional. On February 11, 1998, this court granted a request by the FCC and a number of long distances carriers to stay the decision pending an appeal to the United States Court of Appeals for the Fifth Circuit. If this decision is upheld and/or repeated in other jurisdictions, RBOC entry into the in-region interLATA long distance markets may occur much more rapidly than envisioned under the Telecommunications Act. Although the outcomes of court actions cannot be predicted, decisions permitting early entry of the RBOCs into in-region, interLATA long distance could have a material adverse effect on the Company's business. Although the Telecommunications Act and other federal and state regulatory initiatives will afford the Company new business opportunities, regulators are likely to provide the ILECs with an increased degree of flexibility with regard to pricing of their services as competition increases. If the ILECs elect to lower their rates and sustain lower rates over time, this may adversely affect the revenues of the Company and place downward pressure on the rates the Company can charge. The Company believes the effect of lower rates may be offset by the increased revenues available by offering new services to its target customers, but there can be no assurance that this will occur. In addition, if future regulatory decisions afford the Local Exchange Carriers ("LECs") excessive pricing flexibility or other regulatory relief, such decisions could have a material adverse effect on the Company. Competition for Provision of Local Exchange Services. In the local exchange market, ILECs, including RBOCs, continue to hold near-monopoly positions. The Company also faces competition or prospective competition from one or more ICPs, many of which have significantly greater financial resources than the Company, and from other competitive providers, including non-facilities-based providers. Various 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 the Company's markets, subject to joint marketing restrictions. The largest long distance carriers (AT&T, MCI, Sprint and any other carrier with 5% or more of the pre-subscribed access lines), however, are prevented under the Telecommunications Act from bundling local services resold from an RBOC in a particular state with their long -5- distance services until the earlier of (i) February 8, 1999 or (ii) the date on which the RBOC whose services are being resold obtains in-region long distance authority in that state. In the event the RBOCs soon begin offering in-region long distance service, the largest long distance carriers will be permitted to bundle local and long distance services that much earlier, removing one of the competitive advantages currently enjoyed by the Company. In addition to these long distance service providers, entities that currently offer or are potentially capable of offering switched services include ICPs, cable television companies, electric utilities, other long distance carriers, microwave carriers, wireless telephone system operators and large customers who build private networks. Wireless telephone system operators have become competitors in the provision of local services because the FCC has authorized cellular, personal communications service, and other Commercial Mobile Radio Services ("CMRS") providers to offer wireless services to fixed locations, rather than just to mobile customers. This authority to provide fixed as well as mobile services will enable CMRS providers to offer wireless local loop service and other services to fixed locations (e.g., office and apartment buildings) in direct competition with the Company and other providers of traditional fixed telephone service. In addition, the FCC recently auctioned substantial blocks of spectrum for fixed use including, among other things, local exchange service. Exploitation of this spectrum is expected to increase competition in the local market. The World Trade Organization ("WTO") recently concluded an agreement (the "WTO Agreement") that could result in additional competitors entering the U.S. local and long-distance markets. Under the WTO Agreement, the United States committed to open telecommunications markets to foreign-owned carriers. The FCC has adopted streamlined procedures for processing market entry applications from foreign carriers, making it easier for such carriers to compete in the U.S. There can be no assurance that the WTO Agreement will not have a material impact on the Company's business. Competition for Provision of Long Distance Services. The long distance market is significantly more competitive than the local exchange market with numerous entities competing for the same customers. In addition, customers frequently change long distance providers in response to the offering of lower rates or promotional incentives by competitors, resulting in a high average churn rate. 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 once RBOCs are permitted to offer interLATA long distance services. Data and Internet Services. The market for high speed data services and access to the Internet is highly competitive, and the Company expects that competition will continue to intensify. The Company's competitors in this market will include ISPs, other telecommunications companies. Many of these competitors have greater financial, technological and marketing resources than those available to the Company. In addition, various RBOCs have filed petitions to the FCC requesting regulatory relief in connection with the provision of their own data services. GOVERNMENT REGULATION The Company's local and long distance telephony service, and to a lesser extent its data services, are subject to federal, state, and, to some extent, local regulation. The FCC exercises jurisdiction over all telecommunications common carriers, including the Company, to the extent that they provide interstate or international communications. Each state regulatory commission retains jurisdiction over the same carriers with respect to the provision of intrastate communications. Local governments sometimes impose franchise or licensing requirements on telecommunications carriers and regulate construction activities involving public right-of-way. Changes to the regulations imposed by any of these regulators could affect the Company. While the Company believes that the current trend toward relaxed regulatory oversight and competition will benefit the Company, the Company cannot predict the manner in which all aspects of the Telecommunications Act will be implemented by the FCC and by state regulators or the impact that such regulation will have on its business. -6- The Company is subject to FCC and state proceedings, rulemakings, and regulations, and judicial appeal of such proceedings, rulemakings and regulations, which address, among other things, access charges, fees for universal service contributions, ILEC resale obligations, wholesale rates, and prices and terms of interconnection and unbundling. The outcome of these proceedings, rulemakings, judicial appeals, and subsequent FCC or state actions may make it more difficult or expensive for the Company or its competitors to do business. Such developments could have a material effect on the Company. The Company also cannot predict whether other regulatory decisions and changes will enhance or lessen the competitiveness of the Company relative to other providers of the products and services offered by the Company. In addition, the Company cannot predict what other costs or requirements might be imposed on the Company by state or local governmental authorities and whether or not any additional costs or requirements will have a material adverse effect on the Company. Federal Legislation The Telecommunications Act requires that local and state barriers to entry into the local exchange market be removed and has established broad uniform standards under which the FCC and the state commissions are to implement local competition and co-carrier arrangements in the local exchange market. Under certain conditions and subject to certain exceptions, major ILECs are now required to make available at a discount for resale by new entrants all services offered by the LEC on a retail basis. The Telecommunications Act also imposes significant obligations on the RBOCs and other ILECs, including the obligation to interconnect their networks with the networks of competitors. Each ILEC is required not only to open its network but also to "unbundle" various elements of the network, such as the local loop and switching or transport functions. States have begun, and in a number of cases completed, regulatory proceedings to determine the pricing of these unbundled network elements and services, and the results of these proceedings will determine whether it is economically attractive to use these elements. All LECs, including Competitive Local Exchange Carriers ("CLECs"), must fulfill various obligations so as not to impede the ability of other carriers to provide services. These include the duty to permit resale of their services, the duty to provide number portability and dialing parity, the duty to provide access for competitors to poles, ducts, conduits and rights-of-way, and the duty to provide reciprocal compensation for the transport and termination of telecommunication traffic to and from other LEC's networks. Section 271 of the Telecommunications Act provides that the RBOCs must fulfill additional conditions before they will be permitted to offer in-region interLATA toll services: (1) the RBOC must have met the requirements of the Telecommunications Act's 14-point competitive checklist and (2) the RBOC must have entered into an approved interconnection agreement with one or more unaffiliated, facilities-based competitors in some portion of the state pursuant to which such competitors provide both business and residential service (or that by a date certain no such competitors have "requested" interconnection as defined in the Telecommunications Act). If the FCC determines, after consultation with the Department of Justice and the relevant state commissions, that these requirements have been met and that the RBOC's provision of in-region long distance services in a state is in the public interest, the FCC must authorize the RBOC to provide such services. In 1997, the FCC denied the application of several RBOCs for in-region long distance authority. Unless rendered moot as a result of the Wichita Falls Decision, the Company anticipates that a number of RBOCs will file additional applications in 1998. As noted above, however, the Wichita Falls Decision found Section 271 of the Act, among others, to be unconstitutional. Accordingly, the Wichita Falls Decision, to the extent that it is upheld, may reduce the incentive that RBOCs have to open their networks to competition. The Telecommunications Act is meant to eliminate state and local statutory and regulatory barriers to entry, thus accelerating the process of creating a competitive environment in all markets. This preemption of state laws barring local competition and the relaxation of regulatory restraints should enhance the Company's ability to expand its service offerings nationwide. At the same time, the Telecommunications Act will also substantially increase the competition the Company will face in its various markets. -7- Federal Regulation The FCC has issued a variety of regulations pursuant to the Telecommunications Act and may issue numerous additional such regulations. The outcome of these various ongoing FCC rulemaking proceedings or judicial appeals of such proceedings could materially affect the Company's operations. In May 1997, the FCC issued new regulations regarding the implementation of the universal service program and the assessment of access charges on carriers obtaining access to local exchange networks. All telecommunications carriers, including the Company, that provide interstate services are required to contribute, on a equitable and nondiscriminatory basis, to the preservation and advancement of universal service pursuant to a universal funding service mechanism established by the FCC. Mandatory contribution amounts are revised regularly and in May 1997 both the access charge and universal service regimes were substantially revised. As a result of these changes, the costs of business and multiple residential telephone lines are expected to increase. In addition, the new regulations require a reseller, such as the Company, to begin contributing to the universal service programs for low-income consumers and high-cost, rural and insular areas on the basis of the reseller's interstate and international revenues. The Telecommunications Act provides that individual state utility commissions can, consistent with FCC regulations, prohibit resellers from reselling a particular service to specific categories of customers to whom the ILEC does not offer that service at retail. In August 1996, the FCC issued detailed regulations providing that many such limitations are presumptively unreasonable and that states may enact such prohibitions on resale only in certa in limited circumstances. The Telecommunications Act also provides that state commissions shall determine the wholesale rates for local telecommunications services (i.e., the rates charged by ILECs to ICPs such as the Company) on the basis of retail rates less "avoided costs," i.e., marketing, billing, collection and other administrative costs avoided by the ILEC when it sells at wholesale. In August 1996, the FCC issued detailed regulations establishing an interim default discount of between 17% to 25%. Although this portion of the FCC's rules has been overturned on appeal (see below), in practice state commissions have generally adopted discount percentages that fall within the 17-25% default range. In August 1996, the FCC issued regulations that, among other things, set minimum standards governing the terms and prices of interconnection and access to unbundled ILEC network elements and mandating that ILECs negotiate interconnection or resale arrangements in good faith. These regulations indirectly affect the price at which the Company's new facilities-based competitors may ultimately provide service. The Telecommunications Act provides that state commissions shall determine the rates charged for such unbundled elements on the basis of cost plus a reasonable profit. The Company is unable to predict the final form of such state regulation, or its potential impact on the Company or the local exchange market in general. In 1997, the U.S. Court of Appeals for the Eighth Circuit vacated certain portions of FCC regulations, including, among other things, provisions addressing the availability of certain services for resale, establishing a methodology for pricing interconnection and unbundled network elements, a rule permitting new entrants to "pick and choose" among various provisions of existing interconnection agreements, and the obligation of incumbent LECs to combine network elements. The U.S. Supreme Court has agreed to review the Eighth Circuit's decision. If upheld, the rulings could make it more difficult for the Company to take advantage of ILEC services. The FCC recently issued regulations to eliminate the ability of nondominant carriers such as the Company to file interstate long-distance tariffs of rates and operating procedures and permitting (but not requiring) non-dominant local carriers such as the Company to withdraw their tariffs for interstate services. Various carriers have filed suit to overturn the FCC regulations, and the U.S. Court of Appeals for the D.C. Circuit has stayed the regulations pending its decision in that appeal, which is not expected until sometime later this year. In the meantime, however, the FCC issued a Reconsideration Order (on August 20, 1997), which reverses certain aspects of the FCC's previous regulations. The Reconsideration Order would still significantly limit the ability of carriers to tariff long distance -8- services. When not allowed to tariff the long distance services it may seek to provide, the Company would be required to provide service through a contract and forego legal rights pertaining to reliance on a "filed rate." In August 1997, the FCC issued rules transferring responsibility for administering and assigning local telephone numbers from the RBOCs and a few other LECs to a neutral entity in each geographic region in the United States. In August 1996, the FCC issued new numbering regulations that (a) prohibit states from creating new area codes that could unfairly hinder LEC competitors (including the Company) by requiring their customers to use 10 digit dialing while existing ILEC customers use 7 digit dialing, and (b) prohibit ILECs (which are still administering central office numbers pending selection of the neutral administrator) from charging "code opening" fees to competitors (such as the Company) unless they charge the same fee to all carriers including themselves. In addition, each carrier is required to contribute to the cost of numbering administration through a formula based on net telecommunications revenues. In July 1996, the FCC released rules requiring all LECs, including CLECs, to have the capability to permit both residential and business consumers to retain their telephone numbers when switching from one local service provider to another (known as "number portability"). In August 1996 the FCC promulgated regulations that classify CMRS providers as telecommunications carriers, thus giving them the same rights to interconnection and reciprocal compensation under the Telecommunications Act as other non-LEC telecommunications carriers, including the Company. State Regulation Certain local and long distance services have historically been classified as intrastate and therefore subject to state regulation. As its local service business and product lines expand, the Company will offer more intrastate service and become increasingly subject to state regulation. The Telecommunications Act maintains the authority of individual state utility 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 Telecommunications Act. For instance, states impose tariff and filing requirements, consumer protection measures and obligations to contribute to universal and other funds. The Company has state regulatory authority to provide competitive local exchange services and interexchange services in the seven states in its current market. The Company also has state regulatory authority to provide interexchange services in approximately 16 additional states. In certain states, in which the Company has or has had de minimis intrastate interexchange revenues, the Company has not obtained authorization to provide such interexchange services or has allowed such authorization to lapse. The Company has either subsequently obtained, or is in the process of applying to obtain, the appropriate authorization in these states. Local Government Regulation Should the Company decide to operate its own transport or other facilities over public rights-of-way, it may be required to obtain various permits and authorizations from municipalities in which it operates such facilities and grant rights of way to other carriers. Some municipalities may impose such restrictions regardless of whether an entity operates such facilities. The actions of municipal governments in imposing conditions on the grant of permits or other authorizations, or their failure to act in granting such permits or authorizations, except as preempted by the FCC, could have a material adverse effect on the Company's business. EMPLOYEES As of June 30, 1998, the Company employed 341 persons. None of the employees is represented by a collective bargaining agreement. -9- ITEM 2. PROPERTIES The Company is headquartered in leased space in Waltham, Massachusetts. The Company also leases one office in California, two in Connecticut, five in Massachusetts, two in Maine, one in New Hampshire, four in New York and one in Vermont. Although the Company believes that its leased facilities are adequate at this time, the Company expects to lease a significant number of additional sales facilities in connection with its planned expansion in existing markets and into new markets. ITEM 3. LEGAL PROCEEDINGS (a) Pending Legal Proceedings. In December 1997, the Company terminated its agency contract and filed suit (the "Bell Atlantic Litigation") against Bell Atlantic in federal court in the Southern District of Maine for breaches of the contract, including the failure of Bell Atlantic's retail division to pay $14 million in agency commissions (approximately $11.3 million as of July 10, 1998) owed to the Company. The Company also asserted violations by Bell Atlantic of antitrust laws and the Telecommunications Act. Bell Atlantic filed counterclaims in federal court in the Southern District of New York asserting that the Company breached a provision of the agency contract prohibiting the Company from selling non-Bell Atlantic local services to certain agency customers for a one-year period following termination of the contract. Based on that provision, Bell Atlantic obtained a temporary restraining order (the "TRO") that prohibits the Company from marketing certain local telecommunications services to any Bell Atlantic customer for whom the Company was responsible for account management, or to whom the Company sold Bell Atlantic services, during 1997. This prohibition will terminate in December 1998, or upon the earlier dissolution of the TRO. The Company has made a motion to dissolve the TRO and the federal court in Maine has held a hearing to consider the Company's motion. Bell Atlantic's counterclaims have been consolidated with the Company's suit in the federal court in the Southern District of Maine. The Company estimates that the TRO applies to less than 5% of the Company's target customers in its current markets. The Company continues to provide many of these customers with other services such as long distance and Internet access that are not covered by the terms of the TRO. The Company is otherwise party to suits arising in the normal course of business which management believes are not material individually or in the aggregate. (b) Legal Proceedings Terminated in the Fourth Quarter. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY SECURITIES AND RELATED STOCKHOLDER MATTERS The Company's Common Stock trades on the Nasdaq National Market under the symbol "CPTL." The following tables set forth the ranges of the high and low sale prices for the Company's outstanding Common Stock for the periods indicated. -10-
Three Months Ended High Sale Low Sale - ------------------ --------- -------- June 30, 1996 $18.00 $9.75 September 30, 1996 $13.75 $8.00 December 31, 1996 $11.75 $6.38 March 31, 1997 $ 9.13 $6.38 June 30, 1997 $10.00 $6.88 September 30, 1997 $ 9.75 $7.06 December 31, 1997 $15.94 $8.00 March 31, 1998 $14.94 $5.13
As of July 10, 1998, there were 357 holders of record of the Company's Common Stock. The Company believes there were in excess of 1,500 beneficial holders of the Common Stock as of such date. The Company has never paid a cash dividend on its Common Stock and has no present intention of paying dividends in the foreseeable future. The Company intends to retain earnings, if any, to develop and expand its business. In addition, the terms of the Series A Convertible Preferred Stock restrict, and the terms of future debt financings are expected to restrict, the ability of the Company to pay dividends on Common Stock. ITEM 6. SELECTED HISTORICAL FINANCIAL DATA OF THE COMPANY The following selected financial data have been derived from the Company's financial statements. The following data should be read in conjunction with the Company's financial statements and related notes appearing elsewhere in this Report on Form 10-K. All earnings per share and weighted average share information included in the accompanying financial statements have been restated to reflect the 25% stock split effected in Fiscal 1995, and the three-for-two stock split and the two-for-one stock split effected in Fiscal 1996.
Fiscal Year ended March 31, 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- (dollars in thousands, except per share information) STATEMENT OF OPERATIONS DATA Agency revenues....................................... $14,483 $18,898 $25,492 $29,195 $24,775 Telecommunications revenues........................... 462 3,038 5,383 11,095 16,172 Total revenues................................... 14,945 21,936 30,875 40,290 40,947 Cost of telecommunications revenue.................... 369 2,451 4,242 8,709 14,038 Selling, general and administrative................... 14,484 17,319 20,009 23,820 31,492 Income (loss) from operations......................... 92 2,166 6,624 7,761 (4,583) Income (loss) before income taxes..................... 141 2,322 6,830 7,960 (4,370) Net income (loss)..................................... 75 1,472 4,094 4,683 (2,884) Earnings (loss) per share Basic............................................ 0.01 0.18 0.43 0.49 (0.29) Diluted.......................................... 0.01 0.17 0.38 0.43 (0.29)
As of March 31, 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- (dollars in thousands) BALANCE SHEET DATA Cash and cash equivalents............................. $ 1,239 $ 2,391 $ 3,942 $ 6,406 $ 2,168 Total assets.......................................... 5,399 7,726 12,509 20,186 30,967
-11- Total long-term debt.................................. --- --- --- --- --- Stockholders' equity.................................. 3,871 5,526 9,495 14,292 11,580
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Financial Statements and Notes set forth elsewhere in this Report. OVERVIEW CTC is a rapidly growing ICP with a 14-year track record of telecommunications marketing, sales and service experience. Building upon its substantial experience in providing sophisticated telecommunications solutions, the Company designs, sells and implements fully-integrated voice and data solutions tailored to meet its customers needs. The Company offers local, long distance, Internet access, Frame Relay and other data services on a single integrated bill. The Company currently serves small to medium-sized business customers primarily in seven Northeastern states through its 181-member direct sales force and 85 customer care representatives located in 16 branch offices throughout the region. Since 1984, the Company has on several occasions successfully realigned its strategy to capitalize on market opportunities and respond to change. CTC originally sold key systems and PBX telephone systems. In 1984, after the divestiture of AT&T, the Company became the first agent for any RBOC in the United States. As an agent, CTC focused on selling point-to-point data services, Centrex and NYNEX Corporation network-based local telecommunications services primarily to medium size business customers. In 1994, the Company added the sale of long distance services and subsequently, Frame Relay, Internet access and other data services under its own brand name. In December 1997, the Company left the Bell Atlantic agency program to become an ISP and sell local telecommunications services under its own brand name as a complement to the other services it offers. Historically, CTC's revenues had consisted of agency revenues earned as an agent, primarily for Bell Atlantic, and of telecommunications revenues earned from the sale of long distance, Frame Relay, Internet access and other communications services. For the nine months ended December 31, 1997, agency revenues accounted for approximately 71% of the Company's revenues and telecommunications revenues accounted for the remainder. As a result of the Company's termination of its agency contract with Bell Atlantic in December 1997, the Company will no longer earn agency revenues from Bell Atlantic. Telecommunications revenues are not expected to be affected in any material way by the change in status. In addition, since becoming an ICP the Company has derived, and expects to continue to derive, telecommunications revenue from the sale of local telephone service under its own brand name. Although management believes that the Company's facilities-based ICP strategy will have a positive effect on the Company's results of operations over the long term, this strategy is expected to have a negative effect on the Company's financial condition and results of operations over the short term. The Company anticipates significant losses and negative cash flow at least through the fiscal year ending March 31, 1999, which the Company expects will be primarily attributable to the deployment of the ICN and expected expansion of operations. Fiscal Year Ended March 31, 1998 Compared to Fiscal Year Ended March 31, 1997 The results for the fiscal year ended March 31, 1998 ("Fiscal 1998") reflect the Company's decision to terminate its agency relationship with Bell Atlantic in December 1997 and commence operations as an ICP. This decision adversely affected revenues and expenses to a certain extent in the third quarter as the Company prepared for this transition and significantly affected revenues in the fourth quarter after the transition had been effected. Total revenues of $40,947,000 for Fiscal 1998 were essentially flat as compared to $40,290,000 for the fiscal year ended March 31, 1997 ("Fiscal 1997"). Agency revenues decreased 15% to $24,775,000 for Fiscal 1998 from $29,195,000 in Fiscal 1997, primarily as a result of fourth quarter revenues of only $194,000, as compared to $8,354,000 for the same period of Fiscal 1997. This decrease reflects the fact that the Company left the Bell Atlantic agency program in December 1997, and thus no Bell Atlantic agency revenues were reported in the fourth quarter of Fiscal 1998. Telecommunications revenues increased 46% to $16,172,000 for Fiscal 1998 from $11,095,000 for Fiscal 1997. This increase reflects the increased sales of long distance, Internet access, and frame relay data services as well the commencement of the Company's sale of local telecommunications services as an ICP in the fourth quarter of Fiscal 1998. Although local telecommunications sales increased during the fourth quarter, they were significantly less than expected by the Company as a result of the imposition of the TRO in February 1998, thereby requiring the Company to sell these local services only to new -12- customers, resulting in a longer sales cycle. Costs of telecommunications revenues increased 61% to $14,039,000 for Fiscal 1998 from $8,709,000 for Fiscal 1997. As a percentage of telecommunications revenues, cost of telecommunications revenues was 87% for Fiscal 1998 as compared to 78% for Fiscal 1997. This overall increase was due primarily to increased sales of telecommunications services and increased costs for those services sold. Due largely to the initiation of local telecommunications sales in the fourth fiscal quarter, cost of telecommunications revenues for this period increased 127% to $5,944,000 from $2,615,000 for the same period in Fiscal 1997. These increases as a percentage of revenues were attributable to fixed costs associated with the sale of local telecommunications services, lower long distance rates extended to customers in advance of rate decreases from CTC's long distance supplier, increased costs associated with adding new customers and services, and costs associated with phasing out the Company's debit card program. As a result, the Company believes that gross margins for the fourth quarter are not representative and expects gross margins to improve in future quarters. Selling, general and administrative expenses increased 32% to $31,492,000 in Fiscal 1998 from $23,820,000 in Fiscal 1997. This increase was a result of the increased number of sales and service employees hired in connection with the strategy shift, increased payments of commission and bonuses, increased corporate and administrative expenses, increased depreciation associated with greater capital expenditures, expenses related to new branch openings and a $1,200,000 charge for estimated costs of the Bell Atlantic litigation. The Company reported a loss of $2,884,000 for Fiscal 1998 as compared to net income of $4,683,000 for Fiscal 1997, primarily as the result of a $6,008,000 loss in the fourth quarter. Fiscal Year Ended March 31, 1997 Compared to Fiscal Year Ended March 31, 1996 Total revenues for Fiscal 1997 increased 30% to $40,290,000 as compared to $30,876,000 for the fiscal year ended March 31, 1996 ("Fiscal 1996"). Agency revenues increased 15% to $29,195,000 in Fiscal 1997 as compared to $25,493,000 for Fiscal 1996 due to the addition of new customers, increased sales to existing customers and the addition of new services to the Company's portfolio. Effective January 1996, NYNEX reduced certain fees and commissions payable under its 1996 agency agreement with the Company. As a result, although unit sales of Centrex and Data Products, two flagship NYNEX products, increased 30% and 66%, respectively, revenues increased only 15% as stated above. Telecommunications revenues increased 106% to $11,095,000 for Fiscal 1997 from $5,383,000 for Fiscal 1996. This increase can be attributed to the addition of new customers to the service, as well as the introduction of new products, primarily Internet access. Selling, general and administrative expenses increased 19% to $23,820,000 for Fiscal 1997 from $20,009,000 for Fiscal 1996. As a percentage of revenues, these expenses were 59% for Fiscal 1997, as compared to 65% for Fiscal 1996. The increase in selling, general and administrative expenses is attributable to the increase in variable sales commission and bonus expenses incurred in connection with the substantial increase in revenues. In addition, the Company increased the number of sales offices, particularly in the Northeast, hired additional sales executives, expanded the facilities at several of its existing sales branches and made additional investments in its Information System in Fiscal 1997. Net income increased to $4,683,000 in Fiscal 1997 from $4,094,000 in Fiscal 1996, as a result of revenue growth primarily in the Northeast, combined with a continuing effort to control operating expenses. LIQUIDITY AND CAPITAL RESOURCES Historically, the Company funded its working capital and operating expenditures primarily from cash flow from operations. Principally as a result of Bell Atlantic's failure to pay approximately $14 million (approximately $11.3 million as of July 14, 1998) in agency commissions which the Company believes it is owed under its former agency contract and losses incurred in connection with CTC's transition to an ICP strategy, the Company required additional working capital from outside sources. As of July 14, 1998, the Company borrowed $8.3 million under the Credit Facility, which CTC entered into in November 1997 in anticipation of its transition to an ICP strategy. In April 1998, the Company sold $12 million of Series A Convertible Preferred Stock and warrants (the "Spectrum Financing") to Spectrum and other private investors in a private placement. The Company has sued Bell Atlantic and believes the collection of the agency commissions is probable. However, there is no assurance that the Company will be successful in collecting those commissions. If the Company fails to collect any of the agency commissions sought or if their collection becomes less than probable, the Company would be required to write off the amounts reflected in its financial statements that it is unable to collect or for which collection becomes less than probable. Delay in the collection of, or the write-off of, the agency commissions may adversely affect the Company. As of March 31, 1998, the Company was not in compliance with certain covenants under the Credit Facility as a result of $6 million of net losses incurred in the fourth quarter of Fiscal 1998 in conmnection with the Company's transition to an ICP strategy. The Company has obtained waivers of these defaults through September 30, 1998 and has agreed to reduce availability under the Credit Facility to $9 million. The Company has obtained a commitment for the Interim Facility from its current lender. The Interim Facility, which would mature on June 30, 1999, would provide secured revolving loans of up to $20 million to refinance the Credit Facility, to fund capital expenditures and operating losses and for general corporate purposes. The commitment, which is subject to certain conditions, extends to September 30, 1998. To satisfy one of those conditions, the Company has received a commitment from Spectrum to purchase $5 million of Preferred Stock which extends until June 30, 1999. The Company believes that the Interim Facility and the Interim Spectrum Financing, if required, together with cash on hand would be sufficient to refinance the Credit Facility and to fund the Company's existing operations for at least the next 12 months. However, CTC would be required to delay its proposed geographic expansion and deployment of facilities or to obtain additional financing within the next 6 months. The implementation of the Company's business plan to further penetrate its existing markets as an ICP, deploy the ICN in its existing markets, expand its sales presence into six additional states in the Boston-Washington D.C. corridor and enhance the CTC Information System and the repayment of the Credit Facility will require the Company to raise significant capital. The Company does not expect to consummate the $125 million private offering of senior discount notes and warrants under Rule 144A which it has been seeking and is actively engaged in the negotiation of commitments with alternative sources of capital to fund its business plans. Although the Company is highly optimistic that it will be successful in obtaining such financing based upon its negotiations, there can be no assurance that the Company will be able to consummate financing in the amount, on the terms and on the schedule required to implement the Company's business plan, if at all. The timing and amount of the Company's actual capital requirements may be materially affected by many factors, including the timing and availability of financing, the timing and actual cost of expansion into new markets and deployment of the ICN, the extent of competition and pricing of telecommunications services in its markets, acceptance of the Company's services, technological change and potential acquisitions. -13- YEAR 2000 COMPLIANCE The Company has evaluated the effect of the year 2000 date on its information systems and is implementing plans to ensure its systems and applications will effectively process information necessary to support ongoing operations of the Company in the year 2000 and beyond. The Company currently expects that its systems will be year 2000 compliant by the end of 1998. Based on management's current estimates, the costs of system modifications and enhancements, which have been and will be expensed as incurred, are not expected to be material to the results of operation or the financial position of the Company. The Company has made inquiries with its significant suppliers to determine the extent to which the Company's interface systems and operations are vulnerable to those third parties' failure to rectify their own year 2000 issues. There can be no assurance that the systems of other companies on which the Company's systems rely will be timely converted and will not have an adverse effect on the Company's operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Financial Statements and Notes thereto comprising a portion of this Annual Report on Form 10-K on pages F-1 to F-17. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. -14- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Identification of Directors
Other Capacities Period Served in Which Age as Director Currently Serving --- ------------- ----------------- Robert J. Fabbricatore 55 Since 1980 Chairman and Chief Executive Officer Richard J. Santagati 54 Since 1991 None J. Richard Murphy 53 Since 1995 None Henry Hermann 56 Since 1996 Consultant Ralph C. Sillari 43 Since 1997 None William P. Collatos 44 Since 1998 None Kevin J. Maroni 35 Since 1998 None
Mr. Robert 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 Fabbricatore is the brother of Thomas Fabbricatore. Mr. Santagati became a director of the Company in September 1991. He has been the President of Merrimack College in North Andover, Massachusetts since 1994. Mr. Santagati was a partner of Lighthouse Management, Inc., a private investment firm located in Boston, Massachusetts from 1991 to 1993 and, from 1991 to February 1994, 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. Murphy became a Director of the Company in August 1995. Mr. Murphy has been the Director of the Financial Consulting Group of Moody, Cavanaugh and Company, LLP, a North Andover, Massachusetts public accounting firm, since April 1996. Mr. Murphy was an officer, director and principal stockholder (ii) from 1990 to 1995 of Arlington Data Corporation, a systems integration company located in Amesbury, Massachusetts; (ii) from 1992 to 1996 of Arlington Data Consultants, Inc., a company engaged in the installation and maintenance of computer systems and hardware; and (iii) from 1994 to 1996 of Computer Emporium, Inc., a company engaged in processing parking violations for municipalities. In June 1996, Arlington Data Corporation filed for bankruptcy under Chapter 11 of the Bankruptcy Code. Mr. Hermann became a director of the Company in September 1996. Since November 1997, he has operated Hermann Companies, a financial services company engaged in portfolio management, securities analysis and financial consulting. 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 Brokers Transaction Services. From May 1997 to November 1997, he was employed by Kuhns Brothers & Company, Inc., as a principal and Executive Vice President. For the previous nine years, he was employed by WR Lazard, Laidlaw and Luther, Inc., a securities brokerage firm, as Vice President, Securities Analyst and Portfolio Manager. Mr. Hermann has been an NASD Board of Arbitrators Member since 1991. Mr. Hermann has provided financial consulting services to the Company since 1993. Mr. 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 Executive Vice President in the Business and Entrepreneurial Services Division in Boston, Massachusetts. Mr. Collatos became a director of the Company in April 1998 as a condition to the Spectrum Financing. Mr. -15- Collatos is a founding General Partner of Spectrum. Prior to founding Spectrum in 1994, Mr. Collatos was a founding General Partner of Media/Communications Partners and a General Partner of TA Associates. Mr. Collatos is a director of Galaxy Telecom Inc., TSR Paging Inc., Golden Sky Systems Inc., ITXC Corp. and Internet Network Services Holdings Ltd. Mr. Maroni became a director of the Company in April 1998 as a condition to the Spectrum Financing. Mr. Maroni is a General Partner of Spectrum, which he joined in 1994. Prior to joining Spectrum, he served as Manager, Finance and Development at Time Warner Telecommunications, where he was involved in corporate development projects. Mr. Maroni is a director of Pathnet, Inc., Formus Communications, Inc., WNP Communications, Inc. and American Cellular Corp. Pursuant to Section 50A of Chapter 156B of the Massachusetts General Laws and as provided in the Company's Amended and Restated By-laws, the Board of Directors is classified into three classes, as nearly as equal in number as possible, so that each director (after a transitional period) will serve for three years, with one class of directors being elected each year. The board is currently comprised of two Class I Directors (Messrs. Hermann and Sillari), two Class II Directors (Messrs. Murphy and Santagati) and three Class III Directors (Messrs. Fabbricatore, Maroni and Collatos). The terms of the Class I, Class II and Class III Directors expire upon the election and qualification of successor directors at annual meetings of stockholders held following the end of fiscal years 1998, 1999 and 2000, respectively. DIRECTOR COMPENSATION Directors of the Company who are employees do not receive compensation for their services as directors. Directors who are not employees receive an annual retainer of $10,000. On May 16, 1997, the Company granted to Messrs. Hermann, Murphy and Santagati stock options to purchase 10,000, 10,000 and 15,000 shares, respectively, of its Common Stock at a purchase price of $7.44 per share. On October 20, 1997, the Company granted to Mr. Sillari a stock option to purchase 10,000 shares of its Common Stock at a purchase price of $8.25 per share upon his becoming a director of the Company. These options were repriced on March 20, 1998 to $7.19 per share. COMMITTEES OF THE BOARD OF DIRECTORS The Company has established an Audit Committee, Compensation Committee and a Nominating Committee. The Audit Committee consists of Messrs. Murphy and Hermann. The Audit Committee is responsible for reviewing the internal accounting controls of the Company, meeting and conferring with the Company's certified public accountants and reviewing the results of the accountants' auditing engagement. The Compensation Committee consists of Messrs. Maroni, Santagati and Murphy. The Compensation Committee establishes compensation and benefits for the Company's senior executives. The Committee also determines the number and terms of stock options granted to employees, directors and consultants of the Company under the Company's stock option plans. The Nominating Committee consists of Messrs. Santagati, Murphy and Sillari. The Nominating Committee recommends candidates for nomination to the Board of Directors. The Committee also reviews and makes recommendations regarding compensation for non-employee directors. VOTING AGREEMENT Pursuant to a Voting Agreement dated April 10, 1998 between Robert J. Fabbricatore and certain of his affiliates and Spectrum, Mr. Fabbricatore and certain of his affiliates agreed to vote at each annual or special meeting at which directors of the Company are to be elected all of the shares of Common Stock held by them in favor of persons designated by a majority of the outstanding shares of Series A Preferred Stock as nominees for directors, subject to certain limitations based on the number of shares of Series A Preferred Stock outstanding at any time. -16- (b) Identification of Executive Officers
Name Age Current Office Held - ---- --- ------------------- Robert J. Fabbricatore 55 Chairman, Chief Executive Officer Steven P. Milton 44 President, Chief Operating Officer Steven C. Jones 35 Executive Vice President, Chief Financial Officer and Director of Corporate Development John D. Pittenger 45 Executive Vice President-Finance and Administration, Treasurer and Clerk David E. Mahan 56 Vice President-Market and Strategic Planning Michael H. Donnellan 44 Vice President - Operations Thomas Fabbricatore 39 Vice President - Regulatory and Electronic Media Anthony D. Vermette 37 Vice President - Sales
Mr. 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, most recently, Vice President-Sales and Marketing. Mr. Jones joined the Company in early 1998 and has served as an Executive Vice President and Chief Financial Officer since April 1998. From 1994 to April 1998, Mr. Jones worked in the telecommunications investment banking division of Merrill Lynch & Co., most recently as a Vice President. From 1991 to 1994, Mr. Jones was an Associate at BT Securities Corp. Mr. Pittenger has served as Executive Vice President-Finance and Administration since April 1998 and as Treasurer and Clerk 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. Mr. Mahan joined the Company in October 1995 as Vice President-Marketing and Strategic Planning and in June 1996 became an executive officer of the Company. Prior to joining the Company, Mr. Mahan held a number of senior management level positions with NYNEX, most recently as Vice President-Sales Channel Management from 1993 to 1995. Mr. Donnellan has been employed by the Company since 1988 in a number of positions. He was named Vice President-Operations in 1995 and became an executive officer of the Company in October 1997. Mr. Thomas J. Fabbricatore joined the Company in 1982. He was named Vice President-Regulatory and Electronic Media in 1991 and became an executive officer of the Company in October 1997. Thomas Fabbricatore is the brother of Robert J. Fabbricatore. Mr. Vermette has been employed by the Company in a variety of positions since 1987. Mr. Vermette was named Vice President-Sales in 1996 and became an executive officer in October 1997. For a description of the business background of Mr. Robert Fabbricatore see "Identification of Directors" above. -17- ITEM 11. EXECUTIVE COMPENSATION The following table provides certain summary information concerning the compensation paid or accrued by the Company to or on behalf of the Company's Chief Executive Officer and each of the four other most highly paid executive officers of the Company ("Named Executive Officers") during the fiscal year ended March 31, 1998. SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Compensation ------------------- ---------------------- Securities Other Underlying All Name and Salary Bonus Annual Options Other Principal Position Year ($) ($) Compensation($) (#)(1) Compensation - ------------------- ---- --- --- --------------- ---- ------------ Robert J. Fabbricatore, 1998 240,000 60,000 - 150,000 $19,550 Chairman and Chief 1997 240,000 60,000 - - 18,075 Executive Officer 1996 240,000 60,000 - - 16,100 Steven P. Milton, 1998 100,000 40,000 5,200 150,000 4,200 President and Chief 1997 100,000 40,000 5,200 - 4,075 Operating Officer 1996 100,000 40,000 5,200 - 4,200 Anthony D. Vermette, 1998 86,647 58,424 4,000 100,000 3,456 Vice President 1997 80,000 54,198 4,000 - 3,776 1996 80,000 28,000 4,000 - 3,240 Michael H. Donnellan, 1998 92,500 4,000 4,000 80,000 3,975 Vice President of 1997 80,000 32,000 4,000 - 3,360 Operations 1996 63,000 132,119 4,000 - 3,887 David E. Mahan, Vice 1998 100,000 40,000 5,004 260,000 4,075 President - Market 1997 100,000 40,000 5,004 - 4,075 Planning & Development 1996(3) 50,000 20,000 2,500 100,000 -
(1) On March 20, 1998, the Company repriced all previously granted options that had an exercise price in excess of $7.00 per share. Includes 75,000, 75,000, 50,000, 40,000 and 180,000 shares underlying options previously granted to Messrs. Fabbricatore, Milton, Vermette, Donnellan, and Mahan, respectively, that were canceled as a result of the repricing. (2) Includes 50% matching contributions in the amounts of $4,750, $4,200, $4,200, $3,456, $3,975 and $4,075 accrued on behalf of Messrs. Fabbricatore, Milton, Vermette, Donnellan, and Mahan, respectively, to the CTC Communications Corp. 401(k) Savings Plan. Also included is the actuarial benefit in the amount of approximately $14,800 on the "split- dollar" life insurance policy for the benefit of Mr. Fabbricatore. (3) Mr. Mahan commenced employment with the Company on October 1, 1995. The following table sets forth information concerning option grants and option holdings for the fiscal year ended March 31, 1998 with respect to the Named Executive Officers. -18- OPTION GRANTS IN LAST FISCAL YEAR
% of Total Potential Realizable Value No. of Options as Assumed Annual Rates Securities Granted to of Stock Price Appreciation Underlying Employees Exercise for Option Term ---------------------------- Option in Fiscal Price Expiration Name Granted (#) Year ($/Sh) Date 5%($) 10%($) ---- ----------- ---- ------ ---- ----- ----- Robert J. Fabbricatore 75,000(1) 3% $8.18 5/16/2002 $98,339 $284,788 75,000 3% 7.91 5/16/2002 95,033 275,216 Steven P. Milton 75,000(1) 3% 7.44 5/16/2002 154,124 340,573 75,000 3% 7.19 5/16/2002 148,943 329,126 Anthony D. Vermette 50,000(1) 2% 7.44 5/16/2002 102,749 227,049 50,000 2% 7.19 5/16/2002 99,296 219,417 Michael H. Donnellan 40,000(1) 1% 7.44 5/16/2002 82,199 181,639 40,000 1% 7.19 5/16/2002 79,436 175,534 David E. Mahan 80,000(1) 3% 7.44 5/16/2002 164,399 363,278 80,000 3% 7.19 5/16/2002 158,873 351,068 100,000 4% 7.19 10/02/2000 198,391 438,835
__________________ (1) Canceled as a result of option repricing. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth information concerning the exercise of options by the Named Executive Officers during the fiscal year ended March 31, 1998 and the March 31, 1998 aggregate value of unexercised options held by each of the Named Executive Officers.
Number of Securities Value of Unexercised In- Underlying Unexercised the-Money Options at Options at Fiscal Fiscal Year End ($) Shares Year End (#)(1) (1)(2) ------------------------------------------------ acquired on Exercisable/ Exercisable/ Name exercise (#) Value Realized($) Unexercisable Unexercisable - ---- ------------ ---------------- ------------------------------------------------ Robert J. Fabbricatore..... ___ ___ 25,167 83,389 143,704 106,401 Anthony D. Vermette........ 13,251 142,484 59,649 69,500 412,913 209,731 Michael H. Donnellan....... ___ ___ 77,626 61,750 545,503 208,188 Steven P. Milton........... ___ ___ 27,000 84,000 161,487 166,329 David E. Mahan............. ___ ___ 50,000 130,000 75,000 195,000
(1) All shares and amounts, as necessary, have been adjusted to reflect the 25% Common Stock dividend effected in March 1995, the three-for-two stock split effect in July 1995 and the two-for-one stock split effected in October 1995. (2) Assumes a fair market value of the Common Stock of the Company at March 31, 1998 of $8.69 per share. -19- EMPLOYMENT AGREEMENT Mr. Jones is currently employed as Executive Vice-President, Chief Financial Officer and Director of Corporate Development pursuant to an agreement dated as of February 27, 1998. The agreement provides for an initial term of three years and will automatically be extended for additional one-year periods on the anniversary of the Effective Date (as defined therein) provided that neither Mr. Jones nor the Company gives notice of termination 90 days prior to any such anniversary. Under this agreement, Mr. Jones is entitled to receive an annual salary of $150,000. Mr. Jones is eligible to receive an annual bonus of at least $75,000 based upon the achievement of certain performance objectives. Pursuant to his employment agreement, Mr. Jones was granted options to purchase 300,000 shares of Common Stock exercisable at $7.06 per share and vesting over a three year period. If the Company terminates Mr. Jones without cause, or Mr. Jones terminates the agreement for (i) ''good reason'' as defined therein or (ii) in connection with a change of control, Mr. Jones is entitled to a severance payment equal to a lump sum amount in cash, equal to the sum of (i) two year's base salary at the highest annual base salary then in effect and (ii) the greater of twice his highest annual bonus or $150,000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information as of July 10, 1998 with respect to each stockholder known by the Company to beneficially own more than 5% of the outstanding shares of the Company's Common Stock, the beneficial ownership of the Company's Common Stock by each director and named executive officer of the Company, and by all of the directors and officers of the Company as a group. Based on the information furnished by the beneficial owners of the Common Stock listed below, the Company believes that each such stockholder exercises sole voting and investment power with respect to the shares beneficially owned.
BENEFICIAL OWNERSHIP -------------------- NAME NUMBER PERCENT OF CLASS - ---- --------------------------- Robert J. Fabbricatore(1)......... 2,759,891 27.5% Spectrum Equity Investors II, L.P.(2)............. 1,476,454 12.9 Henry Hermann(3).................... 215,922 2.2 Richard J. Santagati(4).............. 84,500 * J. Richard Murphy(5)................. 14,334 * Ralph C. Sillari........................ 500 * William P. Collatos(2)............ 1,476,454 12.9 Kevin J. Maroni(2)................ 1,476,454 12.9 Steven P. Milton(6)..................436,682 4.4 David E. Mahan (7).................. 133,100 1.3 Michael H. Donnellan(8)............. 107,340 1.1 Anthony J. Vermette(9)............... 98,057 1.0 All Officers and Directors as as Group(14 persons)(10).......... 5,832,932 48.5
- --------------------- * Less than 1%. (1) Includes 62,498 shares owned by Mr. Fabbricatore as trustee of a trust for his children and 1,133,239 shares as a general partner of a family partnership; also includes 43,917 shares issuable upon exercise of options exercisable within 60 days of July 10, 1998. Mr. Fabbricatore's address is c/o CTC Communications Corp., 360 Second Avenue, Waltham, Massachusetts 02154. (2) Includes 131,511 shares issuable upon the exercise of a warrant exercisable within 60 days of July 10, 1998 and 1,344,943 shares issuable upon conversion of Series A Preferred Stock as of July 10, 1998. As general partners of Spectrum, each of Mr. Collatos, Mr. Maroni and Brion B. Applegate may be deemed to be beneficial owners of the shares beneficially owned by Spectrum. The address of Spectrum and its general partners is One International Place, 29th Floor, Boston, Massachusetts 02110. (3) Includes 9,750 shares held by Mr. Hermann's spouse and 10,334 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. -20- (4) Includes 9,500 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. (5) Includes 1,000 shares owned by Mr. Murphy as trustee of a trust for his spouse and 13,334 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. (6) Includes 4,500 shares owned by Mr. Milton as trustee of a trust for his children and 45,750 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. (7) Includes 70,000 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. (8) Includes 87,626 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. (9) Includes 72,149 shares issuable upon the exercise of options exercisable within 60 days of July 10, 1998. (10) Includes the shares described in footnotes (1) through (9) above. PREFERRED STOCK As of July 10, 1998, Spectrum Equity Investors II, L.P., located at One International Place, Boston, MA 02110, owned 657,555 of the 666,666 shares, or 98.6%, of the Series A Preferred Stock outstanding. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company leases from trusts, of which Robert J. Fabbricatore, the Company's Chairman and Chief Executive Officer, is a beneficiary, office space in Springfield, Massachusetts and southern New Hampshire. Rental payments under the leases totaled approximately $134,000, $133,000 and $133,000 in Fiscal 1996, Fiscal 1997 and Fiscal 1998, respectively. The Company subleases part of its Waltham facility at its cost to Comm-Tract Corp., a company in which Mr. Fabbricatore is a principal stockholder. Sublease income totaled $73,417, $80,416 and $119,416 for Fiscal 1996, Fiscal 1997 and Fiscal 1998, respectively. The Company also contracts with Comm-Tract Corp. for the installation of telephone lines and for the service and maintenance of equipment marketed by the Company. During Fiscal 1996, Fiscal 1997 and Fiscal 1998, Comm-Tract Corp. provided the Company with services, inventory and equipment aggregating $40,880, $97,190 and $233,034, respectively. The Company believes that the payments to the trusts and Comm-Tract Corp. are comparable to the costs for such services, inventory and equipment, and for rentals of similar facilities, which the Company would be required to pay to unaffiliated individuals in arms-length transactions. In connection with the exercise of Company stock options in Fiscal 1995, Steven P. Milton was advanced the sum of $135,825 by the Company, which remained outstanding at March 31, 1998. The loan is payable on demand and bears interest at 8.0% per annum. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors and executive officers, and persons who own more than ten percent of a registered class of the Company's equity securities, to file with the Securities and Exchange Commission (the "Commission") initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are required by Commission regulations to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and, with respect to its officer and directors, written representations that no other reports were required, during Fiscal 1998, all Section 16(a) filing requirements applicable to its officers, directors and greater than tem percent beneficial owners were complied with. In making the foregoing statement, the Company has relied on the written representations of its directors and officers and copies of the reports that have been filed with the Commission. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K (a)(1) The following financial statements are included in Part II, Item 8: -21- Balance Sheets March 31, 1998 and 1997 Statements of Income Years Ended March 31, 1998, 1997 and 1996 Statements of Stockholders' Equity Years Ended March 31, 1998, 1997 and 1996 Statements of Operations Years Ended March 31, 1998, 1997 and 1996 Notes to Financial Statements (a)(2) The following financial statement schedule for the years ended March 31, 1998, 1997 and 1996 is submitted herewith: Schedule II - Valuation and Qualifying Accounts All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. (b) Reports on Form 8-K. On February 3, 1998, the Company filed a report on Form 8-K disclosing the Fleet Credit Facility and the Bell Atlantic Litigation. (c) Exhibits. NUMBER DESCRIPTION OF EXHIBIT 3.1 Restated Articles of Organization, as amended(6) 3.2 Amended and Restated By-Laws of Registrant(6) 4.1 Form of Common Stock Certificate(5) 9.1 Voting Agreement dated April 10, 1998 among Robert Fabbricatore and certain of his affiliates and Spectrum(7) 10.1 1996 Stock Option Plan(3) 10.2 1993 Stock Option Plan(5) 10.3 Employee Stock Purchase Plan(4) 10.4 Lease for premises at 360 Second Ave., Waltham MA(5) 10.5 Sublease for premises at 360 Second Ave., Waltham MA(5) 10.6 Lease for premises at 110 Hartwell Ave., Lexington MA(5) 10.7 Lease for premises at 120 Broadway, New York, NY(5) 10.8 Agreement dated February 1, 1996 between NYNEX and the Company(5) 10.9 Agreement dated May 1, 1997 between Pacific Bell and the Company (5) 10.10 Agreement dated January 1, 1996 between SNET America, Inc. and the Company(5) 10.11 Agreement dated June 23, 1995 between IXC Long Distance, Inc. and the Company, as amended(5) 10.12 Agreement dated August 19, 1996 between Innovative Telecom Corp. and the Company(5) 10.13 Agreement dated October 20, 1994 between Frontier Communications International, Inc. and the Company, as amended(5) 10.14 Agreement dated January 21, 1997 between Intermedia Communications Inc. and the Company(5) -22- 10.15 Employment Agreement between the Company and Steve Jones dated February 27, 1998(7) 10.16 Securities Purchase Agreement dated April 10, 1998 among the Company and the Purchasers named therein(6) 10.17 Registration Rights Agreement dated April 10, 1998 among the Company and the Holders named therein(6) 10.18 Form of Warrant dated April 10, 1998(6) 23.1 Consent of Ernst & Young LLP(7) 27 Financial Data Schedule(7) 99.1 Risk Factors(7) ___________________ (1) Incorporated by reference to an Exhibit filed as part of the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1996. (2) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-18 (Reg. No. 2-96419-B). (3) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-8 (File No. 333-17613). (4) Incorporated by reference to an Exhibit filed as part of the Registrant's Registration Statement on Form S-8 (File No. 33-44337). (5) 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. (6) Incorporated by reference to the Registrant's Current Report on Form 8-K dated May 15, 1998 filed with the Commission on May 15, 1998. (7) Filed herewith. -23- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf by the undersigned thereunto duly authorized. CTC COMMUNICATIONS CORP. /S/ ROBERT J. FABBRICATORE --------------------------- Robert J. Fabbricatore, Chairman and CEO Date: July 15, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. /S/ ROBERT J. FABBRICATORE --------------------------- Robert J. Fabbricatore, Chairman and Chief Executive Officer /S/ STEVEN C. JONES --------------------------- Steven C. Jones, Executive Vice President, Chief Financial Officer and Director of Corporate Development (principal financial officer) /S/ JOHN D. PITTENGER --------------------------- John D. Pittenger Executive Vice President-Finance and Administration (principal accounting officer) /S/ RICHARD J. SANTAGATI --------------------------- Richard J. Santagati, Director /S/ J. RICHARD MURPHY --------------------------- J. Richard Murphy, Director /S/ HENRY HERMANN --------------------------- Henry Hermann, Director /S/ RALPH C. SILLARI --------------------------- Ralph C. Sillari, Director /S/ WILLIAM P. COLLATOS --------------------------- William P. Collatos, Director -24- /S/ KEVIN J. MARONI --------------------------- Kevin J. Maroni, Director Date: July 15, 1998 -25- CTC COMMUNICATIONS CORP. INDEX TO FINANCIAL STATEMENTS Audited Financial Statements Report of Independent Auditors........................................... F-2 Balance Sheets as of March 31, 1998 and 1997............................. F-3 Statements of Operations for the years ended March 31, 1998, 1997 and 1996.................................................................... F-4 Statements of Stockholders' Equity for the years ended March 31, 1998, 1997 and 1996........................................................... F-5 Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996.................................................................... F-6 Notes to Financial Statements............................................ F-7
F-1 REPORT OF INDEPENDENT AUDITORS Board of Directors CTC Communications Corp. We have audited the accompanying financial statements of CTC Communications Corp., as of March 31, 1998 and 1997, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended March 31, 1998. 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 based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 financial statements referred to above present fairly, in all material respects, the financial position of CTC Communications Corp. at March 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 1998, in conformity with generally accepted accounting principles. 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. Ernst & Young LLP Boston, Massachusetts May 28, 1998, except for Note 1, as to which the date is July 15, 1998 F-2 CTC COMMUNICATIONS CORP. BALANCE SHEETS
MARCH 31 ------------------------ 1998 1997 ----------- ----------- ASSETS Current assets: Cash and cash equivalents.......................... $ 2,167,930 $ 6,405,670 Accounts receivable, less allowance for doubtful accounts of $492,000 in 1998 and $377,000 in 1997.............................................. 17,288,183 10,904,820 Prepaid expenses and other current assets.......... 791,736 447,441 Amounts due from officers and employees............ 84,754 46,112 Income tax receivable.............................. 2,152,579 ----------- ----------- Total current assets............................. 22,485,182 17,804,043 Equipment: Equipment.......................................... 13,376,970 7,268,372 Accumulated depreciation........................... (6,837,683) (5,565,650) ----------- ----------- 6,539,287 1,702,722 Deferred income taxes................................ 1,834,000 566,000 Other assets......................................... 108,885 113,685 ----------- ----------- $30,967,354 $20,186,450 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses.............. $ 8,958,476 $ 3,238,416 Accrued income taxes............................... 225,948 Accrued salaries and related taxes................. 756,159 2,423,825 Deferred revenue................................... 6,588 Current portion of obligations under capital leases............................................ 231,796 Current portion of note payable to bank............ 1,196,400 ----------- ----------- Total current liabilities........................ 11,142,831 5,894,777 Obligations under capital leases, net of current portion............................................. 1,114,277 Note payable to bank, net of current portion......... 7,130,671 Commitments and contingencies........................ Stockholders' equity: Series Preferred Stock--par value $1.00 per share; authorized 1,000,000 shares, none outstanding..... Common Stock, par value $.01 per share; authorized 25,000,000 shares, issued 9,980,661 and 9,629,407 shares in 1998 and 1997, respectively............. 99,806 96,294 Additional paid-in capital......................... 5,245,704 4,758,454 Deferred compensation.............................. (318,410) Retained earnings.................................. 6,688,300 9,572,750 ----------- ----------- 11,715,400 14,427,498 Amounts due from stockholders...................... (135,825) (135,825) ----------- ----------- 11,579,575 14,291,673 ----------- ----------- $30,967,354 $20,186,450 =========== ===========
See accompanying notes. F-3 CTC COMMUNICATIONS CORP. STATEMENTS OF OPERATIONS
YEAR ENDED MARCH 31 ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Revenues: Agency............................... $24,775,420 $29,195,261 $25,492,511 Telecommunications................... 16,171,716 11,094,838 5,383,414 ----------- ----------- ----------- 40,947,136 40,290,099 30,875,925 Costs and expenses: Cost of telecommunications revenues.. 14,038,565 8,709,122 4,241,575 Selling, general and administrative expenses............................ 31,491,963 23,819,714 20,009,432 ----------- ----------- ----------- 45,530,528 32,528,836 24,251,007 ----------- ----------- ----------- Income (loss) from operations.......... (4,583,392) 7,761,263 6,624,918 Other: Interest income...................... 145,012 201,369 195,979 Interest expense..................... (106,465) (17,753) (604) Other................................ 174,395 15,052 9,631 ----------- ----------- ----------- 212,942 198,668 205,006 ----------- ----------- ----------- Earnings (loss) before income taxes.... (4,370,450) 7,959,931 6,829,924 Provision (benefit) for income taxes... (1,486,000) 3,277,000 2,736,000 ----------- ----------- ----------- Net income (loss)...................... $(2,884,450) $ 4,682,931 $ 4,093,924 =========== =========== =========== Earnings (loss) per common share: Basic................................ $ (0.29) $ 0.49 $ 0.43 =========== =========== =========== Diluted.............................. $ (0.29) $ 0.43 $ 0.38 =========== =========== =========== Shares used in computing earnings (loss) per common share: Basic................................ 9,886,000 9,600,000 9,446,000 =========== =========== =========== Diluted.............................. 9,886,000 10,773,000 10,712,000 =========== =========== ===========
See accompanying notes. F-4 CTC COMMUNICATIONS CORP. STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL AMOUNTS -------------------- PAID-IN DEFERRED RETAINED TREASURY DUE FROM SHARES PAR VALUE CAPITAL COMPENSATION EARNINGS STOCK STOCKHOLDERS TOTAL --------- --------- ---------- ------------ ----------- --------- ------------ ----------- Balance at March 31, 1995................... 3,124,437 $31,244 $4,871,302 $ 796,734 $ (13,860) $(159,825) $ 5,525,595 Issuance of stock pursuant to employee stock purchase plan... 9,082 91 58,153 58,244 Exercise of employee stock options......... 197,143 1,971 121,053 123,024 Acquisition of treasury stock................. (329,125) (329,125) Retirement of treasury stock................. (25,454) (254) (342,731) 342,985 Settlement of amounts due from stockholders.......... 24,000 24,000 Issuance of stock upon 3 for 2 stock split... 1,560,742 15,607 (15,607) (839) (839) Issuance of stock upon 2 for 1 stock split... 4,718,172 47,182 (47,182) Net income............. 4,093,924 4,093,924 --------- ------- ---------- --------- ----------- --------- --------- ----------- Balance at March 31, 1996................... 9,584,122 95,841 4,644,988 4,889,819 0 (135,825) 9,494,823 Issuance of stock pursuant to employee stock purchase plan... 8,714 87 70,088 70,175 Exercise of employee stock options......... 36,571 366 43,378 43,744 Net income............. 4,682,931 4,682,931 --------- ------- ---------- --------- ----------- --------- --------- ----------- Balance at March 31, 1997................... 9,629,407 96,294 4,758,454 9,572,750 0 (135,825) 14,291,673 Issuance of stock pursuant to employee stock purchase plan... 9,844 98 71,662 71,760 Exercise of employee stock options......... 376,387 3,764 347,222 350,986 Acquisition of treasury stock................. (271,072) (271,072) Retirement of treasury stock................. (34,977) (350) (270,722) 271,072 Deferred compensation.. 339,088 $(318,410) 20,678 Net loss............... (2,884,450) (2,884,450) --------- ------- ---------- --------- ----------- --------- --------- ----------- Balance at March 31, 1998................... 9,980,661 $99,806 $5,245,704 $(318,410) $ 6,688,300 0 $(135,825) $11,579,575 ========= ======= ========== ========= =========== ========= ========= ===========
See accompanying notes. F-5 CTC COMMUNICATIONS CORP. STATEMENTS OF CASH FLOWS
YEAR ENDED MARCH 31 ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- OPERATING ACTIVITIES Net income (loss)...................... $(2,884,450) $ 4,682,931 $ 4,093,924 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization........ 1,417,866 742,895 660,338 Provision for doubtful accounts...... 1,421,000 316,669 61,763 Deferred income taxes................ (1,268,000) (289,000) (124,000) Stock compensation expense........... 20,678 Gain on sale of fixed asset.......... (143,333) Changes in operating assets and liabilities: Accounts receivable................ (7,804,363) (4,664,260) (2,979,772) Other current assets............... (382,937) (123,789) (231,642) Income tax receivable.............. (2,152,579) 21,125 (21,125) Other assets....................... 4,800 4,800 (90,200) Accounts payable, accrued expenses, accrued salaries and related taxes............................. 4,052,394 2,657,149 1,103,061 Accrued income taxes............... (225,948) 225,948 (281,569) Deferred revenue and other......... (6,588) (2,714) 1,128 ----------- ----------- ----------- Net cash provided by (used in) operating activities.................. (7,951,460) 3,571,754 2,191,906 INVESTING ACTIVITY Additions to equipment, net............ (4,765,025) (1,221,879) (759,204) ----------- ----------- ----------- Net cash used in investing activity.... (4,765,025) (1,221,879) (759,204) FINANCING ACTIVITIES Proceeds from issuance of common stock................................. 151,674 113,919 119,467 Borrowings under note payable to bank, net of repayments..................... 8,327,071 Cash paid for fractional shares in connection with stock splits.......... (839) ----------- ----------- ----------- Net cash provided by financing activities............................ 8,478,745 113,919 118,628 ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents........................... (4,237,740) 2,463,794 1,551,330 Cash and cash equivalents at beginning of year............................... 6,405,670 3,941,876 2,390,546 ----------- ----------- ----------- Cash and cash equivalents at end of year.................................. $ 2,167,930 $ 6,405,670 $ 3,941,876 =========== =========== ===========
See accompanying notes. F-6 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS MARCH 31, 1998 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY CTC Communications Corp. (the Company) is an integrated communications provider (ICP), which offers local, long distance, Internet access, Frame Relay and other data services under its own brand name on a single integrated bill. The Company serves small to medium-sized business customers in seven Northeastern states. Prior to becoming an ICP in January 1998, the Company was a sales agent for Bell Atlantic Corp. (Bell Atlantic) and other telecommunications providers selling local telecommunications services as an agent since 1984. The Company has also offered long distance and data services under its own brand name since 1994. In late 1998, the Company plans to begin deploying a data-centric network in its existing markets. The Company has obtained a commitment for an interim credit facility (the Interim Facility) from its current lender. The Interim Facility, which would mature on June 30, 1999, would provide secured revolving loans of up to $20 million to refinance the Company's existing credit facility (the Credit Facility), to fund capital expenditures and significant operating losses expected to be incurred in connection with the Company's transition to an ICP strategy and for general corporate purposes. The commitment, which is subject to certain conditions, extends to September 30, 1998. To satisfy one of those conditions, the Company has received a commitment from Spectrum to purchase $5 million of Preferred Stock which extends until June 30, 1999 (the Interim Spectrum Financing). The Company believes that the Interim Facility and the Interim Spectrum Financing, if required, together with cash on hand would be sufficient to refinance the Credit Facility and to fund the Company's existing operations for at least the next 12 months. However, CTC would be required to delay its proposed geographic expansion and deployment of facilities or to obtain additional financing within the next 6 months. The implementation of the Company's business plan to further penetrate its existing markets as an ICP, deploy the ICN in its existing markets, expand its sales presence into six additional states in the Boston-Washington D.C. corridor and enhance the CTC Information System and the repayment of the Credit Facility will require the Company to raise significant capital. The Company has been seeking and is actively engaged in the negotiation of commitments with alternative sources of long-term financing to fund its business plans. Although the Company is highly optimistic that it will be successful in obtaining such financing based upon its negotiations, there can be no assurance that the Company will be able to consummate financing in the amount, on the terms and on the schedule required to implement the Company's business plan, if at all. Agency revenues derived from commissions received from Bell Atlantic represented 48%, 63% and 69% of the Company's total revenues in 1998, 1997 and 1996, respectively. Accounts receivable from Bell Atlantic amounted to 63% and 70% of total accounts receivable at March 31, 1998 and 1997, respectively. See Note 2. CASH AND CASH EQUIVALENTS The Company considers highly liquid investments with maturities of less than three months at the date of acquisition as cash equivalents. EQUIPMENT Equipment is stated on the basis of cost. Depreciation, including amortization of capitalized leases, is computed using the straight-line method. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to income as incurred; significant renewals and betterments are capitalized. REVENUE RECOGNITION Telecommunications revenues are recognized as the usage accrues on the network. Agency revenues are recognized when ordered and, if commissions are based on usage, revenues are recognized as earned. Provisions for cancellations are made at the time revenue is recognized and actual experience prior to the developments described in Note 2 has consistently been within management's estimates. INCOME TAXES The Company provides for income taxes under the liability method prescribed by Statement of Financial Accounting Standards (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. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. ACCOUNTING PRONOUNCEMENTS In 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. Both SFAS 130 and SFAS 131 are effective for fiscal years beginning after December 15, 1997. The Company believes that the adoption of these new accounting standards will not have a material impact on the Company's financial statements. F-7 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) EARNINGS PER SHARE In 1997, the FASB issued SFAS No. 128, Earnings per Share. 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. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to the SFAS No. 128 requirements. RISKS AND UNCERTAINTIES Concentration of Credit Risk Financial instruments which potentially subject the Company to a concentration of credit risk principally consist of cash and cash equivalents and trade receivables. The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of these instruments. Significant Estimates and Assumptions The financial statements have been prepared in conformity with generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles 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 provision for doubtful accounts, cancellation of orders and certain accrued expenses. Actual results could differ from those estimates. ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair market value of the shares at the date of the grant (110% of the fair market value for owners of 20% or more of the Company's Common Stock). The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123, Accounting for Stock-Based Compensation, requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 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. F-8 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 2. BELL ATLANTIC LITIGATION In December 1997, the Company terminated its agency contract and filed suit against Bell Atlantic for breaches of contract, including the failure of Bell Atlantic's retail division to pay $14 million in agency commissions (approximately $12 million at March 31, 1998) owed to the Company. The Company also asserted violations by Bell Atlantic of antitrust laws and the Telecommunications Act. The Company intends to pursue this suit vigorously. Although the Company believes the collection of the agency commissions sought in the suit is probable, there can be no assurance that the Company will be successful in collecting those commissions. If the Company fails to collect any of the agency commissions sought or if their collection becomes less than probable, the Company would be required to write off the amounts reflected in its financial statements that it is unable to collect or for which collection becomes less than probable. Delay in collection of, or the write-off of, the agency commissions sought may adversely affect the Company. 3. RELATED-PARTY TRANSACTIONS The installation of telephone systems is generally subcontracted to a company controlled by the Chairman of the Company. Amounts paid to this subcontractor which are based on fair market value amounted to $1,723, $28,217 and $1,089 in 1998, 1997 and 1996, respectively. Additionally, inventory and equipment purchased from this subcontractor at fair market value amounted to $231,052, $68,973 and $39,791 in 1998, 1997 and 1996, respectively. The Company leases office space from trusts in which the Chairman is a beneficiary. Rent expense for these facilities aggregated $132,656, $132,656 and $133,949 in 1998, 1997 and 1996, respectively. These office space leases expire in fiscal 1998. The Company subleases a part of its corporate facility to a company controlled by the Chairman of the Company. Terms of the sublease are identical with those included in the Company's lease. Sublease income totaled $119,416, $80,416 and $73,417 in 1998, 1997 and 1996, respectively. 4. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consist of the following:
MARCH 31 --------------------- 1998 1997 ---------- ---------- Trade accounts payable................................ $5,778,048 $2,015,409 Accrued cost of telecommunications revenue............ 888,031 790,039 Bell Atlantic litigation.............................. 1,200,000 Other................................................. 1,092,397 432,968
5. NOTE PAYABLE TO BANK In November 1997, the Company replaced its existing $5,000,000 revolving line of credit agreement with a bank credit facility consisting of $15,000,000 revolving line of credit, a $5,000,000 equipment line of credit, and a $5,000,000 working capital line of credit. The revolving line of credit bears interest at Libor plus 1.5% to 3.00%, or prime rate plus up to 0.5%, depending on certain coverage ratios of the Company and expires in September, 2000. The equipment and working capital lines of credit bear interest at Libor plus 1.75% to 3.25%, or prime rate plus up to 1%, depending on certain leverage ratios of the Company and expire in September 2000. At March 31, 1998, $1,339,000 and $4,018,000 was available for borrowing under the revolving line of credit, and the equipment line of credit, respectively, and no amounts were available for borrowing under the working capital line of credit. As of March 31, 1998, the Company was not in compliance with certain covenants under its bank credit facility as a result of the Company's fourth quarter net loss of approximately $6 million. The bank has waived F-9 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) such covenant noncompliance under the Facility until September 30, 1998. See Note 1. Note payable to bank consisted of the following at March 31, 1998: Revolving line of credit due September 1, 2000................. $ 2,345,071 Equipment line of credit due in annual principal installments of $196,400 through January 2003 (7.44% at March 31, 1998).... 982,000 Working capital line of credit due in annual principal payments of $1,000,000 through March 2003 (7.44% at March 31, 1998).... 5,000,000 ----------- 8,327,071 Less: current portion.......................................... (1,196,400) ----------- $ 7,130,671 ===========
Maturities of long-term debt are the following at March 31: 1999.............................................................. $1,196,400 2000.............................................................. 1,196,400 2001.............................................................. 3,541,471 2002.............................................................. 1,196,400 2003.............................................................. 1,196,400
The bank has a security interest in and lien on all of the tangible and intangible personal property and fixtures of the Company, including all accounts receivable and equipment. 6. 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 March 31, 1998:
OPERATING SUBLEASE LEASES INCOME NET ---------- --------- ---------- Year ending March 31: 1999..................................... $1,399,383 $(107,766) $1,291,617 2000..................................... 1,098,624 (109,898) 988,726 2001..................................... 1,010,819 (111,420) 899,399 2002..................................... 937,665 (111,420) 826,245 2003..................................... 671,930 (111,420) 560,510 ---------- --------- ---------- Net future minimum lease payments.......... $5,118,421 $(551,924) $4,566,497 ========== ========= ==========
Rental expense for operating leases amounted to $1,121,916, $1,001,919 and $673,321 in 1998, 1997 and 1996, respectively. Sublease income amounted to $119,416, $90,016 and $82,217 in 1998, 1997 and 1996, respectively. F-10 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) The Company leases equipment under capital leases. At March 31, 1998, the Company has capitalized leased equipment totaling $1,346,073 with related accumulated amortization of $134,607. The following is a schedule by year of future minimum lease payments due under capital leases, together with the present value of the minimum lease payments as of March 31, 1998: Years ending March 31: 1999........................................................... $ 300,308 2000........................................................... 300,308 2001........................................................... 300,308 2002........................................................... 300,308 2003........................................................... 300,308 Thereafter..................................................... 25,026 ---------- 1,526,566 Less amount representing interest................................ (180,493) ---------- Present value of minimum lease payments.......................... 1,346,073 Less current portion of obligations under capital leases......... (231,796) ---------- Obligations under capital leases................................. $1,114,277 ==========
7. TELECOMMUNICATIONS AGREEMENTS On January 15, 1996, the Company entered into a four-year nonexclusive agreement with a long-distance service provider for the right to provide long distance service to its customers at prices affected by volume attainment levels during the term of the agreement. The Company is not obligated to purchase any minimum levels of usage over the term of the agreement, but rates may be adjusted due to the failure of achieving certain volume commitments. These provisions had no effect on the financial statements for the years ended March 31, 1998, 1997 and 1996. On October 20, 1994, the Company entered into a three-year non-exclusive agreement with a long-distance service provider for the right to provide long distance service to its customers at fixed prices by service during the term of the agreement. On October 11, 1996, the Company entered into an amendment to the agreement which extended the term of the agreement by five years from the date of the amendment. Over such extension period, the Company shall be liable for a minimum aggregate usage commitment of $25 million. Furthermore, the rates set forth under the aforementioned amendment may be adjusted due to the failure of meeting certain periodic volume commitments. Due to existing and expected usage, these provisions had no effect on the financial statements for the years ended March 31, 1998 and 1997. Prior to the execution of the agreements described above, and through March 31, 1998, the Company also provided long distance service to customers under an informal non-exclusive arrangement with another long distance service provider. The Company is not obligated to purchase any minimum level of usage on the network, and there are no other performance obligations. 8. STOCKHOLDERS' EQUITY COMMON STOCK On July 13, 1995, the Board of Directors declared a 3 for 2 stock split in the form of a dividend payable to shareholders of record on July 25, 1995. A total of 1,560,742 shares of common stock were issued and $839 in cash was paid for fractional share amounts. On October 10, 1995, the Board of Directors declared a 2 for 1 stock split in the form of a dividend payable to shareholders of record on October 23, 1995. A total of 4,718,172 shares of common stock were issued. F-11 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 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. 9. BENEFIT PLANS DEFINED CONTRIBUTION PLAN The Company maintains a defined contribution plan (401(k) plan) covering all employees who meet certain eligibility requirements. Participants may make contributions to the plan up to 15% of their compensation (as defined) up to the maximum established by law. 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 plan were $310,788, $230,079 and $210,063 in 1998, 1997 and 1996, respectively. Administrative costs paid by the Company were $5,960, $1,275 and $7,982 in 1998, 1997 and 1996, respectively. 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 the 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 three years in the period ended March 31, 1998. Indicated below is a summary of shares of common stock purchased by the ESPP. All share and per share amounts indicated below have been presented to reflect the stock dividend and stock splits described above. In July 1997 and February 1998, the ESPP purchased 5,438 shares at $6.48 per share and 4,406 shares at $8.29 per share, respectively. In July 1996 and February 1997, the ESPP purchased 2,998 shares at $11.05 per share and 5,716 shares at $6.48 per share, respectively. In July 1995 and January 1996, the ESPP purchased 7,011 shares at $3.26 per share and 2,345 shares at $11.05 per share, respectively. STOCK OPTION PLANS Under the terms of its 1993 Stock Option Plan and 1996 Stock Option Plan (collectively, the Plans), the Company may grant stock options for the purchase of Common Stock to all employees, directors and consultants. The Plans generally provide that the exercise price for an incentive stock option (which may only be granted to employees) will be fixed by a committee of the Board of Directors but will not be less than 100% (110% for 10% stockholders) of the fair market value per share on the date of grant. Nonqualified options may also be granted under the Plans to directors, employees and consultants. Nonqualified options under the 1993 Plan may be granted at an exercise price of no less than 85% (110% for 10% stockholders) of the fair market value per share on the date of grant and under the 1996 Plan may be granted with an exercise price less than, equal to or greater than the fair market value per share on the date of the grant. 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. On March 20, 1998, the Board of Directors approved the repricing of 1,175,500 options with a new exercise price of $7.19 ($7.91 for 10% stockholders). F-12 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) STOCK-BASED COMPENSATION Pro forma information regarding net income (loss) and earnings (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 and shares issued pursuant to the ESPP under the fair value method of that Statement. The fair value for these options and shares issued pursuant to the ESPP were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
OPTIONS ESPP ------------------- ------------------- 1998 1997 1996 1998 1997 1996 ----- ----- ----- ----- ----- ----- Expected life (years)............. 2.96 3.98 3.49 0.50 0.50 0.50 Interest rate..................... 5.93% 6.28% 6.12% 5.43% 5.4% 6.48% Volatility........................ 85.14 87.88 87.88 64.67 93.03 80.93 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 estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma net income (loss) and earnings (loss) per common share are as follows:
1998 1997 1996 ----------- ---------- ---------- Pro forma net income (loss)............. $(4,973,000) $4,094,000 $3,550,000 Pro forma earnings (loss) per common share.................................. $ (0.50) $ 0.39 $ 0.34
The effects on 1996, 1997 and 1998 pro forma net income (loss) and earnings (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 include only one, two and three years of option grants under the Company's plans. A summary of the Company's stock option activity, and related information for the years ended March 31 follows:
1998 1997 1996 ------------------- -------------------- -------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE --------- --------- --------- --------- --------- --------- Outstanding at beginning of year................ 1,953,112 $4.36 1,995,878 $4.01 1,526,850 $1.45 Options granted....... 2,791,000 7.11 280,539 9.67 1,000,250 8.06 Options terminated.... 1,402,718 8.36 (286,734) 7.54 (290,689) 2.37 Options exercised..... 376,387 .93 (36,571) 1.20 (240,533) 0.51 --------- --------- --------- Outstanding at end of year................... 2,965,007 $5.50 1,953,112 $4.36 1,995,878 $4.01 ========= ========= ========= Exercisable at end of year................... 698,250 772,282 613,824 ========= ========= ========= Weighted-average fair value of options granted during the year................... $ 4.01 $ 6.43 $ 5.09 ========= ========= =========
F-13 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) The following table presents weighted-average price and life information about significant option groups outstanding at March 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------- -------------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE --------------- ----------- ---------------- -------------- ----------- -------------- $0.25 187,500 0.1 years $0.25 187,500 $0.25 0.53 86,397 0.6 years 0.53 86,397 0.53 0.90- 1.10 207,854 1.5 years 1.10 147,261 1.10 2.70- 2.98 257,056 2.0 years 2.74 189,792 2.74 6.00- 7.06 1,041,700 6.4 years 6.44 10,500 6.16 7.19 1,100,500 4.2 years 7.19 76,800 7.19 $7.91 75,000 4.1 years $7.91 0 $0.00 --------- ------- 2,965,007 698,250 ========= =======
1998 1997 1996 ----------- ----------- ----------- Numerator: Net income (loss) (numerator for basic and diluted earnings (loss) per common share).................. $(2,884,450) $ 4,682,931 $ 4,093,924 Denominator: Denominator for basic earnings (loss) per common share-weighted average shares..................... 9,886,000 9,600,000 9,446,000 Effect of employee stock options.... 1,173,000 1,266,000 ----------- ----------- ----------- Denominator for diluted earnings (loss) per common share............ 9,886,000 10,773,000 10,712,000 =========== =========== =========== Basic earnings (loss) per common share................................ $ (0.29) $ 0.49 $ 0.43 =========== =========== =========== Diluted earnings (loss) per common share................................ $ (0.29) $ 0.43 $ 0.38 =========== =========== ===========
10. INCOME TAXES The provision (benefit) for income taxes consisted of the following:
1998 1997 1996 ----------- ---------- ---------- Current: Federal............................... $ (218,000) $2,660,000 $2,135,000 State................................. 906,000 725,000 ----------- ---------- ---------- (218,000) 3,566,000 2,860,000 Deferred tax benefit.................... (1,268,000) (289,000) (124,000) ----------- ---------- ---------- $(1,486,000) $3,277,000 $2,736,000 =========== ========== ==========
F-14 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) Significant components of the Company's deferred tax liabilities and assets as of March 31, are as follows:
1998 1997 ---------- -------- Deferred tax assets: Depreciation......................................... $ 64,000 $191,000 Accruals and allowances.............................. 1,751,000 445,000 Net operating state loss carryforward................ 96,000 ---------- -------- Total deferred tax asset............................... 1,911,000 636,000 Deferred tax liability: Prepaid expenses..................................... (38,000) (31,000) Cash surrender value of life insurance policy........ (39,000) (39,000) ---------- -------- Total deferred tax liability........................... (77,000) (70,000) ---------- -------- Net deferred tax asset................................. $1,834,000 $566,000 ========== ========
The income tax expense is different from that which would be obtained by applying the statutory federal income tax rate to income before income taxes. The items causing this difference are as follows:
1998 1997 1996 ----------- ---------- ---------- Tax at U.S. statutory rate............. $(1,486,000) $2,706,000 $2,322,000 State income taxes, net of federal benefit............................... 552,000 466,000 Other.................................. 19,000 (52,000) ----------- ---------- ---------- $(1,486,000) $3,277,000 $2,736,000 =========== ========== ==========
Income taxes paid in 1998, 1997 and 1996 amounted to $2,160,527, $3,319,000 and $3,163,000, respectively. 11. SUPPLEMENTAL CASH FLOW INFORMATION In March 1996, the Company received shares of common stock with an aggregate fair market value of $251,771 in lieu of cash for settlement of amounts due from an officer. These shares and the related amount were accounted for as treasury stock and were subsequently retired. In September 1995, the Company received shares of common stock with an aggregate fair market value of $25,039 in lieu of cash for settlement of amount due from a non-employee of $24,000 plus accrued interest of $1,039. These shares and the related amount were accounted for as treasury stock and were subsequently retired. During fiscal 1998 and 1996, and in connection with the exercise of employee stock options, the Company received shares of common stock with an aggregate fair market value of $271,072 and $52,315 in lieu of cash upon the exercise of these options. These shares and the related amount were accounted for as treasury stock and were subsequently retired. These noncash transactions have been excluded from the statements of cash flows for the years ended March 31, 1998 and 1996. 12. SUBSEQUENT EVENTS In April 1998, the Company privately placed $12 million of Series A Convertible Preferred Stock (Series A Preferred Stock) and warrants to purchase Common Stock with Spectrum Equity Investors II, L.P. and other private investors. The Series A Preferred Stock may be redeemed at the option of the holders of a majority of the Series A Preferred Stock at any time on or after the earlier of (i) April 9, 2010 and (ii) the date 180 days after the maturity F-15 CTC COMMUNICATIONS CORP. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) date of any debt financing consummated on or before October 9, 1998 yielding proceeds of at least $75 million. The Series A Preferred Stock is convertible into shares of Common Stock. On the date of issuance, the shares of Series A Preferred Stock were convertible into 1,333,333 shares of the Company's Common Stock, which conversion ratio is subject to certain adjustments. The warrants entitle the holder thereof to purchase one share of Common Stock at an exercise price of $9.00 per share. The warrants expire on April 10, 2003. See also Note 1. 13. QUARTERLY INFORMATION (UNAUDITED) A summary of operating results and pro forma net income (loss) per share for the quarterly periods in the two years ended March 31, 1998 is set forth below
QUARTER ENDED ------------------------------------------------------------- JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31 TOTAL ----------- ------------ ----------- ----------- ----------- Year ended March 31, 1998 Total revenues........ $11,658,954 $11,845,097 $11,155,646 $ 6,287,439 $40,947,136 Gross profit.......... 9,216,118 9,132,848 8,215,645 343,960 26,908,571 Earnings (loss)....... 1,374,000 1,244,000 506,000 (6,008,450) (2,884,450) Earnings (loss) per common share--basic.. $0.14 $0.13 $0.05 $(0.60) $(0.29) Earnings (loss) per common share-- diluted.............. $0.13 $0.12 $0.05 $(0.60) $(0.29) Year ended March 31, 1997 Total revenues........ $ 9,007,461 $ 9,617,068 $10,193,787 $11,471,783 $40,290,099 Gross profit.......... 7,325,606 7,463,843 7,932,162 8,859,366 31,580,977 Earnings.............. 1,194,186 1,048,828 1,159,000 1,280,917 4,682,931 Earnings per common share--basic......... $0.12 $0.11 $0.12 $0.13 $0.49 Earnings per common share--diluted....... $0.11 $0.10 $0.11 $0.12 $0.43
Fiscal year 1997 and the first two quarters of fiscal year 1998 earnings per common share amounts have been restated to comply with Statement of Financial Accounting Standard No. 128, Earnings per Share. F-16 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS CTC COMMUNICATIONS CORP.
- ----------------------------------------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - -----------------------------------------------------------------------------------------------------------
Additions ---------- (1) (2) Charged to Balance at Charged to Other Balance at Beginning Costs and Accounts - Deductions End of Description of Period Expenses Describe - Describe Period - ----------------------------------------------------------------------------------------------------------- Year ended March 31, 1998: Allowance for doubtful accounts $377,000 $1,421,109 $1,306,109 (a) $492,000 Year ended March 31, 1997: Allowance for doubtful accounts $190,215 $316,669 $129,884 (a) $377,000 Year ended March 31, 1996: $128,452 $ 61,763 $ 0 $190,215 Allowance for doubtful accounts
(a) = Bad debts written off net of collections. F-17 EXHIBIT INDEX NUMBER DESCRIPTION OF EXHIBIT 9.1 Voting Agreement dated April 10, 1998 among Robert Fabbricatore and certain of his affiliates and Spectrum 10.15 Employment Agreement between the Company and Steve Jones dated February 27, 1998 23.1 Consent of Ernst & Young LLP 27 Financial Data Schedule 99.1 Risk Factors EX-9.1 2 VOTING AGREEMENT EXHIBIT 9.1 VOTING AGREEMENT This Voting Agreement ("Agreement") is made and entered into as of the 10th day of April, 1998 by and among Robert J. Fabbricatore, Robert J. Fabbricatore Family Limited Partnership and Robert J. Fabbricatore as trustee for Rita Fabbricatore, Danielle Fabbricatore and Douglas Fabbricatore (collectively, the "Stockholders") and Spectrum Equity Investors II, L.P. ("Spectrum"). All capitalized terms used but not otherwise defined herein shall have the meaning given to them in the Purchase Agreement referred to below. RECITALS: WHEREAS, pursuant to the Securities Purchase Agreement (the "Purchase Agreement") between the CTC Communications Corp. (the "Company") and Spectrum dated as of the date hereof, Spectrum and certain other purchasers named therein will purchase from the Company 666,666 shares of authorized but unissued Series A Convertible Preferred Stock, $1.00 par value, of the Company (the "Series A Preferred Stock"); WHEREAS, the Stockholders own in the aggregate 2,715,974 shares of Common Stock of the Company; WHEREAS, the parties believe it is in each of their respective best interest to provide for certain rights and obligations with respect to voting for certain directors; WHEREAS, Spectrum's willingness to purchase the Series A Preferred Stock is conditioned upon the Stockholders entering into this Agreement and the execution and delivery of this Agreement is a condition precedent to the closing of the transactions contemplated by the Purchase Agreement; NOW THEREFORE, in consideration of the foregoing, the mutual covenants herein contained and other consideration, the adequacy of which is hereby acknowledged, the parties hereby agree as follows: 1. Voting Agreement. ---------------- (a) At each annual or special meeting of the stockholders of the Company occurring on or after the date of this Agreement at which directors of the Company are to be elected, or by a consent in writing of such stockholders in lieu thereof, the Stockholders entitled to vote at such meeting agree to vote (or consent in writing in lieu thereof) all of the voting securities of the Company owned or controlled by them whether now owned or controlled or if ownership or control is hereafter acquired to elect as directors of the Company (i) two persons designated in writing by the holders of a majority of the outstanding shares of Series A Preferred Stock (the "Requisite Series A Holders") if at the time the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent at least seven and 27/100 percent (7.27%) of the Company's Common Stock Deemed Outstanding or (ii) one person designated in writing by the Requisite Series A Holders if at the time the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent at least four and 55/100 percent (4.55%) and less than seven and 27/100 percent (7.27%) of the Company's Common Stock Deemed Outstanding; provided, however, that at such time as the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent less than seven and 27/100 percent (7.27%) but more than four and 55/100 percent (4.55%) of the Company's Common Stock Deemed Outstanding, upon request by the Stockholders, Spectrum agrees to use reasonable efforts to cause one of the directors designated by the Requisite Series A Holders to resign effective immediately; and provided, further, that at such time as the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent less than four and 55/100 percent (4.55%), upon request by the Stockholders, Spectrum agrees to use reasonable efforts to cause one or both of the directors designated by the Requisite Series A Holders to resign effective immediately. (b) The initial nominees for directors designated by the Requisite Series A Holders pursuant to Section 1(a) hereof shall be Kevin J. Maroni and William P. Collatos. (c) The Stockholders agree not to vote to remove a director designated by the Requisite Series A Holders unless so instructed by the Requisite Series A Holders, and if so instructed, the Stockholders shall so vote; provided, however, that at such time as the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent less than seven and 27/100 percent (7.27%) but more than four and 55/100 percent (4.55%) of the Company's Common Stock Deemed Outstanding, the Stockholders shall be entitled to vote for the removal of one of the directors designated by the Requisite Series A Holders; and provided, further, that at such time as the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent less than four and 55/100 percent (4.55%), the Stockholders shall be entitled to vote for the removal of one or both of the directors designated by the Requisite Series A Holders to resign effective immediately. 2. Transfers. The Stockholders agree that they will not transfer any of --------- the voting securities of the Company owned or controlled by them, whether now owned or controlled or if ownership or control is hereafter acquired, to an Affiliate of such Stockholder, except pursuant to Rule 144 or a transaction registered under the Securities Act, unless the transferee of any such voting securities agrees to hold the shares so acquired with all the rights conferred by, and subject to the restrictions imposed by, this Agreement and agrees, as a condition of -2- such transfer, to execute and deliver to Spectrum an agreement pursuant to which such transferee agrees to become party to this Agreement and to be bound by all the terms and conditions hereof. 3. Termination. This Agreement shall terminate upon the earliest to ----------- occur of the following: (a) the date as of which the outstanding shares of Series A Preferred Stock and Preferred Stock Derivatives represent less than four and 55/100 percent (4.55%) of the Company's Common Stock Deemed Outstanding; (b) the date as of which no share of Series A Preferred Stock are outstanding; and (c) a written agreement to do so signed by each of Spectrum and the Stockholders. 4. Complete Agreement. This Agreement, those documents expressly ------------------ referred to herein and other documents of even date herewith embody the complete agreement and understanding among the parties and supersede and preempt any prior understandings, agreements or representations by or among the parties, written or oral, which may have related to the subject matter hereof in any way. 5. Counterparts. This Agreement may be executed in any number of ------------ counterparts and by different parties hereto in separate counterparts, with the same effect as if all parties had signed the same document. All such counterparts shall be deemed an original, shall be construed together and shall constitute one and the same instrument. 6. Choice of Law. The construction, validity and interpretation of this ------------- Agreement shall be governed by the internal law, and not the law of conflicts, of the State of Massachusetts. 7. Remedies. Each of the parties to this Agreement will be entitled to -------- enforce its rights under this Agreement specifically, to recover damages by reason of any breach of any provision of this Agreement and to exercise all other rights existing in its favor. The parties hereto agree and acknowledge that money damages may not be an adequate remedy for any breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity of competent jurisdiction for specific performance and/or injunctive relief in order to enforce or prevent any violations of the provisions of this Agreement. In the event a party hereto brings an action under this Agreement, the prevailing party in such dispute shall be entitled to recover from the losing party under or with respect to this Agreement, including without limitation such reasonable fees and expenses of attorneys -3- and accountants, which shall include, without limitation, all fees, costs and expenses of appeals. 8. Amendments. This Agreement may be amended only by a written agreement ---------- executed by each of the Stockholders and the Requisite Series A Holders. [THE REMAINDER OF THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK] -4- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first above written. THE STOCKHOLDERS: /s/ Robert J. Fabbricatore ______________________________________ ROBERT J. FABBRICATORE ROBERT J. FABBRICATORE, AS TRUSTEE FOR RITA FABBRICATORE,DANIELLE FABBRICATORE AND DOUGLAS FABBRICATORE /s/ Robert J. Fabbricatore, as Trustee ______________________________________ ROBERT J. FABBRICATORE FAMILY LIMITED PARTNERSHIP By: Robert J. Fabbricatore, as General Partner /s/ Robert J. Fabbricatore ______________________________________ SPECTRUM EQUITY INVESTORS II, L.P. By: Spectrum Equity Associates II, L.P., its General Partner By: /s/ Kevin J. Maroni ______________________________________ Kevin J. Maroni, a General Partner -5- EX-10.15 3 EMPLOYMENT AGREEMENT EXHIBIT 10.15 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is entered into as of the 27/th/ day of FEBRUARY, 1998, between CTC Communications Corp, a Massachusetts Corporation, (the"Company"), which term shall include any successor corporation, and STEVEN C. JONES (the "Executive''). W I T N E S S E T H: ------------------- WHEREAS, the Executive has certain skills and experiences which will prove beneficial to the Company in managing the finances of the Company and assisting in the strategic planning and implementation of the Company's current and future strategies; and WHEREAS, the Company desires to employ the Executive, and the Executive desires to be employed by the Company on the terms and subject to the considerations set forth herein. NOW, THEREFORE, in consideration of the mutual promises herein contained, the parties agree as follows: 1. EMPLOYMENT: ---------- (a) Position. The Company hereby employs the Executive and the Executive -------- hereby accepts such employment, on the terms and subject to the conditions hereinafter set forth. Beginning on the Officer Election Date (as defined in Section 2(c) hereof), the Executive shall be elected as an officer of the Company and shall have the title and responsibilities of Executive Vice President, Chief Financial Officer and Director of Corporate Development. (b) Reporting and Duties. The Executive shall report directly to the Company's -------------------- Chief Executive Officer ("CEO") or to the Company's Board of Directors (the "Board"). The Executive shall be required to devote his full business time, attention and effort to the Company's business and affairs and perform diligently such duties as are customarily performed by executives in similar positions with companies similar in character or size to the Company, all subject to the direction of the CEO or the Board, together with such other duties as may be reasonably requested from time to time by the CEO or the Board, which duties shall be consistent with his positions as set forth above. The Executive agrees to use all of his skills and business judgment and render services to the best of his ability to serve the interests of the Company. Subject to the terms of Section 9, nothing in this Agreement shall preclude Executive from serving on community and civic boards, participating in industry associations, or otherwise engaging in other non-commercial activities which do not unreasonably interfere with his duties to the Company. Notwithstanding the preceding sentence, the Company acknowledges and agrees that the Executive shall be entitled to continue participating in any current or future business ventures with his spouse so long as such business ventures do not unreasonably interfere or conflict with his duties to the Company. (c) Support Services. The Executive shall be entitled to all of the ----------------- administrative, operational and facility support customary for a similarly situated executive. This support shall include, without limitation, a suitably appointed private office, access to a secretary or administrative assistant, direct access to a Bloomberg Financial Markets terminal, and payment of or reimbursement for reasonable cellular telephone expenses, expenses of the Executive maintaining his professional license and standing and any and all other business expenses reasonably incurred on behalf of or in the course of performing duties for the Company, all documented in accordance with the expense reimbursement policies established from time to time by the Company and in effect for other similarly situated executives. The Executive agrees to provide such documentation of these expenses as may be reasonably required. 2. TERM AND EFFECTIVE DATE: ----------------------- (a) Term. Unless earlier terminated as herein provided, the Executive's ----- employment with the Company hereunder shall commence at the Effective Date and shall end on the last day of the "Term". For purposes of this Agreement, the "Term" of this Agreement shall mean an initial three year period, plus any extensions made as provided in this Section 2. On each anniversary of the Effective Date, the Term shall automatically be extended for an additional year unless, not later than ninety (90) days prior to any such anniversary, the Company or the Executive shall have given notice not to extend the Term. For purposes of this Agreement, the "Employment Period" (which in no event shall extend beyond the Term) shall mean the period during which Executive has an obligation to render services hereunder, as described in Section 1(b) hereof, taking into account any Notice of Termination (as defined in Section 7(a) hereof) which may be given by either the Company or the Executive. Nothing in this Section shall limit the right of the Company or the Executive to terminate the Executive's employment hereunder on the terms and conditions set forth in Sections 5, 6, 7, and 8 hereof. (b) Effective Date of Employment. The Effective Date of Employment under ---------------------------- this Agreement shall be February 27th, 1998 or as soon thereafter as Executive is able to start using his best efforts (the "Effective Date of Employment" or the "Effective Date"). (c) Officer Election Date. Beginning on April 1/st/, 1998 or as soon --------------------- thereafter as is reasonably possible using the Company's best efforts, the Company shall elect the Executive as an officer of the Company with the title Executive Vice President, Chief Financial Officer, and Director of Corporate Development. From the Effective Date of Employment until April 1, 1998, the Executive shall be an employee, but not an officer, of the Company. (d) Leave of Absence. The Company acknowledges and agrees that the ---------------- Executive shall have a leave of absence without pay in the Spring/Summer of 1998 for approximately 10 weeks. The Executive agrees to be reasonably available by phone during such leave of absence. 3. COMPENSATION AND BENEFITS: ------------------------- Throughout the Term the Company shall pay or provide, as the case may be, to the Executive the compensation and other benefits and rights set forth in this Section 3, and the additional compensation and benefits set forth in Sections 8 and 10, as applicable. (a) Base Salary. During the term hereof, the Company shall pay to the ----------- Executive a "Base Salary," payable in accordance with the Company's usual pay practices for executive officers (and in any event no less frequently than monthly), at a minimum rate of $150,000 per annum, which shall be reviewed annually by the Company's Board and which may be increased, but not decreased. (b) Annual Bonus. Subject to the provisions of paragraph 8, the Executive ------------ shall receive a cash bonus for each fiscal year, or part thereof, that he is employed by the Company. Such cash bonus in any given year shall be conditioned upon the Executive having met certain annual performance objectives stipulated by the Company's CEO or the Board and communicated to the Executive in writing at least nine months prior to the end of any given fiscal year and shall be payable within 30 days after the end of such fiscal year. The final amount of any cash bonus in any given year shall be determined solely at the discretion of the Board, provided, however, that the Executive's bonus for any given fiscal year during the Term of this Agreement shall be a minimum of $75,000. (c) Stock Options. The Executive shall be entitled to participate, at a ------------- level appropriate to his positions with the Company, in any stock option plan or stock-based compensation plan which the Company maintains from time to time. The Company agrees that it will take such actions as are -2- necessary (including, without limitation, amendment of the Employees Incentive Stock Option Plan, the 1985 Stock Option Plan, the 1993 Incentive Stock Option Plan, and/or the 1996 Stock Option Plan (such existing plans as hereinafter referred to as the "Existing Stock Option Plans") or create a new stock option plan as may be necessary) to assure the following: (i) The Executive is awarded effective as of the date of this Agreement qualified incentive stock options to purchase 300,000 common shares of the Company (the "Options"). Such Options shall have a ten year term and the strike price shall be equal to 100% of the closing per share price of the Company's common stock at the close of the trading day on the date of this Agreement. The Company acknowledges and agrees that it will waive any provisions in any existing or newly created incentive stock option plans that the Executive be an employee of the Company for a minimum of six months prior to granting such Options. The Options shall vest in equal 25% increments according to the following schedule:
Option Shares Represented Vesting Date ------------------------- ------------- 75,000 April 1, 1998 75,000 March 31, 1999 75,000 March 31, 2000 75,000 March 31, 2001
The Company acknowledges that the award of the Options to purchase the above 300,000 common shares is based upon the premise that: (a) the Company has issued and outstanding approximately ten (10) million common shares as of the date hereof; (b) total common shares purchasable with respect to options available under the Company's Existing Stock Option Plans do not exceed three (3) million common shares as of the date hereof; and (c) there are no other equity or equity-linked securities (including, without limitation, convertible notes, convertible preferred stock, warrants, options, or any other type of security that consists of any type of right to purchase common shares; such equity or equity-link securities hereinafter referred to as "Equity Securities") outstanding as of the date hereof. (ii) To the extent a change of control provision is not already provided for in any existing or newly created incentive stock option plans in a manner which is satisfactory to the Executive and consistent with the terms of this Agreement, the Company shall modify such existing or newly created stock option plans such that all Options or Future Stock Benefits (as defined in Section 8(b) hereof) held by the Executive shall become fully vested and exercisable and all restrictions upon any restricted shares held by the Executive will lapse immediately prior to a Change of Control as defined in Section 4 of this Agreement. (iii) That the Company's Existing Stock Option Plans or future stock option plans contain certain antidilution provisions that stipulate that any event which effects the common shares of the Company in such a way that an adjustment of the Options or Future Stock Benefits is appropriate in order to prevent dilution of the rights of the Executive under the Options or Future Stock Benefits (including, without limitation, any dividend or other distribution (whether in cash or in kind), recapitalization, stock split, reverse split, reorganization, merger, consolidation, spin-off, combination, repurchase, or share exchange, or other similar corporate transaction or event), the Company shall make appropriate equitable adjustments, which may include, without limitation, adjustments to any or all of the number and kind of common shares of stock of the Company (or other securities) which may thereafter be issued upon exercise of the then outstanding Options or Future Stock Benefits and adjustments to the exercise price of all such Options and Future Stock Benefits. To the extent the Company's Existing Stock Option Plans do not contain such antidilution provisions or a reasonable proxy thereto, the Company shall work with the Executive to find a mutually agreeable solution. -3- (iv) Each grant of Options or Future Stock Benefits shall be evidenced by a separate Option Grant Agreement which shall be satisfactory to the Executive and executed within thirty (30) days of (a) the Effective Date of this Agreement in the case of the Options or (b) the grant date in the case of Future Stock Benefits. (c) Relocation Expense. If the Executive decides to permanently relocate ------------------ himself and his family to the Boston, MA area or such other area as mutually agreed upon with the Company (the "Permanent Relocation"), the Company shall reimburse the Executive for all reasonable relocation expenses, up to $30,000, incurred with respect to the relocation of the Executive and his family. Notwithstanding the above, the Company shall reimburse the Executive for all reasonable commuting expenses until a Permanent Relocation occurs. The Company shall also reimburse the Executive for all reasonable expenses which he may incur with respect to establishing and maintaining temporary living quarters in the Boston area, or such other area as mutually agreed upon, until a Permanent Relocation occurs. If any such relocation, commuting, or living quarters expenses are treated as taxable income to the Executive, the Company shall make an additional payment to the Executive which shall make him whole with respect to the imposition of any federal, state, or local income tax on such taxable income. (d) Insurance. Beginning on the Effective Date, the Company shall provide --------- the Executive such life, medical, hospitalization, disability and dental insurance for the Executive, and as appropriate for, his spouse and eligible family members, as is in accordance with the Company's policy for seniors officers of the Company. The Company acknowledges and agrees that it will waive any waiting period for new employees. (e) Retirement and Other Benefit Plans. The Executive shall be eligible ---------------------------------- to participate in all retirement and other benefit plans of the Company generally available from time to time to employees and for senior executives of the Company and for which the Executive qualifies under the terms thereof, without regard to his tenure at the Company. The Executive shall also be entitled to participate in any equity or other employee benefit plans and other fringe benefits that are generally available to executive officers or directors from time to time, as distinguished from general management, of the Company. The Executive's participation in and benefits under any such plan shall be on the terms and subject to the conditions specified in the governing document of the particular plan. 4. CHANGE OF CONTROL: ----------------- (a) Definition. For the purposes of this Agreement, a "Change of ---------- Control" shall be deemed to have occurred if any of the events set forth in any of the following paragraphs (i) - (iv) shall have occurred: (i) if any Person (as defined in Section 4b hereof) or Group is or becomes the Beneficial Owner (as defined in Section 4c hereof), directly or indirectly, of securities of the Company representing thirty percent (30%) or more of the combined voting power of the Company's then outstanding voting securities, except with respect to current officers or directors. (ii) if during any period of two consecutive years, the following individuals cease for any reason to constitute a majority of the number of directors then serving: individuals who at the beginning of such period constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of the Company) whose appointment or election by the Board or nomination for election by the Company's shareholders was approved or recommended by a vote of at least two thirds (2/3) of the directors then still in office who either were directors at the beginning of such period or whose appointment, election or nomination for election was previously so approved or recommended; or -4- (iii) if the shareholders of the Company approve a merger or consolidation of the Company with any other corporation or the issuance of voting securities of the Company in connection with a merger or consolidation of the Company (or any direct or indirect subsidiary of the Company) pursuant to the applicable stock exchange requirements, other than (x) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior to such merger or consolidation continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof) at least fifty percent (50%) of the combined voting power of the securities of the Company or such surviving entity or any parent thereof outstanding immediately after such merger or consolidation, or (y) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing thirty percent (30%) or more of the combined voting power of the Company's then outstanding securities (iv) if the shareholders of the Company approve a plan of complete liquidation or dissolution of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets. (b) For purposes of this Agreement, "Person" and "Group" shall have the meaning given in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended from time to time (the "Exchange Act"), as modified and used in Sections 13(d) and 14(d) thereof, except that such terms shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its affiliates, or (iii) an underwriter temporarily holding securities pursuant to an offering of such securities. (c) For purposes of this Agreement, "Beneficial Owner" shall have the meaning set forth in Rule 13d-3 under the Exchange Act. (d) In the event of a Change of Control, all unvested Options (as defined in Section 3(c)(i) hereof) Future Stock Benefits (as defined in Section 8(b) hereof) shall immediately vest. 5. TERMINATION BY THE COMPANY: -------------------------- The Executive's employment hereunder may be terminated as follows: (a) Death. The Executive's employment shall terminate upon his death. ----- Upon such termination, the Executive's estate or designated beneficiary, as the case may be, shall become entitled to the payments provided in Section 8(b) hereof. (b) Permanent Disability. If, as a result of the Executive's incapacity -------------------- due to physical or mental illness (as determined by a medical doctor mutually agreed to by the Executive or his legal representative and the Company), the Executive shall have been absent from his duties hereunder on a full-time basis for either one hundred eighty (180) consecutive days or for an aggregate two hundred ten (210) days within a consecutive 12 month period and, within (30) days after Notice of Termination is given, shall not have returned to the performance of his duties hereunder on a full-time basis ("Permanent Disability"), the Company may terminate the Executive's employment for Permanent Disability. Upon such a termination, the Executive shall become entitled to the payments provided in Section 8(c) hereof. (c) Cause. The Company may terminate the Executive's employment hereunder ----- for "Cause" (as defined in this Section 5(c)). Upon such a termination, the Executive shall become entitled to the payments provided in Section 8(d) hereof. For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment hereunder upon: -5- (i) the willful (or grossly negligent) and continued failure by the Executive to substantially perform his duties hereunder (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or any such actual or anticipated failure after the Executive has delivered a "Notice of Termination for Good Reason" as defined in Section 6(a) hereof, or during a "Window Period" as defined in Section 6(b) hereof) after demand for substantial performance is delivered by the Company that specifically identifies the manner in which the Company believes the Executive has not substantially performed his duties; or (ii) the active participation by the Executive in an act or series of acts of willful malfeasance or gross misconduct, recklessness or gross negligence which a reasonable person would expect to have a material adverse effect on the Company; or (iii) any breach by the Executive of any of the provisions of Section 9 hereof; or (iv) the Executive's being convicted of, or pleading guilty to, a felony. For purposes of this paragraph, no act, or failure to act, on the Executive's part shall be considered "willful" unless done or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. Further, unless the Executive has been convicted of, or pleaded guilty to, a felony, the Executive shall not be deemed to have been terminated without (1) reasonable notice to the Executive setting forth the reasons for the Company's intention to terminate for Cause, (2) an opportunity for the Executive, together with his counsel, to be heard before the Board, and (3) delivery to the Executive of a Notice of Termination from the Board finding that, in the good faith opinion of a majority of the Board, the Executive was guilty of conduct set forth above in clauses (i), (ii), or (iii) of this Section 6(c), and specifying the particulars thereof in reasonable detail. (d) Without Cause. The Company may terminate the Executive's employment ------------- hereunder without Cause at any time. Upon such a termination, the Executive shall become entitled to the payments and benefits provided in section 8(e) hereof. 6. TERMINATION BY THE EXECUTIVE: ---------------------------- (a) Termination for Good Reason. The Executive may terminate his ---------------------------- employment hereunder at anytime for "Good Reason". Upon such Termination For Good Reason, the Executive shall become entitled to the payments and benefits provided in Section 8(e) hereof. For the purposes of this Agreement, the definition of "Good Reason" shall include: (i) any significant diminution in Executive's title, duties and responsibilities or such title, duties and responsibilities are otherwise diminished such that they no longer reflect the title, duties and responsibilities customary for a Chief Financial Officer and/or Director of Corporate Development, which diminution is not cured within thirty (30) days after notice from the Executive, (ii) the Company (or any successor thereto) hires or appoints a person, other than Executive, to the position (or functional equivalent, regardless of actual title) of Chief Financial Officer and/or Director of Corporate Development, (iii) any failure of the Company to pay any compensation to the Executive within thirty (30) days of the Executive's notice to the Company that payment is overdue; and/or (iv) the Company's breach of a material term or condition of this Agreement, and the Company's failure to correct such breach within thirty (30) days after the Executive's notice thereof (specifying in reasonable detail the particulars of such noncompliance). (b) Termination During a Window Period. The Executive may terminate his ---------------------------------- employment hereunder without Good Reason by giving a Notice of Termination during a "Window Period", which for purposes of this Agreement, shall mean the sixty (60) day period beginning with the first day following the ninety (90) day period which immediately follows a Change of Control. Upon a Window Period termination, the Executive shall become entitled to the payments and benefits provided in Section 8(e) hereof. -6- (c) Termination Without Good Reason Outside a Window Period. The ------------------------------------------------------- Executive may terminate his employment hereunder without Good Reason and outside of a Window Period, upon giving thirty (30) days written notice to the Company. In the event of such a termination, the Executive shall comply with any reasonable request of the Company to assist in providing for an orderly transition of authority, but such assistance shall not delay the Executive's termination of employment longer than sixty (60) days beyond the giving of the Executive's Notice of Termination. Upon such a termination, the Executive shall become entitled to the payments provided in Section 8(f) hereof. 7. TERMINATION NOTICES, TIMING, AND DISPUTES: ------------------------------------------ (a) Notice of Termination. Any purported termination of the Executive's --------------------- employment (other than termination pursuant to Section 5(a) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 11(h) hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice that shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. (b) Date of Termination. For purposes of this Agreement, "Date of ------------------- Termination" shall mean the following: (i) if the Executive's employment is terminated by his death, the date of his death; (ii) if the Executive's employment is terminated pursuant to Section 5(b) or 5(d) hereof, thirty (30) days after the Notice of Termination is given; (iii) if the Executive's employment is terminated pursuant to Section 5(c) hereof, the date specified in the Notice of Termination; (iv) if the Executive's employment is terminated pursuant to Section 6(a) or 6(b) hereof, thirty (30) days after the Notice of Termination is given; and (v) if the Executive's employment is terminated pursuant to Section 6(c) hereof, the date determined in accordance with said Section. (c) Dispute Concerning Termination. If within fifteen (15) days after any ------------------------------ Notice of Termination is given, or, if later, prior to the Date of Termination (as determined without regard to this Section 7(c)), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be extended until the earlier to occur of (i) the date on which the Term ends or (ii) the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by the final determination of an arbitration panel in accordance with Section 11(g), which is not subject to appeal; provided, however, that the Date of Termination shall be extended by a notice of dispute given by the Executive only if such notice is given in good faith and the Executive pursues the resolution of such dispute with reasonable diligence. (d) Compensation During Dispute. Except in the event of Termination for --------------------------- Cause by the Company, I if the Date of Termination is extended in accordance with Section 7(c) hereof, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, Base Salary and Annual Bonus) and continue the Executive as a participant in all compensation, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given, until the Date of Termination, as determined in accordance with Section 7(c) hereof. Amounts paid under this Section 7(d) are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement. 8. COMPENSATION DURING DISABILITY OR UPON TERMINATION: --------------------------------------------------- (a) Disability Period. During any period during the Term hereof that the ----------------- Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("Disability Period"), the Executive shall continue to (i) receive his full Base Salary, (ii) remain eligible to receive an Annual Bonus under Section 3(b) hereof, and (iii) participate in the plans and -7- arrangements described in Section 3(e) and 3(f) hereof (except to the extent such participation is not permitted under the terms of such plans and arrangements). (b) Termination By Death: If the Executive's employment is terminated by -------------------- death, the Executive's estate shall be entitled to receive as soon as is practicable after the date of death: (i) any accrued but unpaid salary and other benefits up to and including the date of Executive's death, and (ii) life insurance benefits pursuant to any life insurance purchased by the Company for the benefit of the Executive. In addition, any unvested Options and any other unvested options, restricted stock or stock appreciation rights which may be granted after the date of this Agreement (such future options, restricted stock or stock appreciation rights hereinafter being referred to as "Future Stock Benefits") shall vest immediately. (c) Termination For Permanent Disability: If the Executive's employment ------------------------------------ is terminated by the Company for Permanent Disability, the Executive shall be entitled to receive any accrued but unpaid salary and other benefits up to and including the date of the Executive's termination. In addition, any unvested Options pursuant to Section 3(c) and any other unvested Future Stock Benefits shall vest immediately. (d) Termination for Cause. If the Executive's employment is terminated by --------------------- the Company for Cause, the Company shall not have any other or further obligations to the Executive under this Agreement except (i) as to that portion of any unpaid Base Salary and other benefits accrued and earned under this Agreement to the date of termination, and (ii) as may be provided in accordance with the terms of retirement and other benefit plans pursuant to Section 3(e) and 3(f). (e) Termination Without Cause, Termination For Good Reason, and ----------------------------------------------------------- Termination During a Window Period. If the Executive's employment ----------------------------------- hereunder is terminated (1) by the Company without Cause, (2) by the Executive for Good Reason, or (3) by the Executive during a Window Period, then: (i) As soon as practicable after the Date of Termination, but no later than ten (10) days after such date, the Company shall pay to the Executive any amounts earned, accrued or owing the Executive under the terms hereunder for services to the Date of Termination. (ii) As soon as practicable after the Date of Termination, but no later than ten (10) days after such date, the Company shall pay to the Executive a lump sum amount, in cash, equal to the sum of (A) any Annual Bonus which has been allocated or awarded to the Executive, but not yet paid, for a completed fiscal year preceding the Date of Termination under any Annual Bonus plan, and (B) a pro rata portion to the Date of Termination of the Annual Bonus for the year in which the Date of Termination occurs, assuming the Executive would have received an Annual Bonus equivalent to the highest previous Annual Bonus which the Executive received in any given year during the Employment Period. In the event such termination occurs in the first year of employment, the Executive's pro rata Annual Bonus will be based on a full year bonus of $75,000. (iii) In lieu of any further salary or bonus payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay as a severance payment to the Executive, within ten (10) days immediately following the Date of Termination, a lump sum amount, in cash, equal to the sum of: (A) two year's Base Salary at the Executive's highest annual Base Salary rate in effect during the Employment Period and (B) an amount equivalent to twice the highest Annual Bonus that the Executive received in any given year during the Employment Period or $150,000, whichever is higher. (iv) The Company shall maintain in full force and effect, for the continued benefit of the Executive until the later of (x) the second anniversary of the Date of Termination or (y) the end of the Term, each "employee welfare benefit plan" (as defined in Section 3(1) of the Employee -8- Retirement Income Security Act of 1974, as amended ("ERISA")), other than any disability plan, in which the Executive was entitled to participate immediately prior to the Date of Termination, provided that the Executive's continued participation is possible under the general terms and provisions of such plans. In the event that the Executive's participation in any such plan is barred, the Company shall arrange to provide the Executive with benefits substantially similar to those which the Executive would otherwise have been entitled to receive under the plan from which his continued participation is barred; (v) Any unvested Options or Future Stock Benefits shall, to the extent not already vested, vest immediately upon the Date of Termination; (vi) The Company shall have no additional obligations to the Executive under this Agreement except to the extent provided in Sections 3(e) and 3(f). (f) Termination Without Cause Outside a Window Period by the Executive. If ------------------------------------------------------------------ the Executive's employment is terminated by the Executive without Cause outside of a Window Period, the Company shall not have any other or further obligations to the Executive under this Agreement except (i) as to that portion of any unpaid Base Salary and other benefits accrued and earned under this Agreement to the date of termination, and (ii) as may be provided in accordance with the terms of retirement and other benefit plans pursuant to Section 3(e) and 3(f). In addition, the pro rata portion of any unvested Options or Future Stock Benefits that were scheduled to vest in the year of the Executive's termination shall vest immediately. Such pro rata amount will be determined in each such case for the Options and Future Stock Benefits by taking the number of Options or Future Stock Benefits (whichever the case may be) which were scheduled to vest on the next succeeding vesting date after the Date of Termination and multiplying each by a fraction, the numerator of which is the number of days that have elapsed from the vesting date immediately preceding the Date of Termination (or the grant date) to the Date of Termination, and the denominator of which shall be the number of days scheduled between the most recent vesting date preceding the Date of Termination (or the grant date) and the vesting date first succeeding the Date of Termination (such formula hereinafter referred to as the "Pro Rata Option Formula"). (g) Mitigation. The Executive shall not be required to mitigate amounts ---------- payable pursuant to Section 8 hereof by seeking employment or otherwise, but any payments made or benefits provided pursuant to Section 8(e)(iv) hereof shall be offset by any similar payments or benefits made available without cost to the Executive from any subsequent employment during the Term (determined immediately prior to such termination of employment.) 9. CONFIDENTIAL INFORMATION: ------------------------ (a) Unauthorized Disclosure. The Executive shall not, either during the ----------------------- Executive's employment hereunder or thereafter, disclose, divulge, discuss, copy or otherwise use or suffer to be used in any manner, other than in accordance with the Executive's duties hereunder, any confidential or proprietary information relating to the Company's business, prospects, finances, operations, customers, products, services, rates, properties or otherwise to its particular business or other trade secrets of the Company, it being acknowledged by the Executive that all such information regarding the business of the Company compiled or obtained by, or furnished to, the Executive while the Executive shall have been employed by or associated with the Company is confidential and/or proprietary information and the Company's exclusive property; provided, however, that the foregoing restrictions shall not apply to the extent that such information: (i) is clearly obtainable in the public domain; or (ii) becomes obtainable in the public domain, except by reason of the breach by the Executive of the terms hereof; or -9- (iii) is required to be disclosed by rule of law or by order of a court or governmental body or agency. (b) The Executive agrees and understands that the remedy at law for any breach by him of this Section 9 will be inadequate and that the damages flowing from such breach are not readily susceptible to being measured in monetary terms. Accordingly, it is acknowledged that the Company shall be entitled to seek immediate injunctive relief. Nothing in this Section 9 shall be deemed to limit the Company's remedies at law or in equity for any breach by the Executive of any of the provisions of this Section 9 which may be pursued or availed of by the Company. (c) The Executive acknowledges that the Executive's obligations under this Section 9 shall survive regardless of whether the Executive's employment by the Company is terminated, voluntarily or involuntarily, by the Company or the Executive, with Cause or without Cause. 10. EXCISE TAX GROSS-UP PAYMENT: --------------------------- (a) Notwithstanding anything herein to the contrary, if it is determined that any payment and/or other compensation under the terms of this Agreement or otherwise would be subject to the excise tax imposed by Section 4999 and/or Section 280 of the Internal Revenue Code (the "Code") or any interest or penalties should be assessed with respect to such excise tax (such excise tax, together with any interest or penalties thereon, is herein referred to as an "Excise Tax"), then Executive shall be entitled to an additional cash payment (a "Gross-Up Payment") in an amount that will place Executive in the same after-tax economic position that Executive would have enjoyed if the Excise Tax had not applied to such payment and/or other compensation. The amount of the Gross-Up Payment shall be determined by an accounting firm selected by the Executive in his sole discretion (the "Accounting Firm") in accordance with such formula as the Accounting Firm deems appropriate. No Gross-Up Payments shall be payable hereunder if the Accounting Firm determines that the payments and/or other compensation are not subject to an Excise Tax. The Accounting Firm shall be paid by the Company (or any successor thereto) for services performed hereunder. (b) All determinations required under this Section 10, including whether a Gross-Up Payment is required, the amount of the payment and/or other compensation constituting excess parachute payments, and the amount of the Gross-Up Payment, shall be made by the Accounting Firm, which shall provide detailed supporting calculations to both Executive and the Company within fifteen (15) days of any date reasonably requested by the Executive on which a determination under this Section 10 is necessary or advisable. The Company shall pay to the Executive, in cash, subject to any applicable tax withholding requirements, the Gross-Up Payment within fifteen (15) days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by Executive, the Company agrees that the Accounting Firm shall provide the Executive with an opinion that the Accounting Firm, having substantial authority under the Code and other tax regulations and based on its judgement and an assessment of the facts, does not believe the Executive will have to report an Excise Tax on the Executive's federal income tax return. Any determination by the Accounting Firm shall be binding upon the Executive and the Company (or any successor thereto). (c) In the event that it is finally determined by the Internal Revenue Service on audit or in a judicial proceeding that the Executive is liable for any Excise Tax in an amount other than that determined by the Accounting Firm, the Gross-Up Payment shall be recomputed by the Accounting Firm based on the Excise Tax that is finally determined to be due. The Executive shall refund any resulting overpayment (together with interest at the prevailing short-term applicable federal rate under section 1274 of the Code) and the payer of the original Gross-Up Payment shall pay to the Executive any resulting shortfall (together with interest at the short-term applicable federal rate under section 1274 of the Code), promptly following such recomputation. The Company shall indemnify the Executive against any costs and expenses (including the reasonable fees of -10- attorneys and accountants) incurred in connection with any audit or examination of, or legal proceedings in connection with, his tax return for any taxable year for which an Excise Tax is, or is alleged to be, due, to the extent attributable to the issue of such Excise Tax. MISCELLANEOUS: - ------------- (a) The Executive represents and warrants that he is not a party to any agreement, contract or understanding, whether employment or otherwise, which would restrict or prohibit him from undertaking or performing employment in accordance with the terms and conditions of this Agreement. (b) The provisions of this Agreement are severable and if any one or more provisions may be determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions and any partially unenforceable provision to the extent enforceable in any jurisdiction nevertheless shall be binding and enforceable. (c) At all times during and after Executive's employment and the date of this Agreement, the Company shall indemnify the Executive to the fullest extent permitted by law for all expenses, costs, liabilities and legal fees which the Executive may incur in the discharge of his duties hereunder and shall at all times maintain appropriate provisions in its articles of incorporation and bylaws which mandate that the Company provide such indemnification. The Company shall also provide, for the benefit of the Executive, Directors and Officers' liability insurance in amounts which are customary for directors and officers of other public companies similar in character or size to the Company. Any termination of the Executive's employment or of this Agreement shall have no effect on the continuing operation of this Section 11(c). (d) The Company shall reimburse Executive for reasonable fees and expenses incurred in connection with the negotiation and execution of this Agreement, including, without limitation, the reasonable fees and expenses of his attorneys. (e) The Company will require any purchaser of all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Executive, to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, "Company" shall mean the Company as herein before defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 11(e) or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (f) This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts unless otherwise provided herein, shall be paid in accordance with terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. (g) Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then pertaining in the metropolitan Boston, MA area, and judgment upon the award rendered by the arbitrator or arbitrators may be entered in any court having jurisdiction thereof. The arbitrator or arbitrators shall be deemed to possess the powers to issue mandatory orders and restraining orders in connection with such arbitration. The Company (or any successor thereto) and the Executive each agree to use their best efforts to begin the arbitration process -11- within three months of any notification from the other party requesting arbitration to settle a dispute. The Company (or any successor thereto) shall pay all costs of any such proceeding. (h) All notices and other communications required or permitted under this Agreement shall be in writing, and shall be deemed properly given if delivered personally, mailed by registered or certified mail in the United States mail, postage prepaid, return receipt requested, sent by facsimile, or sent by Express Mail, Federal Express or nationally recognized express delivery service, as follows: If to the Company or the Board: CTC Communications Corp. 360 Second Avenue Waltham, MA 02154 Attention: Chief Executive Officer Fax Number: (781) 890-1613 If to the Executive: Steven C. Jones 795-A Meadowland Drive Naples, FL 34108 Notice given by hand, certified or registered mail, or by Express Mail, Federal Express or other such express delivery service, shall be effective upon actual receipt. Notice given by facsimile transmission shall be effective upon telephonic confirmation of receipt by the party to whom it is addressed. All notices by facsimile transmission shall be followed up promptly after transmission by delivering an original copy by hand, certified or registered mail, or by Express Mail, Federal Express or other such delivery service. Any party may change any address to which notice is to be given to it by giving notice as provided above of such change of address. (i) The failure of either party to enforce any provision or provisions of this Agreement shall not in any way be construed as a waiver of any such provision or provisions as to any future violations thereof, nor prevent that party thereafter from enforcing each and every other provision of this Agreement. The rights granted the parties herein are cumulative and the waiver of any single remedy shall constitute a waiver of such party's right to assert all other legal remedies available to it under the circumstances. (j) This Agreement supersedes all prior agreements and understandings between the parties and may not be modified or terminated orally. No modification or attempted waiver shall be valid unless in writing and signed by the party against whom the same is sought to be enforced. -12- (k) This Agreement shall be governed by, and construed in accordance with the provisions of, the law of the Commonwealth of Massachusetts, without reference to provisions that refer a matter to the law of any other jurisdiction. Each party hereto hereby irrevocably submits itself to the non-exclusive personal jurisdiction of the federal and state courts sitting in Massachusetts; accordingly, subject to the provisions for arbitration provided in Section 11(g), any justiciable matters involving the Company and the Executive with respect to this Agreement may be adjudicated only in a federal or state court sitting in Massachusetts. (l) All payments required to be made by the Company hereunder to the Executive shall be subject to the withholding of such amounts relating to taxes and other government assessments as the Company may reasonably determine it should withhold pursuant to any applicable law, rule or regulation. (m) Captions and section headings used herein are for convenience and are not a part of this Agreement and shall not be used in construing it. (n) Where necessary or appropriate to the meaning hereof, the singular and plural shall be deemed to include each other, and the masculine, feminine and neuter shall be deemed to include each other. (o) This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of this Agreement by telecopier shall be effective as delivery of a manually executed counterpart of this Agreement. -13- IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first set forth above. CTC COMMUNICATIONS CORP.: By: /s/ Robert J. Fabbricatore _____________________________________ Robert J. Fabbricatore Chairman and Chief Executive Officer EXECUTIVE: By: /s/ Steven C. Jones ___________________________________ Steven C. Jones Address: 795-A Meadowland Drive Naples, FL 34108 -14- EX-23.1 4 CONSENT OF ERNST & YOUNG EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-44337) pertaining to the Employee Stock Purchase Plan of CTC Communications Corp. and the Registration Statement (Form S-8 No. 333-17613) pertaining to the 1996 Stock Option Plan of CTC Communications Corp. of our report dated May 28, 1998, except for Note 1, as to which the date is July 15, 1998, with respect to the financial statements and schedule of CTC Communications Corp. included in the Annual Report (Form 10-K) for the year ended March 31, 1998. /s/ ERNST & YOUNG LLP ERNST & YOUNG LLP Boston, Massachusetts July 15, 1998 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS MAR-31-1998 MAR-31-1998 2,168 0 17,288 492 0 22,386 13,377 6,838 30,967 11,143 0 0 0 100 11,480 30,967 40,947 41,267 14,039 45,531 0 0 106 (4,370) (1,486) (2,884) 0 0 0 (2,884) (0.29) (0.29)
EX-99.1 6 RISK FACTORS EXHIBIT 99.1 RISK FACTORS LIMITED HISTORY AS AN ICP; RISKS RELATING TO IMPLEMENTATION OF NEW STRATEGY Although the Company has sold integrated telecommunications services for over 14 years, it sold local telephone services as an agent for Bell Atlantic Corp. ("Bell Atlantic") until December 1997 and only began offering such services as an integrated communications provider ("ICP") under its own brand name after that time. As a result of the Company terminating its agency relationship with Bell Atlantic, agency revenues, which accounted for approximately 71% of the Company's revenues for the nine month period ended December 31, 1997 are no longer generated by the Company. For the fourth quarter ended March 31, 1998, agency revenues decreased from $8.4 million to $194,000 and total revenues decreased from $11.5 million to $6.2 million. There can be no assurance that the Company's prior experience in the sale of telecommunications services as a sales agent will result in the Company generating sufficient cash flow to service its debt obligations or to compete successfully under its new strategy. The Company plans to deploy its own Integrated Communications Network ("ICN"). The Company has no experience in deploying, operating and maintaining a telecommunications network. The Company's ability to successfully deploy its ICN will require the negotiation of interconnection agreements with incumbent local exchange carriers ("ILECs"), which can take considerable time, effort and expense and which are subject to federal, state and local regulation. There can be no assurance that the Company will be able to successfully negotiate such agreements or to effectively deploy, operate or maintain its facilities or increase or maintain its cash flow from operations by deploying a network. Further, there can be no assurance that the packet-switched design of the network will provide the expected functionality in serving its target market or that customers will be willing to migrate the provision of their services onto the Company's network. The Company has engaged a network services integrator to design, engineer and manage the buildout of the ICN in the Company's existing markets. Any failure or inability by the network integrator to perform these functions could cause delays or additional costs in providing services to customers and building out the Company's ICN in specific markets. Any such failure could materially and adversely affect the Company's business and results of operations. If the Company fails to effectively transition to an ICP platform, fails to obtain or retain a significant number of customers or is unable to effectively deploy, operate or maintain its network, such failure could have an adverse effect on the Company's business, results of operations and financial condition. In addition, the implementation of its new strategy and the deployment of its network has increased and will continue to increase the Company's expenses significantly. Accordingly, the Company expects to incur significant negative cash flow during the next several years as it implements its business strategy, penetrates its existing markets as an ICP, enters new markets, deploys its ICN and expands its service offerings. There can be no assurance that the Company will achieve and sustain profitability or positive net cash flow. CAPITAL REQUIREMENTS AND UNCERTAINTY OF FINANCING The Company has obtained a commitment for an interim credit facility (the "Interim Facility") from its current lender. The Interim Facility, which would mature on June 30, 1999, would provide secured revolving loans of up to $20 million to refinance the Credit Facility, to fund capital expenditures and operating losses and for general corporate purposes. The commitment, which is subject to certain conditions, extends to September 30, 1998. To satisfy one of those conditions, the Company has received a commitment from Spectrum to purchase $5 million of Preferred Stock which extends until June 30, 1999. The Company believes that the Interim Facility and the Interim Spectrum Financing, if required, together with cash on hand would be sufficient to refinance the Company's existing credit facility and fund the Company's existing operations for at least the next 12 months. However, CTC would be required to delay its proposed geographic expansion and deployment of facilities or to obtain additional financing within the next 6 months. The implementation of the Company's business plan to further penetrate its existing markets as an ICP, deploy the ICN in its existing markets, expand its sales presence into six additional states in the Boston-Washington D.C. corridor and enhance the CTC Information System and the repayment of the Credit Facility will require the Company to raise significant capital. The Company has been seeking and is actively engaged in the negotiation of commitments with alternative sources of long term financing to fund its business plans. Although the Company is highly optimistic that it will be successful in obtaining such financing based upon its negotiations, there can be no assurance that the Company will be able to consummate financing in the amount, on the terms and on the schedule required to implement the Company's business plan, if at all. The timing and amount of the Company's actual capital requirements may be materially affected by many factors, including the timing and availability of financing, the timing and actual cost of expansion into new markets and deployment of the ICN, the extent of competition and pricing of telecommunications services in its markets, acceptance of the Company's services, technological change and potential acquisitions. Sources of funding the Company's capital requirements may include public offerings or private placements of equity or debt securities, vendor financing and bank loans. There can be no assurance that financing will be available to the Company or, if available, that it can be obtained on a timely basis and on terms acceptable to the Company. Failure to obtain financing when required could result in the delay or abandonment of the Company's business plans which could intern have a material adverse effect on the Company. HIGH LEVERAGE; POSSIBLE INABILITY TO SERVICE INDEBTEDNESS If the any of the proposed financings are consummated, the Company will be highly leveraged. The degree to which the Company is leveraged could have important consequences to the Company's future prospects, including the following: (i) limiting the ability of the Company to obtain any necessary financing in the future for working capital, capital expenditures, debt service requirements or other purposes; (ii) limiting the flexibility of the Company in planning for, or reacting to, changes in its business; (iii) leveraging the Company more highly than some of its competitors, which may place it at a competitive disadvantage; (iv) increasing its vulnerability in the event of a downturn in its business or the economy generally; and (v) requiring that a substantial portion of the Company's cash flow from operations be dedicated to the payment of principal and interest on the Notes and not be available for other purposes. The Company's ability to make scheduled payments of principal of, or to pay the interest on, or to refinance, its indebtedness, or to fund planned capital expenditures will depend on its future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond its control. There can be no assurance that the Company's business will generate sufficient cash flow from operations or that anticipated revenue growth and operating improvements will be realized or will be sufficient to enable the Company to service its indebtedness, or to fund its other liquidity needs. There can be no assurance that the Company will be able to refinance all or a portion of its indebtedness on commercially reasonable terms or at all. If the Company does not generate sufficient cash flow to meet its debt service and working capital requirements, the Company may need to examine alternative strategies that may include actions such as reducing or delaying capital expenditures, restructuring or refinancing its indebtedness, the sale of assets or seeking additional equity and/or debt financing. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. DEPENDENCE ON IN-HOUSE BILLING AND INFORMATION SYSTEM The accurate and prompt billing of the Company's customers is essential to the Company's operations and future profitability. The Company's expected growth and deployment of its ICN could give rise to additional demands on the CTC Information System, and there can be no assurance that it will perform as expected. The failure of the Company to adequately identify all of its information and processing needs (including Year 2000 compliance), the failure of the CTC Information System or the failure of the Company to upgrade the CTC Information System as necessary could have a material adverse effect on the Company and its results of operations. DEPENDENCE ON SUPPLIER PROVIDED TIMELY AND ACCURATE CALL DATE RECORDS; BILLING AND INVOICE DISPUTES In its reseller business, the Company is dependent upon the timely receipt and accuracy of call data records provided to it by its suppliers. There can be no assurance that accurate information will consistently be provided by suppliers or that such information will be provided on a timely basis. Failure by suppliers to provide timely and accurate detail would increase the length of the Company's billing and collection cycles and adversely effect its operating results. The Company pays its suppliers according to the Company's calculation of the charges applicable to the Company based on supplier invoices and computer tape records of all such calls provided by suppliers which may not always reflect current rates and volumes. Accordingly, a supplier may consider the Company to be in arrears in its payments until the amount in dispute is resolved. There can be no assurance that disputes with suppliers will not arise or that such disputes will be resolved in a manner favorable to the Company. In addition, the Company is required to maintain sophisticated billing and reporting systems to service the large volume of services placed over its networks. As resale volumes increase, there can be no assurance that the Company's billing and management systems will be sufficient to provide the Company with accurate and efficient billing and order processing capabilities. DEPENDENCE ON NETWORK INFRASTRUCTURE AND PRODUCTS AND SERVICES OF OTHERS The Company does not currently own any part of a local exchange or long distance network and depends entirely on facilities-based carriers for the transmission of customer traffic. After the deployment of the ICN, it will still rely, at least initially, on others for circuit switching of local voice calls and on fiber optic backbone transmission facilities. There can be no assurance that such switching or transmission facilities will be available to the Company on a timely basis or on terms acceptable to the Company. The Company's success in marketing its services requires that the Company provide superior reliability, capacity and service. Although the Company can exercise direct control of the customer care and support it provides, most of the services that it currently offers are provided by others. Such services are subject to physical damage, power loss, capacity limitations, software defects, breaches of security (by computer virus, break-ins or otherwise) and other factors, certain of which have caused, and will continue to cause, interruptions in service or reduced capacity for the Company's customers. Such problems, although not the result of failures by the Company, can result in dissatisfaction among its customers. In addition, the Company's ability to provide complete telecommunications services to its customers will be dependent to a large extent upon the availability of telecommunications services from others on terms and conditions that are acceptable to the Company and its customers. There can be no assurance that government regulations will continue to mandate the availability of some or all of such services or that the quality or terms on which such services are available will be acceptable to the Company or its customers. CUSTOMER ATTRITION The Company's operating results may be significantly affected by its reseller customer attrition rates. There can be no assurance that customers will continue to purchase long distance or other services through the Company in the future or that the Company will not be subject to increased customer attrition rates. The Company believes that the high level of customer attrition in the industry is primarily a result of national advertising campaigns, telemarketing programs and customer incentives provided by major competitors. There can be no assurance that customer attrition rates will not increase in the future, which could have a material adverse effect on the Company's operating results. ABILITY TO MANAGE GROWTH; RAPID EXPANSION OF OPERATIONS The Company is pursuing a new business plan that, if successfully implemented, will result in rapid growth and expansion of its operations, which will place significant additional demands upon the Company's current management. If this growth is achieved, the Company's success will depend, in part, on its ability to manage this growth and enhance its information, management, operational and financial systems. There can be no assurance that the Company will be able to manage expanding its operations. The Company's failure to manage growth effectively could have a material adverse effect on the Company's business, operating results and financial condition. POTENTIAL IMPACT OF THE BELL ATLANTIC LITIGATION AND THE TRO In December 1997, the Company filed suit against Bell Atlantic for breaches of its agency contract, including the failure of Bell Atlantic's retail division to pay $14 million in agency commissions (approximately $11.3 million as of July 10, 1998) owed to the Company. The Company intends to pursue this suit vigorously. Although the Company believes the collection of the agency commissions sought in the suit is probable, there can be no assurance that the Company will be successful in collecting these commissions. If the Company fails to collect any of the amounts sought or if their collection becomes less than probable, the Company would be required to write off the amounts reflected in its financial statements that it is unable to collect or for which collection becomes less than probable. Delay in the collection or write-off of the agency commissions sought may adversely affect the Company. In the Company's litigation against Bell Atlantic, Bell Atlantic obtained a temporary restraining order (the "TRO") prohibiting the Company until December 30, 1998 from marketing certain local telecommunications services to any Bell Atlantic customer for whom the Company was responsible for account management, or to whom the Company sold Bell Atlantic services, during 1997. Although the Company is seeking to have the TRO modified or dissolved, there is no assurance that it will be successful and the Company's sale of local service to such customer sites could be prohibited until December 30, 1998. The inability of the Company to sell local telephony services to such customers until such date may continue to adversely affect the Company's business. In addition, the Company must use Bell Atlantic infrastructure for nearly all of the local telephony services that it currently provides and, although Bell Atlantic is prohibited by federal law from discriminating against the Company, there can be no assurance that the litigation with Bell Atlantic will not negatively affect the Company's relationships with Bell Atlantic's wholesale division. DEPENDENCE ON KEY PERSONNEL The Company believes that its continued success will depend to a significant extent upon the abilities and continued efforts of its management, particularly members of its senior management team. The loss of the services of any of such individuals could have a material adverse effect on the Company's results of operations. The success of the Company will also depend, in part, upon the Company's ability to identify, hire and retain additional key management as well as highly skilled and qualified sales, service and technical personnel. Competition for qualified personnel in the telecommunications industry is intense, and there can be no assurance that the Company will be able to attract and retain additional employees and retain its current key employees. The inability to hire and retain such personnel could have a material adverse effect on the Company's business. COMPETITION The Company operates in a highly competitive environment and has no significant market share in any market in which it operates. The Company expects that it will face substantial and growing competition from a variety of data transport, data networking and telephony service providers due to regulatory changes, including the continued implementation of the Telecommunications Act of 1996 (the "Telecommunications Act"), and the increase in the size, resources and number of such participants as well as a continuing trend toward business combinations and alliances in the industry. The Company faces competition for the provision of integrated telecommunications services as well as competition in each of the individual market segments that comprise the Company's integrated approach. In each of these market segments, the Company faces competition from larger, better capitalized incumbent providers, which have long standing relationships with their customers and greater name recognition than the Company. REGULATION The Company's local and long distance telephony service, and to a lesser extent its data services, are subject to federal, state, and, to some extent, local regulation. The Federal Communications Commission (the "FCC") exercises jurisdiction over all telecommunications common carriers, including the Company, to the extent that they provide interstate or international communications. Each state regulatory commission retains jurisdiction over the same carriers with respect to the provision of intrastate communications. Local governments sometimes impose franchise or licensing requirements on telecommunications carriers and regulate construction activities involving public right-of-way. Changes to the regulations imposed by any of these regulators could affect the Company. While the Company believes that the current trend toward relaxed regulatory oversight and competition will benefit the Company, the Company cannot predict the manner in which all aspects of the Telecommunications Act will be implemented by the FCC and by state regulators or the impact that such regulation will have on its business. The Company is subject to FCC and state proceedings, rulemakings, and regulations, and judicial appeal of such proceedings, rulemaking and regulations, which address, among other things, access charges, fees for universal service contributions, ILEC resale obligations, wholesale rates, and prices and terms of interconnection and unbundling. The outcome of these rulemakings, judicial appeals, and subsequent FCC or state actions may make it more difficult or expensive for the Company or its competitors to do business. Such developments could have a material effect on the Company. The Company also cannot predict whether other regulatory decisions and changes will enhance or lessen the competitiveness of the Company relative to other providers of the products and services offered by the Company. In addition, the Company cannot predict what other costs or requirements might be imposed on the Company by state or local governmental authorities and whether or not any additional costs or requirements will have a material adverse effect on the Company. RISKS ASSOCIATED WITH POSSIBLE ACQUISITIONS As it expands, the Company may pursue strategic acquisitions. Acquisitions commonly involve certain risks, including, among others: difficulties in assimilating the acquired operations and personnel; potential disruption of the Company's ongoing business and diversion of resources and management time; possible inability of management to maintain uniform standards, controls, procedures and policies; entering markets or businesses in which the Company has little or no direct prior experience; and potential impairment of relationships with employees or customers as a result of changes in management. There can be no assurance that any acquisition will be made, that the Company will be able to obtain any additional financing needed to finance such acquisitions and, if any acquisitions are so made, that the acquired business will be successfully integrated into the Company's operations or that the acquired business will perform as expected. The Company has no definitive agreement with respect to any acquisition, although from time to time it has discussions with other companies and assesses opportunities on an ongoing basis. YEAR 2000 COMPLIANCE The Company has assessed its systems and expects all of them to be year 2000 compliant by the end of 1998. However, there can be no assurance that all systems will function adequately until the occurrence of year 2000. In addition, if the systems of other companies on whose services the Company depends or with whom the Company's systems interface are not year 2000 compliant, there could be a material adverse effect on the Company. CONTROL BY PRINCIPAL SHAREHOLDERS; VOTING AGREEMENT As of July 10, 1998, the officers and directors and parties affiliated with or related to such officers and directors controlled approximately 48.5% of the outstanding voting power of the Common Stock. Robert J. Fabbricatore, the Chairman and Chief Executive Officer of the Company, beneficially owns approximately 27.5% of the outstanding shares of Common Stock. Consequently, the officers and directors will have the ability to exert significant influence over the election of all the members of the Company's Board, and the outcome of all corporate actions requiring stockholder approval. In addition, Mr. Fabbricatore has agreed to vote the shares beneficially owned by him in favor of the election to the Company's Board of Directors of up to two persons designated by the holders of a majority of the Series A Convertible Preferred Stock. IMPACT OF TECHNOLOGICAL CHANGE The telecommunications industry has been characterized by rapid technological change, frequent new service introductions and evolving industry standards. The Company believes that its long-term success will increasingly depend on its ability to offer integrated telecommunications services that exploit advanced technologies and anticipate or adapt to evolving industry standards. There can be no assurance that (i) the Company will be able to offer new services required by its customers, (ii) the Company's services will not be economically or technically outmoded by current or future competitive technologies, (iii) the Company will have sufficient resources to develop or acquire new technologies or introduce new services capable of competing with future technologies or service offerings (iv) all or part of the ICN or the CTC Information System will not be rendered obsolete, (v) the cost of the ICN will decline as rapidly as that of competitive alternatives, or (vi) lower retail rates for telecommunications services will not result from technological change. In addition, increases in technological capabilities or efficiencies could create an incentive for more entities to become facilities-based ICPs. Although the effect of technological change on the future business of the Company cannot be predicted, it could have a material adverse effect on the Company's business, results of operations and financial condition. POSSIBLE VOLATILITY OF STOCK PRICE The stock market historically has experienced volatility which has affected the market price of securities of many companies and which has sometimes been unrelated to the operating performance of such companies. In addition, factors such as announcements of developments related to the Company's business, or that of its competitors, its industry group or its customers, fluctuations in the Company's results of operations, a shortfall in results of operations compared to analysts' expectations and changes in analysts' recommendations or projections, sales of substantial amounts of securities of the Company into the marketplace, regulatory developments affecting the telecommunications industry or data services or general conditions in the telecommunications industry or the worldwide economy, could cause the market price of the Common Stock to fluctuate substantially. ABSENCE OF DIVIDENDS The Company has not paid and does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. The Company intends to retain its earnings, if any, for use in the Company's growth and ongoing operations. In addition, the terms of the Series A Convertible Preferred Stock restrict, and the terms of future debt financings are expected to restrict, the ability of the Company to pay dividends on the Common Stock. POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS AND ISSUANCES OF PREFERRED STOCK Certain provisions of the Company's Articles of Organization and Bylaws and the Massachusetts Business Corporation Law may have the effect of delaying, deterring or preventing a change in control of the Company or preventing the removal of incumbent directors. The existence of these provisions may have a negative impact on the price of the Common Stock and may discourage third party bidders from making a bid for the Company or may reduce any premiums paid to stockholders for their Common Stock. In addition, the Company's Board of Directors has the authority without action by the Company's stockholders to issue shares of the Company's Preferred Stock and to fix the rights, privileges and preferences of such stock, which may have the effect of delaying, deterring or preventing a change in control. Certain provisions of the Company's outstanding Series A Convertible Preferred Stock which provide for payment of the liquidation preference in cash upon the consummation of certain transactions may have the effect of discouraging third parties from entering into such transactions. -----END PRIVACY-ENHANCED MESSAGE-----