-----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, HsA6IWNaUn3SvBlov5h5sgjBYNyyj2ag6mhxxD5Hkq6KPJLb8rE5XgeA0Db1TtY2 Kj3I1otCEI2tCSiqv+JFzA== 0001056114-99-000014.txt : 19990217 0001056114-99-000014.hdr.sgml : 19990217 ACCESSION NUMBER: 0001056114-99-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990216 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-Q SEC ACT: SEC FILE NUMBER: 000-13627 FILM NUMBER: 99542615 BUSINESS ADDRESS: STREET 1: 360 SECOND AVE CITY: WALTHAM STATE: MA ZIP: 02451 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-Q 1 12/31/98 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For Quarter ended December 31, 1998. Commission File Number 0-13627. CTC COMMUNICATIONS CORP. (Exact name of registrant as specified in its charter) Massachusetts 04-2731202 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 360 Second Avenue, Waltham, Massachusetts 02451 (Address of principal executive offices) (Zip Code) (781) 466-8080 (Registrant's telephone number including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the Issuer's classes of Common Stock, as of the latest practicable date: As of February 12, 1998, 10,306,458 shares of Common Stock were outstanding. CTC COMMUNICATIONS CORP. FORM 10-Q INDEX
Part I FINANCIAL STATEMENTS PAGE NO. Item 1. Financial Statements Condensed Balance Sheets as of December 31 and March 31, 1998 3 Condensed Statements of Operations Three Months Ended December 31, 1998 and 1997 4 Condensed Statements of Operations Nine Months Ended December 31, 1998 and 1997 5 Condensed Statements of Cash Flows Nine Months Ended December 31, 1998 and 1997 6 Notes to Condensed Financial Statements 7-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-20 Item 3. Quantitative and Qualitative Inapplicable Disclosures About Market Risk Part II OTHER INFORMATION Item 1. Legal Proceedings Inapplicable Item 2. Changes in Securities 21 Item 3. Default Upon Senior Securities Inapplicable Item 4. Submission of Matters to a Vote of Security Holders 21 Item 5. Other Information Inapplicable Item 6. Exhibits and Reports on Form 8-K 22
2 In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 including, but not limited to, those statements regarding the successful implementation of the Company's business plan, availability of additional financing if required, the ability to improve operational, financial and management information systems, future profitability, the timing and success of the expansion and deployment of facilities, future operations and availability of capital and other future plans, events and performance and other statements located elsewhere herein. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those outlined in Exhibit 99.1 filed with this Quarterly Report. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. CTC COMMUNICATIONS CORP. CONDENSED BALANCE SHEETS
December 31, March 31, 1998 1998 --------------- --------------- ASSETS Current Assets Cash and cash equivalents $ 2,597,116 $ 2,167,930 Accounts receivable, net 26,462,861 17,288,183 Prepaid expenses and other current assets 8,839,184 3,029,069 ------------- ------------- Total Current Assets 37,899,161 22,485,182 Furniture, Fixtures and Equipment 37,889,161 13,376,970 Less accumulated depreciation (10,197,683) (6,837,683) ------------- ------------- Total Equipment 25,441,118 6,539,287 Deferred income taxes 0 1,834,000 Other assets 4,188,531 108,885 ------------- ------------- Total Assets $ 67,528,810 $ 30,967,354 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current Liabilities Accounts payable and accrued expenses $ 29,088,014 $ 8,958,476 Accrued salaries and related taxes 2,342,299 756,159 Current portion of obligations under capital leases 1,312,621 231,796 Current portion of note payable to bank 0 1,196,400 ------------- ------------- Total Current Liabilities 32,742,934 11,142,831 Obligations under capital leases, net of current portion 4,671,226 1,114,277 Notes payable, net of current portion 35,958,287 7,130,671 Series A redeemable convertible preferred stock 12,561,573 0 Stockholders' Equity (Deficit) Common stock 102,911 99,806 Additional paid in capital 6,960,212 5,245,704 Deferred Compensation (238,910) (318,410) Retained-earnings (deficit) (25,063,598) 6,688,300 ------------- ------------- (18,239,385) 11,715,400 Amounts due from stockholders (165,825) (135,825) ------------- ------------- Total Stockholders' Equity (Deficit) (18,405,210) 11,579,575 ------------- ------------- Total Liabilities and Stockholders' Equity (Deficit) $ 67,528,810 $ 30,967,354 ============= =============
The accompanying notes are an integral part of these financial statements. 3 CTC COMMUNICATIONS CORP. CONDENSED STATEMENTS OF OPERATIONS Three Months Ended December 31, December 31, 1998 1997 ------------- ------------- Telecommunications revenues $ 19,024,531 $ 3,535,540 Commission revenues 0 7,620,106 -------------- ------------- Total revenues 19,024,531 11,155,646 Costs and expenses: Cost of telecommunications revenues 16,429,094 2,940,001 Selling, general and administrative expenses 14,303,425 7,381,233 -------------- ------------- 30,732,519 10,321,234 -------------- ------------- Income (loss) from operations (11,707,988) 834,412 Other: Interest income 12,405 29,274 Interest expense (1,207,914) (11,908) Other 3,472 9,222 -------------- ------------- (1,192,037) 26,588 Income (loss) before income taxes (12,900,025) 861,000 Provision (benefit) for income taxes (903,000) 355,000 -------------- ------------- Net income (loss) $ (11,997,025) $ 506,000 ============== ============= Net income (loss) per common share: Basic $ (1.20) $ 0.05 ============== ============= Diluted $ (1.20) $ 0.05 ============== ============= Weighted average number of common shares : Basic 10,260,932 9,917,361 ============== ============= Diluted 10,260,932 11,078,771 ============== ============= The accompanying notes are an integral part of these financial statements. 4 CTC COMMUNICATIONS CORP. CONDENSED STATEMENTS OF OPERATIONS Nine Months Ended December 31, December 31, 1998 1997 -------------- ------------- Telecommunications revenues $ 46,376,407 $ 10,078,325 Commission revenues 0 24,581,370 -------------- ------------- Total revenues 46,376,407 34,659,695 Costs and expenses: Cost of telecommunications revenues 40,425,994 8,095,086 Selling, general and administrative expenses 36,799,882 21,370,033 -------------- ------------- 77,225,876 29,465,119 -------------- ------------- Income (loss) from operations (30,849,469) 5,194,576 Other: Interest income 183,237 126,212 Interest expense (2,608,890) (22,135) Other 36,473 14,348 -------------- ------------- (2,389,180) 118,425 Income (loss) before income taxes (33,238,649) 5,313,001 Provision (benefit) for income taxes (2,327,000) 2,189,000 -------------- ------------- Net income (loss) $ (30,911,649) $ 3,124,001 ============== ============= Net income (loss) per common share: Basic $ (3.15) $ 0.32 ============== ============= Diluted $ (3.15) $ 0.29 ============== ============= Weighted average number of common shares : Basic 10,080,465 9,856,079 ============== ============= Diluted 10,080,465 10,824,001 ============== ============= The accompanying notes are an integral part of these financial statements. 5 CTC COMMUNICATIONS CORP. CONDENSED STATEMENTS OF CASH FLOWS Nine Months Ended December 31, December 31, 1998 1997 ------------- ------------- OPERATING ACTIVITIES Net income (loss) $(30,911,649) $ 3,124,001 Adjustments to reconcile net income to net cash (used) by operating activities: Depreciation and amortization 3,699,173 750,000 Stock compensation expense 79,500 0 Warrants expense 210,926 0 Changes in noncash working capital items: Accounts receivable (9,174,678) (6,475,864) Other current assets (3,976,115) (352,378) Other assets (3,198,072) 3,600 Accounts payable 20,129,538 1,008,833 Accrued liabilities 1,586,140) (527,093) Accrued taxes 0 (224,518) Deferred revenue 0 (6,588) ------------- ------------- Net cash (used) by operating activities (21,555,237) (2,700,007) INVESTING ACTIVITIES Additions to equipment (17,436,552) (4,556,428) ------------- ------------- Net cash used in investing activities (17,436,552) (4,556,428) FINANCING ACTIVITIES Proceeds from notes payable 27,631,216 1,846,073 Proceeds from the issuance of redeemable preferred stock 11,861,321 0 Repayments under capital leases (187,505) 0 Proceeds from the issuance of common stock 115,943 106,170 ------------- ------------- Net cash provided by financing activities 39,420,975 1,952,243 Increase (decrease) in cash 429,186 (5,304,192) Cash at beginning of year 2,167,930 6,405,670 ------------- ------------- Cash and cash equivalents at end of period $ 2,597,116 $ 1,101,478 ============= ============= The accompanying notes are an integral part of these financial statements. 6 CTC COMMUNICATIONS CORP. NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION The accompanying condensed financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and footnote disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. Operating results for the three and nine months ended December 31, 1998 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 1999. These statements should be read in conjunction with the financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1998. NOTE 2: COMMITMENTS AND CONTINGENCIES (a) Pending Legal Proceedings. Lawsuit Against Bell Atlantic. In December 1997, the Company terminated its agency contract and filed suit against Bell Atlantic in Federal District Court for breach of contract, including the failure of Bell Atlantic's retail division to pay $14 million in agency commissions (approximately $11.5 million as of December 31, 1998) owed to the Company. The Company also asserted violations by Bell Atlantic of the antitrust laws and Telecommunications Act. Bell Atlantic filed counterclaims asserting that the Company breached a provision of the agency contract prohibiting the Company from selling non-Bell Atlantic local services to certain agency customers for a one year period following termination of the contract. Based on that provision, Bell Atlantic obtained a TRO, which prohibited the Company from marketing certain local telecommunications services to any Bell Atlantic customer for whom the Company was responsible for account management, or to whom the Company sold Bell Atlantic services in 1997. In July of 1998, the Federal District Court in Portland, Maine ruled that the TRO was improperly issued and dissolved it. The Company's position that it should have full access to market and sell local services to all customers it served as an agent was affirmed by the Court. Bell Atlantic did not appeal this decision. The Company is currently marketing local services to those customers. Trial commenced in February 1999 with respect to the Company's law suit against Bell Atlantic for breach of contract and violations of the Telecommunications Act and antitrust laws and is currently in progress. (b) State Regulatory Proceedings In response to complaints filed by the Company, the Commonwealth of Massachusetts, Department of Telecommunications and Energy ("DTE"), the New York Public Service Commission, the New Hampshire Public Utilities Commission, the Maine Public Utilities Commission and the Rhode Island Public Utilities Commission each ruled that Bell Atlantic's rescinding of its long standing policy of permitting resellers, including the Company, to assume the service contracts of retail customers under contract to Bell Atlantic without contract termination fees violates state law on contract assignment. Certain of the states also cited violations of the resale agreement between the Company and Bell Atlantic and Section 251 of the Telecommunications Act (which provides that ILECs have a duty not to prohibit, and not to impose unreasonable or discriminatory conditions or limitations on, the resale of telecommunications service that the carrier provides at retail to subscribers who are not telecommunications carriers). 7 The DTE has granted Bell Atlantic a stay of its decision based on procedural grounds and agreed to reconsider its earlier decision. Hearings on this issue have also been held in Vermont, but to date, no decision has been rendered. The Company is otherwise party to suits arising in the normal course of business which management believes are not material individually or in the aggregate. NOTE 3. PREFERRED STOCK On April 10, 1998, the Company issued for investment to Spectrum Equity Investors II, L.P. ("Spectrum") and certain other private investors (together with Spectrum, the "Investors") an aggregate of 666,666 shares of Series A Convertible Preferred Stock (the "Preferred Shares") for $12 million, pursuant to the terms and conditions of a Securities Purchase Agreement among the Company and the Investors. The Company also issued for investment to the Investors five-year warrants to purchase an aggregate of 133,333 shares of its Common Stock at an exercise price of $9.00 per share. Spectrum purchased 98.63% of the Preferred Shares and warrants in the private placement. On the date of issuance, the Preferred Shares were convertible into 1,333,333 shares of the Company's Common Stock at $9.00 per share, which conversion ratio is subject to certain adjustments. Reference is made to the Company's Report on Form 8-K and exhibits thereto dated and filed on May 15, 1998 for a complete description of the transaction. NOTE 4. CISCO VENDOR FINANCING FACILITY On October 14, the Company obtained three-year vendor financing facility for up to $25 million with Cisco Capital Corp. Under the terms of the agreement, the Company has agreed to a three year, $25 million volume purchase commitment of Cisco Systems equipment and services and Cisco Capital Corp has agreed to advance funds as these purchases occur. In addition, a portion of the Cisco facility can be utilized for working capital costs associated with the integration and operation of Cisco Systems solutions and related peripherals. Pursuant to the terms of the Cisco Vendor Financing Agreement dated as of October 14, 1998, the Company has agreed to give the Lender a senior security interest in all products provided to the Company by Cisco and other products purchased with the proceeds of the first $15 million advanced under the facility and a subordinate security interest in all other assets of the Company. Under the terms of the facility, the Company is required to pay interest on funds advanced under the facility at an annual rate of 12.5%. In addition, the Company is required to pay a commitment fee of .50% per annum on any unused amounts under the facility and certain other fees. As of February 16, 1999, the Company had borrowed $11.5 million under the facility. Reference is made to the Company's Current Report on Form 8-K and the agreement filed as an exhibit thereto filed on October 14, 1998 for a complete description of the transaction. NOTE 5 GOLDMAN SACHS/FLEET FINANCING As of September 1, 1998, the Company as Borrower, entered into a Loan and Security Agreement with Goldman Sachs Credit Partners L.P. and Fleet National Bank as Lenders. Under the terms of the Loan and Security Agreement, the Lenders have provided a three-year senior secured credit facility to the Company consisting of revolving loans in the aggregate amount of up to $75 million (the "Credit Facility"). Advances under the facility bear interest at 1.75% over the prime rate and are secured by a first priority perfected security interest on all of the Company's assets, provided, however, that the Company has the ability to exclude assets acquired through purchase money financing. In addition, the Company is required to pay a commitment fee of 8 0.5% per annum on any unused amounts under the facility as well as a monthly line fee of $150,000 per month. The Company may borrow $15 million unconditionally and $60 million based on trailing 120 days accounts receivable collections (reducing to the trailing 90 days of collections by March 31, 2000). The Company paid a one-time up front fee of $2,531,250, representing 3 3/8% of the facility. In the event that the Company wishes to prepay the loan, the agreement provides for a prepayment penalty of 2% during the first 18 months of the term of the loan. Warrants to purchase an aggregate of 974,412 shares of the Company's common stock at an purchase price of $6.75 per share were issued to the Lenders in connection with the transaction. The Company has valued the Warrants at $1.3 million which is being amortized and included in interest expense over the three-year term of the Loan and Security Agreement. As of February 16, 1999, the Company had availability under the Credit Facility of $42.4 million and had borrowed approximately $35 million as of that date. NOTE 6. NET INCOME PER SHARE In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share". Statement 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented, and where necessary, restated to conform to the Statement 128 requirements. The following table sets forth the computation of basic and diluted net income per share:
Three Months Ended Nine Months Ended December 31, December 31 1998 1997 1998 1997 ------------------------- -------------------------- Numerator: Net income (loss) (11,997,025) 506,000 (30,911,649) 3,124,001 Accretion to redemption value on redeemable preferred stock (302,200) 0 (840,252) 0 Numerator for basic net income (loss) per share and diluted net income ------------------------ -------------------------- (loss) per share (12,299,225) 506,000 (31,751,901) 3,124,001 ========================= ========================== Denominator: Denominator for basic net income (loss) per share-weighted average shares 10,260,832 9,917,361 10,080,465 9,856,079 Effect of dilutive securities: Employee stock options 0 1,161,410 0 967,922 Denominator for diluted net income ------------------------- -------------------------- (loss) per share-weighted-average shares 10,260,932 11,078,771 10,080,465 10,824,001 ========================== ========================== Basic net income (loss) per share (1.20) 0.05 (3.15) 0.32 ========================== ========================== Diluted net income (loss) per share (1.20) 0.05 (3.15) 0.29 ========================== ==========================
9 NOTE 7 INCOME TAXES The provision (benefit) for income taxes is less than the statutory rate based upon management's assessment of the realizability of net operating losses. The benefit is recognized ratably during the year based on the relationship of amounts recoverable and management's estimate of the total loss for the fiscal year ending March 31, 1999. The effective rate of the benefit may vary with changes in management's estimates. 10 Part I Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Financial Statements and Notes set forth elsewhere in this Report. OVERVIEW CTC Communications Corp. (the "Company"), a Massachusetts corporation, is a rapidly growing integrated communications provider ("ICP") with 15 years of local telecommunications marketing, sales and service experience. The Company offers local, long distance, Internet access, Frame Relay and other data services on a single integrated bill. CTC currently serves predominantly medium-sized business customers in seven Northeastern states through its experienced 172-member direct sales force and 95 customer care representatives located in 25 branch offices throughout the region. Prior to becoming an ICP in January 1998, the Company was the oldest and largest independent sales agent for Nynex Corp. (acquired by Bell Atlantic in August 1997), selling local telecommunications services as an agent since 1984. The Company has also offered long distance and data services under its own brand name since 1994. In late 1997, the Company became certified as a Competitive Local Exchange Carrier ("CLEC") in New York and the six New England states in order to embark upon its ICP strategy and take advantage of market opportunities created by deregulation. In December 1997, the Company terminated its agency agreement with Bell Atlantic and began ICP operations in January 1998. As an ICP, the Company is utilizing its well-developed infrastructure and the same relationship- centered sales approach that it employed as an agent without the limitations on potential customers, services and pricing that were imposed upon it as an agent. Over the next three years, the Company plans to expand within its existing markets and into six additional states in the Boston-Washington, D.C. corridor and add network facilities. In January 1999, the Company began deploying phase I of its state-of-the- art, packet-switched Integrated Communications Network ("ICN"), which the Company believes will enable it to improve margins, enhance customer control and broaden service offerings. The ICN is an advanced Asynchronous Transfer Mode (ATM)-based network, using Cisco Systems, Inc. ("Cisco") BPX(r) 8600 series and MGX(tm) 8800 series IP+ATM wide-area switches, that will deliver enhanced access services such as traditional dedicated services, frame relay, IP, video and circuit emulation transport services. The Company believes that its ICN will ultimately enable it to deliver voice and data services across a single multi-service dedicated connection that is expected to lower customers' overall telecommunications costs and stimulate demand for new bandwidth intensive services. The phase 1 installation includes 22 switching sites in the Company's existing markets in New York and New England and is scheduled to be completed in the Spring of 1999 ("Phase 1"). Beginning in April 1999, the Company is scheduled to begin transitioning selected customers on-net for full beta testing. The Company expects that it will begin transitioning its broader customer base on-net in the Summer of 1999. 11 The Phase 1 switching hubs will be interconnected by leased transmission facilities from Level 3 Communications, LLC ("Level 3") and NorthEast Optic Network, Inc. ("NEON"). The initial transmission infrastructure will consist of three self-healing SONET-based, fiber optic rings covering the southern, western and eastern New England regions. This advanced SONET technology, which permits full circuit redundancy and route diversity, will allow CTC to take advantage of dense wave division multiplexing ("DWDM") to meet increasing customer demands for reliable, high bandwidth voice, data and video connectivity. The Company has also arranged to co-locate its switching hubs in Level 3 and NEON points of presence buildings ("POPs") along selected fiber routes. The Company intends to access its customer locations with leased broadband connectivity such as T-1, xDSL, wireless technologies or fiber optic facilities where they are available. Initially, the Company will offer dedicated long distance and data services over the ICN and will continue to lease local dialtone capabilities through the existing physical connection to the incumbent LEC until these services can be cost effectively integrated into a packet-switched network architecture. Given the revenue mix and size of the customers CTC is targeting for on-net services, the Company believes that it will be capable of transitioning approximately 70% of such average target customer's revenue stream on-net without integrating local dialtone into its network. Based on ongoing research and development activities at Cisco and other telecom equipment suppliers, the Company believes that it will be able to incorporate local dialtone functionality into its packet-switching architecture within the next 24 months. By continuing to lease local dialtone capabilities during this interim period, the Company will avoid the significant capital requirements associated with circuit switching architectures and it will be able to offer ubiquitous service in its target markets. Furthermore, this network strategy initially will enable the Company to significantly simplify the transitioning of existing customers on-net since a disconnection from the incumbent LEC and reconnection to CTC will not be required. In transitioning CTC customers on-net, the Company will simply be required to reprogram a customer's PABX and/or WAN routers to direct long distance and data traffic to the CTC broadband connection to the ICN. This strategy will also allow customers to retain their existing phone numbers as well as have the built in redundancy of the separate physical connection to the incumbent LEC. Prior to deploying the ICN, the Company is building its base of installed access lines through reselling the network services of other telecommunications carriers to targeted customers who can later be transitioned "on-net.". The Company bills its customers for local and long distance usage based on the type of local service utilized, the number, time and duration of calls, the geographic location of the terminating phone numbers and the applicable rate plan in effect at the time of the call. During the period in which the Company resells the services of other telecommunications carriers prior to deploying its ICN, cost of services includes the cost of local and long distance services charged by carriers for recurring charges, per minute usage charges and feature charges, as well as the cost of fixed facilities for dedicated services and special regional calling plans. Following the deployment of the ICN, the cost of services for "on-net" customers will include the leasing costs associated with transmission, co-location and access facilities as well as the depreciation charges associated with the Company's switching equipment. 12 Selling expense consists of the costs of providing sales and other support services for customers including salaries, commissions and bonuses to salesforce personnel. General and administrative expense consists of the costs of the billing and information systems and personnel required to support the Company's operations and growth as well as all amortization expenses. Depreciation is allocated throughout sales, marketing, general and administrative expense based on asset ownership. The Company has experienced significant growth in the past and, depending on the extent of its future growth, may experience significant strain on its management, personnel and information systems. To accommodate this growth, the Company intends, subject to the availability of adequate financing, to continue to implement and improve operational, financial and management information systems. Since implementing its ICP strategy, the Company has expanded its staff to include three additional senior executives and 82 additional employees. The Company is also expanding its information systems to provide improved recordkeeping for customer information and management of uncollectible accounts and fraud control. Historically, the Company's network service revenues have consisted of commissions earned as an agent of Bell Atlantic and other RBOCs and since 1994, revenues from the resale of long distance, frame relay, Internet access and other communications services. For the fiscal year ended March 31, 1998, agency commissions accounted for approximately 60% of network service revenues with resale revenues accounting for 40% of such revenues. As a result of the transition to an ICP strategy in December 1997, agency commissions earned in the future will not be material. 13 RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED DECEMBER 31, 1998 AS COMPARED TO THE THREE AND NINE MONTHS ENDED DECEMBER 31, 1997. The results for the quarter ended December 31, 1998 reflect the Company's operations as an Integrated Communications Provider ("ICP"). In its capacity as an independent agent for the Regional Bell Operating Companies (RBOCs), the Company recorded revenues which represented the fees and commissions earned by the Company for sales of products and services to business customers. As an ICP, the Company purchases local services from the RBOCs at a discount to the retail rate, and resells and bills these services to business customers. The Company also resells other services including long distance, Internet access, and various data services in order to provide a total integrated telecommunications solution to its customers on a single integrated bill. The Company will continue reselling telecommunications services until the deployment of its Integrated Communications Network ("ICN"), at which point the Company will begin migrating customers onto its own network. Total revenues for the third fiscal quarter were $19,025,000, as compared to $11,156,000 for the same period of the preceding Fiscal year, or an increase of 71%. Total revenues for the nine months ended December 31, 1998 were $46,376,000, as compared to $34,660,000, or an increase of 34%. The December quarter revenues also represented an increase of 31% over the September 1998 quarter revenues of $14,516,000. Revenues for local, Internet access and data services increased a combined 55% on a sequential quarter basis due primarily to the addition of new customer relationships. A common basis for measurement of an ICP's progress is the growth in access line equivalents ("ALEs"). During the quarter ended December 31, 1998, the Company provisioned 38,878 net access line equivalents, bringing the total lines in service to 103,272 for the Company's first year as an ICP. Net lines provisioned during the quarter ended December 31, 1998 represented a 61% sequential increase over net lines provisioned during the quarter ended September 30, 1998. The Company experienced the strongest growth in data ALEs with an approximately 67% sequential increase from the quarter ended September 1998, which brings data ALEs in service to 19,638, or 19% of total ALEs as of December 31, 1998. Costs of telecommunications revenues for the quarter ended December 31, 1998 were $16,429,000, as compared to $2,940,000 for the same period of the preceding Fiscal year. For the nine months ended December 31, 1998, costs of telecommunications revenues were $40,426,000, as compared to $8,095,000 for the same period of the preceding Fiscal year. Since substantially all revenues since January 1, 1998 have resulted from operations as ICP, comparative numbers on a year to year basis are not relevant. As a percentage of telecommunications revenues, cost of telecommunications revenues was 86% for the quarter ended December 1998, as compared to 85% for the quarter ended September 1998. The decrease in gross margin is due primarily to the Company's non-resale revenue declining as a percentage of total revenue. Excluding the effects of the non-resale revenue, the gross margin due to resale revenue remained unchanged from the quarter ended September 1999. For the quarter ended December 31, 1998, selling, general and administrative expenses (SG & A) increased 94% to $14,303,000 from $7,381,000 for the same period of the preceding fiscal year. For the nine months ended December 31, 1998, SG & A expenses were $36,800,000, as 14 compared to $21,370,000, or an increase of 72%. These increases were due to the opening of additional branch sales offices during the nine months ended December 31, 1998 and the associated increased number of sales and service employees hired in connection with the transition to the ICP platform. As of December 31, 1998, the Company employed 389 people including 172 Account Executives and 95 Network Coordinators in 25 branch locations throughout New England and New York. In addition, SG & A expenses increased due to operating expenses associated with the network build out, as well as an additional $1,400,000 of increased depreciation expense in the third fiscal quarter and an additional $2,600,000 of depreciation expense year-to-date associated with the investments in the Integrated Communications Network. The final component of the increase is related to legal and regulatory activities. Legal expenses in prosecuting both the anti-trust action against Bell Atlantic now pending in the federal courts and the state regulatory proceedings instituted in each of the New England States against Bell Atlantic for discriminatory practices regarding the Bell Atlantic policy of imposing contract termination fees on its customers as well as the regulatory expenses incurred in obtaining certification as a reseller in additional states, were $813,000 and $3,444,000 respectively, for the three and nine months ended December 31, 1998. Interest and other expense increased to $1,200,000 and $2,400,000, respectively, for the three and nine months ended December 31, 1998. The increase is due to increased borrowings to fund the Company's losses and the investment in the Integrated Communications Network, the fees associated with the Company's credit facility and vendor financing facility, and the amortization of the interest expense associated with the warrants issued to the Company's lenders under the credit facility. The benefit for income taxes has been booked ratably as a percentage of the Company's estimated pre-tax loss over each of the four quarters of the fiscal year. The effective rate of the benefit may vary with changes in management's estimates. As a result of the above factors, the net loss was $11,997,000 and $30,912,000, respectively, for the three and nine months ended December 31, 1998. Liquidity and Capital Resources Working capital at December 31, 1998 amounted to $5,156,000 as compared to $11,342,000 at March 31, 1998, a decrease of 55%, due to an increase in accounts payable resulting from approximately $8,000,000 of fixed assets purchased during the quarter that were not yet funded under the Company's Vendor Financing Facility. These assets were funded during the fourth quarter of fiscal 1999, thereby reducing accounts payable and increasing notes payable by $8,000,000. This was partially offset by a reclassification of deferred income taxes of $1,834,000 from non-current assets to current assets to more accurately reflect its present status. Cash balances at December 31, 1998 and March 31, 1998 totaled approximately $2,597,000 and $2,167,000, respectively. 15 Historically, the Company funded its working capital and operating expenditures primarily from cash flow from operations. As a result of Bell Atlantic's failure to pay approximately $14 million in agency commissions (currently approximately $11.5 million) that the Company believes it is owed under its agency contract (the "Bell Atlantic Receivable"), the losses incurred following transition to an ICP strategy, and the investment required to implement the Integrated Communications Network, the Company has been required to raise additional capital. Although the Company has sued Bell Atlantic and believes the collection of the agency commissions is probable, there is no assurance that the Company will be successful in its collection efforts or that such collections will not be delayed. If the Company fails to collect any of the agency commissions or if their collection becomes less than probable, the Company would be required to write off the uncollected amounts reflected in its financial statements or amounts for which collection becomes less than probable. Delay in the collection or write-off of agency commissions may adversely affect the Company. In April 1998, the Company completed a $12 million private placement of Series A Convertible Preferred Stock and Warrants to Spectrum. Also, on June 30, 1998 the Company received a commitment from Spectrum (the "Spectrum Commitment") to purchase, at the Company's option, an additional $5 million of preferred stock on the same terms and conditions as the Series A Convertible Preferred Stock, which option extends until June 30, 1999. On September 1, 1998, the Company entered into the Loan and Security Agreement (the "Credit Facility") with Goldman Sachs Credit Partners L.P. ("GSCP") and Fleet National Bank ("Fleet") (GSCP and Fleet are together, the "Lenders"). Under the terms of the Credit Facility, the Lenders have provided a three-year senior secured credit facility to the Company consisting of revolving loans in the aggregate amount of up to $75 million. Advances under the facility bear interest at 1.75% over the prime rate and are secured by a first priority perfected security interest on all of the Company's assets, provided, however, that the Company has the ability to exclude assets acquired through purchase money financing. In addition, the Company is required to pay a commitment fee of 0.5% per annum on any unused amounts under the facility as well as a monthly line fee of $150,000 per month. The Company may borrow $15 million unconditionally and an additional $60 million based on trailing 120 days accounts receivable collections (reducing to the trailing 90 days of collections by March 31, 2000). The Company paid a one-time up front fee of $2,531,250, representing 3 3/8% of the facility. In the event that the Company wishes to prepay the loan, the agreement provides for a prepayment penalty of 2.0% during the first 18 months of the term of the loan. Warrants to purchase an aggregate of 974,412 shares of the Company's common stock at a purchase price of $6.75 per share were issued to the Lenders in connection with the transaction. The Company has valued the warrants at $1.3 million which is being amortized and included in interest expense over the three-year term of the Credit Facility. . As of February 16, 1999, the Company had availability under the Credit Facility of $42.4 million and had borrowed approximately $35 million as of that date. In connection with the receipt of the commitment from Toronto Dominion (Texas), Inc. ("TD") (described below), the Company expects that the Lenders will agree to amend certain covenants under the Credit Facility (the "Credit Facility Amendment"). The closing of the Credit Facility Amendment would be subject to various conditions, including the execution of a satisfactory intercreditor agreement with TD (as defined below). 16 On October 14, 1998, the Company entered into an agreement (the "Vendor Facility" and, together with the Credit Facility, the "Senior Facilities") with Cisco System Capital Corporation ("Cisco Capital") for up to $25 million of vendor financing. Under the terms of the agreement, the Company has agreed to a three year, $25 million volume purchase commitment of Cisco equipment and services and Cisco Capital has agreed to advance funds as these purchases occur. In addition, a portion of the Vendor Facility can be utilized for working capital costs associated with the integration and operation of Cisco solutions and related peripherals. Under the terms of the Vendor Facility, the Company is required to pay interest on funds advanced under the facility at an annual rate of 12.5%. In addition to other amounts, the Company is required to pay a commitment fee of .50% per annum on any unused amounts under the facility. The Company paid a closing fee of 1% of the total Vendor Facility. As of February 16, 1999, the Company had borrowed $11.5 million under the Vendor Facility. Pursuant to the terms of the Senior Facilities, the Company obtained an Intercreditor Agreement dated as of September 1, 1998 between Fleet, as Agent, Cisco Capital and Cisco Systems, Inc. Under the Intercreditor Agreement, the Company has agreed to give Cisco Capital a senior security interest in all products provided to the Company by Cisco and other products purchased with the proceeds of the first $15 million advanced under the facility and a subordinate security interest in all other assets of the Company. The Company expects to utilize the proceeds of the Vendor Facility to deploy the first phase of its data-centric ICN in 22 network hub and node sites within the New York and New England regions. Since September 30, 1998, the Company has entered into various lease and vendor financing agreements which provide for the acquisition of up to $16.2 million of equipment and software. In order to ensure that the Company has sufficient liquidity even in the event the Bell Atlantic Receivable is not collected or collection is unduly delayed, on February 12, 1999, the Company obtained a commitment (the "TD Commitment") from Toronto Dominion (Texas), Inc. ("TD") to provide an unsecured standby credit facility for up to $30 million for capital expenditures and other general corporate purposes (the "TD Facility"). The closing of the TD Facility and subsequent draws under the facility are subject to customary conditions, including the execution of definitive documentation, receipt of the Credit Facility Amendment, and execution of a satisfactory intercreditor agreement with the lenders under the Senior Facilities. Under the terms of the TD Commitment, $10 million would be immediately available and the remaining $20 million would become available if the Company raises an additional $5 million in proceeds from the issuance of common or preferred equity (which could be satisfied by calling the Spectrum Commitment), which equity requirement would be reduced by any proceeds received as a result of the Company's litigation with Bell Atlantic in excess of $10 million. The Company will be required to pay certain commitment fees on closing of the TD Facility with additional commitment fees payable if the TD Facility is still outstanding on the dates six months, nine months and one year after the closing. In addition, the Company would be required to pay a quarterly availability fee on unfunded amounts as well as a funding fee for any draws. Draws under the TD Facility would initially bear interest at 7.00% over the three-month US 17 Dollar deposit LIBOR rate and would increase quarterly thereafter. The TD Facility matures 15 months after the closing. Under the terms of the TD Commitment, the Company would be required to repay draws with the proceeds from subsequent issuances of equity or debt securities or from subsequent bank financings. Over the next three years the Company has outstanding commitments ggregating $11.6 million to Level 3 Communications, LLC and NorthEast Optic Network, Inc. for the leasing of transmission and co-location facilities for its ICN pursuant to agreements entered into by the Company in January 1999. Over the next 12 months, the Company intends to (i) further exploit its existing markets, (ii) deploy the ICN in its existing markets, and (iii) enhance the CTC Information System. Over the next three years, subject to the availability of financing, the Company intends to further expand within its existing markets and into six additional states in the New York- Washington, D.C. corridor and continue the deployment of its ICN. The Company believes that the net proceeds of the anticipated TD Facility and the Spectrum Commitment, together with cash on hand and the anticipated availability under the Senior Facilities will be sufficient to fund the Company's capital expenditures, operating losses and working capital requirements for its existing markets for approximately the next 12 months even in the event the Company is unsuccessful or delayed in collecting the Bell Atlantic Receivable. The Company expects to seek additional long-term financing to refinance the anticipated TD Facility and further fund its business plan within the next 3-6 months, capital markets permitting. After the Company has raised sufficient long-term financing to further fund its business plan, the Company expects to repay and terminate the TD Facility. The availability of additional borrowings under the Credit Facility is based on prior receivable collections and subject to complying with the various covenants of such facility. There can be no assurance that additional amounts will be available to the Company when needed or at all. The Company will require substantial additional funding to continue its penetration of, and deployment of its ICN in, its existing markets and to implement the Company's planned geographic expansion of its sales presence and ICN infrastructure into the New York-Washington D.C. corridor. The Company's actual capital requirements may be materially affected by various factors, including the timing and actual cost of implementing the Company's ICN, the timing and costs of expansion into new markets, the extent of competition and pricing of telecommunications services in its markets, acceptance of the Company's services, technological change and potential acquisitions. Partly as a result of (i) Bell Atlantic rescinding its policy permitting assignment of existing contracts to CLECs like the Company (including the negative affect on the borrowing base under the Credit Facility which has resulted from delays in deriving revenue from previous agency customers - See Note 2b, "State Regulatory Proceedings"), (ii) the continuing delay in collecting the Bell Atlantic Receivable and (iii) greater than anticipated capital expenditures, if the TD Facility is not consummated and the Bell Atlantic Receivable is not collected, the Company will need to obtain additional financing, beyond the proceeds of the Spectrum Commitment, in the first or second fiscal quarter of fiscal year 2000. If the Company does not enter into the Credit Facility Amendment, the Company may not remain in compliance with certain operational covenants under the Credit 18 Facility, depending upon, among other factors, the Company's success in deriving revenue from its former agency customers. Sources of funding may include public offerings or private placements of equity or debt securities, vendor financing, equipment lease financing and bank loans. There can be no assurance that additional financing will be available to the Company or, if available, that it can be obtained on a timely basis and on terms acceptable to the Company and within the limitations contained in the Senior Facilities and agreements governing other debt issued by the Company from time to time. Failure to obtain financing when needed would result in the delay or abandonment of the Company's development and expansion plans which would in turn have a material adverse effect on the Company. YEAR 2000 COMPLIANCE Currently, many computer systems and software products are coded to accept only two digit, rather than four digit, entries in the date code field. Date-sensitive software or hardware coded in this manner may not be able to distinguish a year that begins with a "20" instead of a "19," and programs that perform arithmetic operations, make comparisons or sort date fields may not yield correct results with the input of a Year 2000 date. This Year 2000 problem could cause miscalculations or system failures that would affect the Company's operations. The Company's State of Readiness The Company has evaluated the effect of the Year 2000 problem on its information systems and is implementing plans to ensure its systems and applications will effectively process information necessary to support ongoing operations of the Company in the year 2000 and beyond. The Company believes its information technology ("IT") and non-IT systems will be Year 2000 compliant by the end of 1999. In connection with the deployment of the Company's new Integrated Communications Network ("ICN"), the Company has designed a new database architecture for its computer systems which will comply with "Year 2000" requirements. Installation of the ICN and related software is expected to be completed in June 1999 and testing of the system, including its Year 2000 compliance, is expected to commence in May 1999. While the Company expects that all significant IT-related systems will be Year 2000 compliant by mid-1999, there can be no assurance that all Year 2000 problems in the new system will be identified or that the necessary corrective actions will be completed in a timely manner. The Company has requested certification from its significant vendors and suppliers demonstrating their Year 2000 compliance. To date, approximately 60% of vendors and suppliers have delivered such certifications and the Company anticipates that it will receive the additional certifications requested. The Company intends to continuously identify critical vendors and suppliers and communicate with them about their plans and progress in addressing Year 2000 problems. There can be no assurance that the systems of these vendors and suppliers will be timely converted or that the failure to so comply will not have an adverse effect on the Company's operations. 19 The Company's Costs of Year 2000 Remediation The Company has not incurred material costs related specifically to Year 2000 issues and does not expect to in the future. However, there can be no assurance that the costs associated with Year 2000 problems will not be greater than anticipated. The Company's Year 2000 Risk Based on the efforts described above, the Company currently believes that its systems will be Year 2000 compliant in a timely manner. The Company has completed the process of identifying Year 2000 issues in its IT and non-IT systems and expects to complete any remediation efforts by mid-1999. However, there can be no assurance that all Year 2000 problems will be successfully identified, or that the necessary corrective actions will be completed in a timely manner. Failure to successfully identify and remediate Year 2000 problems in critical systems in a timely manner could have a material adverse effect on the Company's results of operations, financial position or cash flow. In addition, the Company believes that there is risk relating to significant vendors' and suppliers' failure to remediate their Year 2000 issues in a timely manner. Although the Company is communicating with its vendors and suppliers regarding the Year 2000 problem, the Company does not know whether these vendors' or suppliers' systems will be Year 2000 compliant in a timely manner. If one or more significant vendors or suppliers are not Year 2000 compliant, this could have a material adverse effect on the Company's results of operations, financial position or cash flow. The Company's Contingency Plans The Company plans by mid-year 1999 to develop contingency plans to be implemented in the event planned solutions prove ineffective in solving Year 2000 compliance. If it were to become necessary for the Company to implement a contingency plan, it is uncertain whether such plan would succeed in avoiding a Year 2000 issue which may otherwise have a material adverse effect on the Company's results of operations, financial position or cash flow. 20 Part II Item 2. Changes in Securities (c) During the quarter ended December 31, 1998, the Company issued a total of 287,010 shares of Common Stock for an aggregate consideration of $114,149 pursuant to the exercise of stock options by thirteen individuals. The shares were issued in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended, as transactions by an issuer not involving a public offering. The recipients of the securities represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were attached to the shares certificates and stop transfer orders given to the Company's transfer agent. All recipients had adequate access to information regarding the Company. Item 4 - Submission of Matters to a Vote of Security Holders (a) The 1998 Annual Meeting of Stockholders of the Company was held on November 16, 1998. (b) Not applicable. (c) Each nominee for Class I director received the following votes:
Withhold Name For Authority - --------------------------------------------------------------- Henry Hermann 10,542,047 21,957 Ralph C. Sillari 10,543,507 20,497
The following table sets forth the other matters voted upon and the respective number of votes cast for, against, number of abstentions and broker nonvotes.
Matter Votes Votes Delivered Voted Upon For Against Abstentions Non Voted - --------------------------------------------------------------------------------- To approve the 1998 Incentive Plan 7,235,345 145,991 43,835 3,138,833 To approve selection of Ernst & Young as accountants for the Company for the fiscal year ending 3/31/99
10,535,255 11,524 17,225 (d) Not applicable. 21 Item 6 - Exhibits and Reports on Form 8-K (a) The following exhibits are included herein: 27 Financial Data Schedule 99.1 Risk Factors (b) Reports on Form 8-K On October 2, 1998 the Registrant filed a Form 8-K disclosing the existence and terms of the Goldman Sachs Credit Partners, L.P./Fleet National Bank $75 million credit facility. On November 6, 1998, the Registrant filed a Form 8-K disclosing the existence and terms of the Cisco Capital Corp. $25 million vendor financing facility. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf by the undersigned thereunto duly authorized. CTC COMMUNICATIONS CORP. Date: February 16, 1999 /S/ ROBERT J. FABBRICATORE ---------------------------- Robert J. Fabbricatore Chairman and CEO Date: February 16, 1999 /S/ STEVEN C. JONES ----------------------------- Steven C. Jones Executive Vice President, and Chief Financial Officer 23 EX-27 2 FDS FOR Q.E. 12/31/98
5 1,000 9-MOS MAR-31-1999 DEC-31-1998 2,597 0 27,335 872 0 37,899 35,639 10,198 67,529 32,743 0 0 12,562 103 18,302 67,529 19,025 19,040 16,429 30,733 0 0 1,208 (12,900) (903) (11,997) 0 0 0 (11,997) (1.20) (1.20)
EX-99.1 3 RISK FACTORS Exhibit 99.1 Limited History as an ICP; Risks Relating to Implementation of New Strategy Although the Company has sold integrated telecommunications services for over 15 years, it sold local telephone services as an agent for Bell Atlantic Corp. ("Bell Atlantic") until December 1997 and only began offering such services as an integrated communications provider ("ICP") under its own brand name after that time. Accordingly, stockholders have limited historical financial and operating information under the Company's current business strategy upon which to base an evaluation of the Company's performance. As a result of the Company terminating its agency relationship with Bell Atlantic, agency revenues are no longer material. There can be no assurance that the Company's prior experience in the sale of telecommunications services as a sales agent will result in the Company generating sufficient cash flow to service its debt obligations or to compete successfully under its new strategy. The Company plans to deploy its own Integrated Communications Network. The Company has had no experience in deploying, operating and maintaining a telecommunications network. The Company's ability to successfully deploy its ICN will require the negotiation of interconnection agreements with incumbent local exchange carriers ("ILECs"), which can take considerable time, effort and expense and which are subject to federal, state and local regulation. There can be no assurance that the Company will be able to successfully negotiate such agreements or to effectively deploy, operate or maintain its facilities or increase or maintain its cash flow from operations by deploying a network. Further, there can be no assurance that the packet-switched design of the network will provide the expected functionality in serving its target market or that customers will be willing to migrate the provision of their services onto the Company's network. The Company has engaged a network services integrator to design, engineer and manage the buildout of the ICN in the Company's existing markets. Any failure or inability by the network integrator to perform these functions could cause delays or additional costs in providing services to customers and building out the Company's ICN in specific markets. Any such failure could materially and adversely affect the Company's business and results of operations. The Company is purchasing most of its network components from Cisco Systems, Inc. ("Cisco"), the failure of such equipment to operate as anticipated or the inability of Cisco to timely supply such equipment could materially and adversely affect the Company's business and results of operations. If the Company fails to effectively transition to an ICP platform, fails to obtain or retain a significant number of customers or is unable to effectively deploy, operate or maintain its network, such failure could have an adverse effect on the Company's business, results of operations and financial condition. In addition, the implementation of its new strategy and the deployment of its network has increased and will continue to increase the Company's expenses significantly. Accordingly, the Company expects to incur significant negative cash flow during the next several years as it implements its business strategy, penetrates its existing markets as an ICP, enters new markets, deploys its ICN and expands its service offerings. There can be no assurance that the Company will achieve and sustain profitability or positive net cash flow. High Leverage; Possible Inability to Service Indebtedness The Company is highly leveraged and expects to seek to fund its business plan with additional debt financing, including equipment leasing, which will further increase the Company's leverage. The degree to which the Company is leveraged could have important consequences to the Company's future prospects, including the following: (i) limiting the ability of the Company to obtain any necessary financing in the future for working capital, capital expenditures, debt service requirements or other purposes; (ii) limiting the flexibility of the Company in planning for, or reacting to, changes in its business; (iii) leveraging the Company more highly than some of its competitors, which may place it at a competitive disadvantage; (iv) increasing its vulnerability in the event of a downturn in its business or the economy generally; and (v) requiring that a substantial portion of the Company's cash flow from operations be dedicated to the payment of principal and interest on its debt and not be available for other purposes. The Company's ability to make scheduled lease payments and payments of principal of, or to pay the interest on, or to refinance, its indebtedness, or to fund planned capital expenditures will depend on its future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond its control. There can be no assurance that the Company's business will generate sufficient cash flow from operations or that anticipated revenue growth and operating improvements will be realized or will be sufficient to enable the Company to service its indebtedness, or to fund its other liquidity needs. There can be no assurance that the Company will be able to refinance all or a portion of its indebtedness on commercially reasonable terms or at all. If the Company does not generate sufficient cash flow to meet its debt service and working capital requirements, the Company may need to examine alternative strategies that may include actions such as reducing or delaying capital expenditures, restructuring or refinancing its indebtedness, the sale of assets or seeking additional equity and/or debt financing. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. Additional Capital Requirements; Uncertainty of Additional Financing Over the next 12 months, the Company intends to (i) further expand its existing markets, (ii) deploy the ICN in its existing markets, and (iii) enhance the CTC Information System. Also, over the next three years, the Company intends to further expand within its existing markets and into six additional states in the New York-Washington, D.C. corridor and continue the deployment of its ICN. The Company believes that the net proceeds of the anticipated TD Facility and the Spectrum Commitment, together with cash on hand and the anticipated availability under the Senior Facilities will be sufficient to fund the Company's capital expenditures, operating losses and working capital requirements for its existing markets for approximately the next 12 months even in the event the Company is unsuccessful or delayed in collecting the Bell Atlantic Receivable. The Company expects to seek additional long-term financing to refinance the anticipated TD Facility and further fund its business plan within the next 3-6 months, capital markets permitting. After the Company has raised sufficient long-term financing to further fund its business plan, the Company expects to repay and terminate the TD Facility. The availability of additional borrowings under the Credit Facility is based on prior receivable collections and subject to complying with the various covenants of such facility. There can be no assurance that additional amounts will be available to the Company when needed or at all. The Company will require substantial additional funding to continue its penetration of, and deployment of its ICN in, its existing markets and to implement the Company's planned geographic expansion of its sales presence and ICN infrastructure into the New York-Washington D.C. corridor. The Company's actual capital requirements may be materially affected by various factors, including the timing and actual cost of implementing the Company's ICN, the timing and costs of expansion into new markets, the extent of competition and pricing of telecommunications services in its markets, acceptance of the Company's services, technological change and potential acquisitions. Partly as a result of (i) Bell Atlantic rescinding its policy permitting assignment of existing contracts to CLECs like the Company (including the negative affect on the borrowing base under the Credit Facility which has resulted from delays in deriving revenue from previous agency customers - See Note 2b, "State Regulatory Proceedings"), (ii) the continuing delay in collecting the Bell Atlantic Receivable and (iii) greater than anticipated capital expenditures, if the facility with Toronto Dominion (Texas), Inc. is not consummated and the Bell Atlantic Receivable is not collected, the Company will need to obtain additional financing, beyond the proceeds of the Spectrum Commitment, in the first or second fiscal quarter of fiscal year 2000. If the Company does not enter into the Credit Facility Amendment, the Company may not remain in compliance with certain operational covenants under the Credit Facility, depending upon, among other things, the Company's success in deriving revenue from its former agency customers. Sources of funding may include public offerings or private placements of equity or debt securities, vendor financing, equipment lease financing and bank loans. There can be no assurance that additional financing will be available to the Company or, if available, that it can be obtained on a timely basis and on terms acceptable to the Company and within the limitations contained in the Senior Facilities and agreements governing other debt issued by the Company from time to time. Failure to obtain financing when needed would result in the delay or abandonment of the Company's development and expansion plans which would in turn have a material adverse effect on the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Dependence on In-House Billing and Information System The accurate and prompt billing of the Company's customers is essential to the Company's operations and future profitability. The Company's expected growth and deployment of its ICN could give rise to additional demands on the CTC Information System, and there can be no assurance that it will perform as expected. The failure of the Company to adequately identify all of its information and processing needs (including Year 2000 compliance), the failure of the CTC Information System or the failure of the Company to upgrade the CTC Information System as necessary could have a material adverse effect on the Company and its results of operations. Dependence on Supplier Provided Timely and Accurate Call Data Records; Billing and Invoice Disputes In its current business, the Company is dependent upon the timely receipt and accuracy of call data records provided to it by its suppliers. There can be no assurance that accurate information will consistently be provided by suppliers or that such information will be provided on a timely basis. Failure by suppliers to provide timely and accurate detail would increase the length of the Company's billing and collection cycles and adversely affect its operating results. The Company pays its suppliers according to the Company's calculation of the charges applicable to the Company based on supplier invoices and computer tape records of all such calls provided by suppliers which may not always reflect current rates and volumes. Accordingly, a supplier may consider the Company to be in arrears in its payments until the amount in dispute is resolved. There can be no assurance that disputes with suppliers will not arise or that such disputes will be resolved in a manner favorable to the Company. In addition, the Company is required to maintain sophisticated billing and reporting systems to service the large volume of services placed over its networks. As resale volumes increase, there can be no assurance that the Company's billing and management systems will be sufficient to provide the Company with accurate and efficient billing and order processing capabilities. Dependence on Network Infrastructure and Products and Services of Others The Company does not currently own any part of a local exchange or long distance network and depends entirely on facilities-based carriers for the transmission of customer traffic. After the deployment of the ICN, it will still rely, at least initially, on others for circuit switching of local voice calls and on fiber optic backbone transmission facilities. There can be no assurance that such switching or transmission facilities will be available to the Company on a timely basis or on terms acceptable to the Company. The Company's success in marketing its services requires that the Company provide superior reliability, capacity and service. Although the Company can exercise direct control of the customer care and support it provides, most of the services that it currently offers are provided by others. Such services are subject to physical damage, power loss, capacity limitations, software defects, breaches of security (by computer virus, break-ins or otherwise) and other factors, certain of which have caused, and will continue to cause, interruptions in service or reduced capacity for the Company's customers. Such problems, although not the result of failures by the Company, can result in dissatisfaction among its customers. In addition, the Company's ability to provide complete telecommunications services to its customers will be dependent to a large extent upon the availability of telecommunications services from others on terms and conditions that are acceptable to the Company and its customers. There can be no assurance that government regulations will continue to mandate the availability of some or all of such services or that the quality or terms on which such services are available will be acceptable to the Company or its customers. Customer Attrition The Company's operating results may be significantly affected by its customer attrition rates. There can be no assurance that customers will continue to purchase local, long distance or other services through the Company in the future or that the Company will not be subject to increased customer attrition rates. The Company believes that the high level of customer attrition in the industry is primarily a result of national advertising campaigns, telemarketing programs and customer incentives provided by major competitors. There can be no assurance that customer attrition rates will not increase in the future, which could have a material adverse effect on the Company's operating results. Ability to Manage Growth; Rapid Expansion of Operations The Company is pursuing a new business plan that, if successfully implemented, will result in rapid growth and expansion of its operations, which will place significant additional demands upon the Company's current management. If this growth is achieved, the Company's success will depend, in part, on its ability to manage this growth and enhance its information, management, operational and financial systems. There can be no assurance that the Company will be able to manage any growth of its operations. The Company's failure to manage growth effectively could have a material adverse effect on the Company's business, operating results and financial condition. Potential Impact of the Lawsuit Against Bell Atlantic In December 1997, the Company filed suit against Bell Atlantic for breaches of its agency contract, including the failure of Bell Atlantic's retail division to pay $14 million in agency commissions (approximately $11.5 million as of January 15, 1999) owed to the Company. The Company is vigorously pursuing this suit. Although the Company believes the collection of the agency commissions sought in the suit is probable, there can be no assurance that the Company will be successful in collecting these commissions. If the Company fails to collect any of the amounts sought or if their collection becomes less than probable, the Company would be required to write off the amounts reflected in its financial statements that it is unable to collect or for which collection becomes less than probable. Delay in the collection or write-off of the agency commissions sought may also adversely affect the Company. Also, Bell Atlantic has recently rescinded its policy in the New England states of permitting resellers, including the Company, to assume the service contracts of retail customers under contract to Bell Atlantic. The failure of the Company's efforts to cause Bell Atlantic to cease and desist from refusing to permit the assignment of existing contracts and to continue its longstanding practice of allowing resellers to assume these customer agreements, without penalty, on a resold basis could have a material adverse effects on the Company's operating results. In addition, the Company must use Bell Atlantic infrastructure for nearly all of the local telephony services that it currently provides and, although Bell Atlantic is prohibited by federal law from discriminating against the Company, there can be no assurance that the litigation with Bell Atlantic will not negatively affect the Company's relationships with Bell Atlantic's wholesale division. Dependence on Key Personnel The Company believes that its continued success will depend to a significant extent upon the abilities and continued efforts of its management, particularly members of its senior management team. The loss of the services of any of such individuals could have a material adverse effect on the Company's results of operations. The success of the Company will also depend, in part, upon the Company's ability to identify, hire and retain additional key management as well as highly skilled and qualified sales, service and technical personnel. Competition for qualified personnel in the telecommunications industry is intense, and there can be no assurance that the Company will be able to attract and retain additional employees and retain its current key employees. The inability to hire and retain such personnel could have a material adverse effect on the Company's business. Competition The Company operates in a highly competitive environment and has no significant market share in any market in which it operates. The Company expects that it will face substantial and growing competition from a variety of data transport, data networking and telephony service providers due to regulatory changes, including the continued implementation of the Telecommunications Act of 1996 (the "Telecommunications Act"), and the increase in the size, resources and number of such participants as well as a continuing trend toward business combinations and alliances in the industry. The Company faces competition for the provision of integrated telecommunications services as well as competition in each of the individual market segments that comprise the Company's integrated approach. In each of these market segments, the Company faces competition from larger, better capitalized incumbent providers, which have long standing relationships with their customers and greater name recognition than the Company. Regulation The Company's local and long distance telephony service, and to a lesser extent its data services, are subject to federal, state, and, to some extent, local regulation. The Federal Communications Commission (the "FCC") exercises jurisdiction over all telecommunications common carriers, including the Company, to the extent that they provide interstate or international communications. Each state regulatory commission retains jurisdiction over the same carriers with respect to the provision of intrastate communications. Local governments sometimes impose franchise or licensing requirements on telecommunications carriers and regulate construction activities involving public right-of-way. Changes to the regulations imposed by any of these regulators could adversely affect the Company. While the Company believes that the current trend toward relaxed regulatory oversight and competition will benefit the Company, the Company cannot predict the manner in which all aspects of the Telecommunications Act will be implemented by the FCC and by state regulators or the impact that such regulation will have on its business. The Company is subject to FCC and state proceedings, rulemakings, and regulations, and judicial appeal of such proceedings, rulemaking and regulations, which address, among other things, access charges, fees for universal service contributions, ILEC resale obligations, wholesale rates, and prices and terms of interconnection and unbundling. The outcome of these rulemakings, judicial appeals, and subsequent FCC or state actions may make it more difficult or expensive for the Company or its competitors to do business. Such developments could have a material effect on the Company. The Company also cannot predict whether other regulatory decisions and changes will enhance or lessen the competitiveness of the Company relative to other providers of the products and services offered by the Company. In addition, the Company cannot predict what other costs or requirements might be imposed on the Company by state or local governmental authorities and whether or not any additional costs or requirements will have a material adverse effect on the Company. Risks Associated With Possible Acquisitions As it expands, the Company may pursue strategic acquisitions. Acquisitions commonly involve certain risks, including, among others: difficulties in assimilating the acquired operations and personnel; potential disruption of the Company's ongoing business and diversion of resources and management time; possible inability of management to maintain uniform standards, controls, procedures and policies; entering markets or businesses in which the Company has little or no direct prior experience; and potential impairment of relationships with employees or customers as a result of changes in management. There can be no assurance that any acquisition will be made, that the Company will be able to obtain any additional financing needed to finance such acquisitions and, if any acquisitions are so made, that the acquired business will be successfully integrated into the Company's operations or that the acquired business will perform as expected. The Company has no definitive agreement with respect to any acquisition, although from time to time it has discussions with other companies and assesses opportunities on an ongoing basis. Year 2000 Compliance Currently, many computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such "Year 2000" requirements. In connection with the deployment of the Company's new ICN, it has designed new database architecture for its computer systems that comply with the Year 2000 requirements. Installation of the computer system and related software is expected to be completed in June 1999 and testing of the system, including Year 2000 compliance, is expected to take place commencing in May 1999. There can be no assurance that the Company's new computer system will function adequately or that all Year 2000 problems will be identified and corrected in a timely manner. In addition, if the systems of other companies on whose services the Company depends or with whom the Company's systems interface are not year 2000 compliant, there could be a material adverse effect on the Company's business, operating results and financial condition. Control By Principal Shareholders; Voting Agreement As of December 31, 1998, the officers and directors and parties affiliated with or related to such officers and directors controlled approximately 51.4% of the Company's outstanding voting power. Robert J. Fabbricatore, the Chairman and Chief Executive Officer of the Company, beneficially owns approximately 26.5% of the outstanding shares of Common Stock. Consequently, the officers and directors will have the ability to exert significant influence over the election of all the members of the Company's Board, and the outcome of all corporate actions requiring stockholder approval. In addition, Mr. Fabbricatore has agreed to vote the shares beneficially owned by him in favor of the election to the Company's Board of Directors of up to two persons designated by the holders of a majority of the Series A Convertible Preferred Stock. Impact Of Technological Change The telecommunications industry has been characterized by rapid technological change, frequent new service introductions and evolving industry standards. The Company believes that its long-term success will increasingly depend on its ability to offer integrated telecommunications services that exploit advanced technologies and anticipate or adapt to evolving industry standards. There can be no assurance that (i) the Company will be able to offer new services required by its customers, (ii) the Company's services will not be economically or technically outmoded by current or future competitive technologies, (iii) the Company will have sufficient resources to develop or acquire new technologies or introduce new services capable of competing with future technologies or service offerings (iv) all or part of the ICN or the CTC Information System will not be rendered obsolete, (v) the cost of the ICN will decline as rapidly as that of competitive alternatives, or (vi) lower retail rates for telecommunications services will not result from technological change. In addition, increases in technological capabilities or efficiencies could create an incentive for more entities to become facilities-based ICPs. Although the effect of technological change on the future business of the Company cannot be predicted, it could have a material adverse effect on the Company's business, results of operations and financial condition. Possible Volatility Of Stock Price The stock market historically has experienced volatility which has affected the market price of securities of many companies and which has sometimes been unrelated to the operating performance of such companies. In addition, factors such as announcements of developments related to the Company's business, or that of its competitors, its industry group or its customers, fluctuations in the Company's results of operations, a shortfall in results of operations compared to analysts' expectations and changes in analysts' recommendations or projections, sales of substantial amounts of securities of the Company into the marketplace, regulatory developments affecting the telecommunications industry or data services or general conditions in the telecommunications industry or the worldwide economy, could cause the market price of the Common Stock to fluctuate substantially. Absence Of Dividends The Company has not paid and does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. The Company intends to retain its earnings, if any, for use in the Company's growth and ongoing operations. In addition, the Goldman Sachs/Fleet Loan and Security Agreement provides that without the Lenders' prior written consent, the Company may not make any distribution or declare any dividends in cash or property other than stock during the three-year term of the Loan and Security Agreement. In addition, the terms of the Series A Convertible Preferred Stock restrict, and the terms of future debt financings are expected to restrict, the ability of the Company to pay dividends on the Common Stock. Potential Effect Of Anti-takeover Provisions And Issuances Of Preferred Stock Certain provisions of the Company's Articles of Organization and Bylaws and the Massachusetts Business Corporation Law may have the effect of delaying, deterring or preventing a change in control of the Company or preventing the removal of incumbent directors. The existence of these provisions may have a negative impact on the price of the Common Stock and may discourage third party bidders from making a bid for the Company or may reduce any premiums paid to stockholders for their Common Stock. In addition, the Company's Board of Directors has the authority without action by the Company's stockholders to issue shares of the Company's Preferred Stock and to fix the rights, privileges and preferences of such stock, which may have the effect of delaying, deterring or preventing a change in control. Certain provisions of the Company's outstanding Series A Convertible Preferred Stock which provide for payment of the liquidation preference in cash upon the consummation of certain transactions may have the effect of discouraging third parties from entering into such transactions. -----END PRIVACY-ENHANCED MESSAGE-----