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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark one)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- ---- EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal year ended JANUARY 31, 2001
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- ---- EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
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Commission File Number 0-2180
COVISTA COMMUNICATIONS, INC.
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(Exact name of Registrant as specified in its charter)
NEW JERSEY 22-1656895
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
150 CLOVE ROAD, LITTLE FALLS, NEW JERSEY 07424
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(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (973) 812-1100
Securities registered pursuant to Section 12 (b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.05 par value per share
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 III of this Form 10-K or any amendment to this
Form 10-K [ ]
Aggregate market value (based upon a $3.00 closing price) of the voting stock
held by nonaffiliates of the Registrant as of April 25, 2001: $7,904,604
Number of shares of Common Stock outstanding on April 25, 2001: 11,769,405
Documents Incorporated By Reference:
None
PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS:
Certain matters discussed in this Annual Report on Form 10-K are
"forward-looking statements" intended to qualify for the safe harbor from
liability provided by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Registrant "believes",
"anticipates", "expects", or words of similar import. Similarly, statements
which describe the Registrant's future plans, objectives or goals are also
forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties which are described in close proximity to such
statements and which could cause actual results to differ materially from those
anticipated as of the date of this Report. Shareholders, potential investors and
other readers are urged to consider these factors in evaluating the
forward-looking statements and are cautioned not to place undue reliance on such
forward-looking statements. The forward-looking statements included herein are
only made as of the date of this Report and the Registrant undertakes no
obligation to publicly update such forward-looking statements to reflect
subsequent events or circumstances.
ITEM 1. Business
GENERAL
Covista Communications, Inc. ("Covista", the "Registrant" or the
"Company") is a leading regional facilities-based long distance
telecommunications and internet service provider servicing both the commercial
and wholesale marketplace. The Registrant's retail segment operates principally
in the Northeast, primarily servicing small and medium-sized businesses. The
Registrant's products and services include a broad range of voice, data and
Internet solutions. The wholesale division provides domestic and international
termination services to carriers worldwide at competitive rates. The Registrant
currently owns and operates two long distance switches, in New York City and
Newark, New Jersey. In addition, the Registrant currently owns and operates two
carrier grade routers, a remote access server and an e-mail server located in
New York City and Northern New Jersey for its internet service offerings.
Covista has a Network Operations Center ("NOC") in Northern New Jersey, to
monitor and control its New Jersey network and to coordinate its various
services.
Covista processes approximately 90% of all its call volume through its
own facilities. The Registrant uses proven technology to provide customized
telecommunications solutions to its customers.
In the retail market, the Registrant has segmented potential customers
and tailored its service offerings, sales, marketing approach and network
development to provide service in a cost-effective manner. The Registrant
believes its customer service to be one of its principal competitive advantages.
The Registrant applies a dedicated team approach to soliciting and servicing its
clients, with substantial involvement of sales, customer service and technical
personnel in all aspects of customer relations. The Registrant intends to
continue to focus its efforts on small to medium-sized customers with sales of
$1 million to $60 million and monthly communications bills that range from $500
to $30,000. The Registrant's focus on customer service has also enabled it to
attract larger customers.
For Fiscal 2001, Covista had gross revenues of approximately $134
million, derived approximately 60% from wholesale and 40% from commercial
services. For Fiscal 2000, the Registrant's gross revenues were approximately
$140 million. The Registrant's commercial sales activities have been
concentrated in Northern New Jersey and New York City, where, the Registrant
believes, approximately half of all United States multinational corporations
have headquarters. Based on industry sources, this area is believed to represent
40% of the total United States telecommunications market. For the near term, at
least, Covista intends to focus its efforts on further penetrating commercial
users of its services in the Northeast, from the Washington, D.C. market through
Boston, Massachusetts, and to augment the services offered to its customers.
The Registrant's principal executive offices are located at Overlook at
Great Notch, 150 Clove Road, Little Falls, New Jersey 07424, and its telephone
number is (973) 812-1100. The Registrant was incorporated in 1959 as Faradyne
Electronics Corp. In November 1991, the Registrant changed its name from
Faradyne Electronics Corp. to Total-Tel USA Communications, Inc. In September,
2000, the Registrant adopted its present name, Covista Communications, Inc.
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INDUSTRY OVERVIEW
HISTORY AND INDUSTRY DEVELOPMENT
Prior to 1984, AT&T dominated both the local exchange and long distance
marketplaces by owning the operating entities that provided both local exchange
and long distance services to most of the United States population. Although
long distance competition began to emerge in the late 1970s, the critical event
triggering the growth of long distance competition was the breakup of AT&T and
the separation of its local and long distance businesses as mandated by the
Modified Final Judgment (the "MFJ") relating to the breakup of AT&T (the "MFJ").
To foster competition in the long distance market, the MFJ prohibited AT&T's
divested local exchange businesses, the Regional Bell Operating Companies
("RBOCs"), from acting as single-source providers of telecommunications
services.
Although the MFJ established the preconditions for competition in the
market for long distance services in 1984, the market for local exchange
services has, until recently, virtually been closed to competition and has
largely been dominated by regulated monopolies. Efforts to open the local
exchange market began in the late 1980s on a state-by-state basis.
The Telecommunications Act of 1996, (the "1996 Act") is considered to
be the most comprehensive reform of the nation's telecommunications laws and
affects the development of competition for local telecommunications services.
The 1996 Act provides for the removal of legal barriers to entry into the local
telecommunications services market, the interconnection of the Incumbent Local
Exchange Carrier (the "ILEC") network with competitors' networks and the
relaxation of the regulation of certain telecommunications services provided by
Local Exchange Carriers ("LECs") and others. Procedures and requirements were
established to be followed by the RBOCs, including the requirement that RBOCs
offer local services for resale as a precondition to their entering into the
long distance and telecommunications equipment manufacturing markets.
The continuing deregulation of the telecommunications industry and
technological change has resulted in an increasingly information-intensive
business environment. Regulatory, technological, marketing and competitive
trends have substantially expanded the Registrant's opportunities in the
converging voice and data communications services markets. For example,
technological advances, including rapid growth of the Internet, the increased
use of packet switching technology for voice communications, and the growth of
multimedia applications, are expected to result in substantial growth in the
high-speed data services market.
This new market opportunity should permit Competitive Local Exchange
Carriers ("CLECs") with operating and marketing expertise to offer a full range
of telecommunications services, including local and long distance calling,
toll-free calling, custom calling features, data services, and Internet access
and services. Telecommunications companies with an established base of long
distance customers may have an opportunity to sell additional services to such
customers.
The Registrant has observed that RBOCs and the Tier I carriers
(carriers with annual revenues in excess of $5 billion), primarily concentrate
their sales and marketing efforts on residential and large business customers.
Thus, the Registrant believes there is a significant market opportunity with
respect to small and medium-sized businesses to which customer service may be
a significant part of their buying decision.
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NETWORK
The Registrant's strategy has been to develop a geographic
concentration of revenue-producing customers through the sale of
telecommunications services in areas where it has installed switching platforms.
CURRENT NETWORK
Switches. Currently, the Registrant operates an advanced
telecommunications network that includes two Alcatel switches, located in New
York City and Newark, New Jersey. The Registrant has installed Alcatel DEX 600
switches in Newark and a Megahub DEX600E switch in New York, which provides
interexchange switching capabilities and is currently being used as the
Registrant's international gateway switching platform.
During Fiscal 2001, the Registrant billed approximately 1.25 billion
minutes, with approximately 90% of its minutes over its own switches. The
Registrant believes that increasing the traffic carried on its own network would
improve operating margins.
International. The Registrant is interconnected with a number of United
States and foreign wholesale international carriers through its New York switch.
The purpose of connecting to a variety of carriers is to provide
state-of-the-art, lowest-cost routing and network reliability. These
interconnected international carriers are also a source of wholesale
international traffic and revenue.
Internet. Currently, the Registrant owns and operates an IP (Internet
Protocol) Network that includes two Cisco 7500 routers, located in New York
City. The Registrant also owns and operates an Ascend TNT remote access server
(RAS) located in New York. The RAS provides dial-up Internet access services.
Through associations with providers of wholesale Digital Subscriber Lines
("DSL"), the Registrant offers DSL internet service in the Philadelphia, New
York, New Jersey and Connecticut markets. The Registrant also offers internet
services over dedicated DS0, DS1 and DS3 digital transmission circuits.
Other Features. The Registrant is interconnected by SS7 out-of-band
digital signaling throughout its network. The SS7 signaling system reduces
connect time delays, thereby enhancing overall network efficiencies.
Additionally, the SS7 technology is designed to permit the anticipated expansion
of the Registrant's Advanced Intelligent Network ("AIN") capabilities throughout
its network. The Registrant's advanced switching platform would enable it to (i)
deploy features and functions quickly throughout its entire network, (ii) expand
switch capacity in a cost-effective manner, and (iii) lower maintenance costs
through reduced training and spare parts requirements.
Security and Reliability. The Registrant has a NOC in Northern New
Jersey, which monitors and controls the Registrant's network and coordinates its
various services from a central location, increasing the security, reliability
and efficiency of the Registrant's operations. Centralized electronic monitoring
and control of the Registrant's network allows the Registrant to avoid
duplication of this function in each switch site. The NOC also helps reduce the
Registrant's per-customer monitoring and customer service costs. In addition,
the Registrant's network employs an "authorized access" architecture. Unlike
many telecommunications companies, which allow universal access to their
network, the Registrant utilizes an automatic number identification security
screening architecture which ensures only the Automatic Number Identification
(ANIs) of those users who have subscribed to the Registrant's services and have
satisfied the Registrant's credit and provisioning criteria have access to the
network. The Registrant believes that this architecture provides the Registrant
the ability to better control bad debt and fraud in a manner which is invisible
and nonintrusive to the customer. This architecture also allows the Registrant
to better manage network capacity, as unauthorized and unplanned users cannot
access the network.
PRINCIPAL PRODUCTS AND SERVICES
PRODUCT AND SERVICE OFFERINGS
The Registrant offers retail telecommunications services primarily to
small and medium-sized businesses. The Registrant's retail service offerings
currently include long distance and toll-free services (both with and without an
AIN), multiple access options, calling card, data, Internet access, DSL, e-mail,
facsimile, directory assistance and teleconferencing services. The Registrant's
wholesale services include domestic and international termination and transport
services to domestic and international telecommunications carriers.
CURRENT SERVICES
Retail Services. The Registrant provides retail telecommunications
services to over 10,000 commercial customers, primarily small and medium-sized
businesses located in the Northeastern region of the United States. The
Registrant sells retail services through its direct retail sales force and
independent marketing representatives. Retail commercial communications services
accounted for approximately 40% of the Registrant's Fiscal 2001
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revenues, and produced revenues of approximately $53,487,000 in Fiscal 2001 and
$69,023,000 in Fiscal 2000. Retail revenues fell in fiscal 2001 due to continued
downward pricing pressure and reductions in volume, which the Registrant
attributes to ever increasing competition within the industry. While the
Registrant believes that it may return to its previous volume levels, as the
worldwide demand for communications services increases, it also believes that
the intense competition for those minutes from other telecommunications
providers will continue to force down prices. This continued downward effect on
price may adversely affect operations.
The Registrant's retail services include the following:
o LONG DISTANCE: The Registrant offers a full range of switched and
dedicated domestic and international long distance services, including
"1+" outbound service in all 50 states along with global termination to
over 200 countries. Long distance services include intra-LATA,
inter-LATA, and worldwide international services. Long distance
features include both verified and non-verified accounting codes,
station-to-station calling, third-party calling, directory assistance
and operator-assisted calling.
o TOLL-FREE SERVICES: The Registrant offers a full range of switched and
dedicated domestic toll-free services, including toll-free origination
in all 50 states, international toll-free origination from over 30
countries, and toll-free directory assistance. AIN enhanced toll-free
services include the following features: Command Routing, Dialed Number
Identification Service Area Code/Exchange Routing, Real Time Automatic
Number Identification Delivery, Day-of-Year Routing, Day-of-Week
Routing, Time-of-Day Routing, Percentage Allocation Routing, PIN
protected 800 services, integrated voice response services and store
locator services.
o ACCESS OPTIONS: The Registrant offers its long distance and toll-free
customers multiple access options, including dedicated access at DS0,
DS1, and DS3 speed(s) and switched access.
o CALLING CARD AND SERVICES: The Registrant offers nationwide switched
access, customized calling card services. Customers have the option of
calling cards, which are personalized, branded or generic.
o INTERNET: The Registrant currently offers high-quality, dedicated DSL
and dial-up Internet access, e-mail, IP addressing and Domain Name
Services.
o DATA SERVICES: The Registrant offers advanced data transmission
services, including private line and Frame Relay services. Data
services have multiple access options, including dedicated access at
DS0, DS1, and DS3 speed(s) and switched access.
o CUSTOMER MANAGEMENT CONTROL FEATURES: All of the Registrant's customers
have the option of customized management reporting features, including
interstate/intrastate area code summaries, international destination
matrix, daily usage summaries, state summaries, time of day summaries,
duration distribution matrix, exception reporting of long duration
calls, and incomplete and blocked call reporting.
Wholesale Services. The Registrant offers the following wholesale services:
domestic and international termination, switch ports, colocation facilities and
transport services to a broad spectrum of domestic and international carriers.
The Registrant offers international wholesale termination and transport services
primarily to domestic and international telecommunications carriers. Once the
Registrant interconnects with a carrier customer, the carrier may utilize the
Registrant on an as-needed basis, depending upon the pricing offered by the
Registrant and its competitors, as well as capacity. The Registrant has been
tested and approved as an authorized carrier for, and included in the routing
tables of all of its long distance and international carrier customers.
Wholesale revenues were approximately $79,743,000 and $70,737,000 during Fiscal
2001 and Fiscal 2000, respectively.
CUSTOMER BASE
TELECOMMUNICATIONS SERVICES MARKET
Overview of the United States Market. The United States market for
telecommunications services can be divided into four basic service sectors: long
distance, local exchange, Internet access and international.
Long Distance Services. A long distance telephone call can be
envisioned as consisting of three segments. Starting with the originating
customer, the call travels along a local exchange network to a long distance
carrier's point of presence ("POP"). At the POP, the call is combined with other
calls and sent along a long distance network to a POP on the long distance
carrier's network near where the call will terminate. The call is then sent from
this POP along a local network to the terminating customer. Long distance
carriers provide only the
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connection between the two local networks; and, unless the long distance carrier
is a local service provider, pay access charges to LECs for originating and
terminating calls.
Local Exchange Services. A local call is one that does not require the
services of a long distance carrier. In general, the local exchange carrier
connects end-user customers within a LATA and also provides the local access
(ingress and egress) of most long distance calls.
Internet Service. Internet services are generally provided in at least
two distinct segments. A local network connection is required from the Internet
Service Provider ("ISP") customer to the ISP's local facilities. For large,
communication-intensive users and for content providers, the connections are
typically unswitched, dedicated connections provided by LECs, Intelligent Call
Processing ("ICP"), or other providers, either as independent service providers
or, in some cases, by a carrier that is both a CLEC and an ISP. For residential
and small and medium-sized business users, these connections are generally
Public Switched Telephone Network ("PSTN") connections obtained on a dial-up
access basis as a local exchange telephone call. Once a local connection is made
to the ISP's local facilities, information can be transmitted and obtained over
a packet-switched IP data network, which may consist of segments provided by
many interconnected networks operated by a number of ISPs. The collection of
interconnected networks makes up the Internet. A key feature of Internet
architecture and packet switching is that a single dedicated channel between
communication points is never established, which distinguishes Internet-based
services from the PSTN.
International Service. A typical international long distance call
originates on a local exchange network or private line and is carried to the
international gateway switch of a long distance carrier. The call is then
transported along a fiber optic cable or a satellite connection to an
international gateway switch in the terminating country and, finally, to another
local exchange network or private line where the call is terminated. Generally,
only a small number of carriers are licensed by a foreign country for
international long distance and, in many countries, only the Post Telephone &
Telegraph administration ("PTT") is licensed or authorized to provide
international long distance service. Any carrier which desires to transport
switched calls to or from a particular country must, in addition to obtaining a
license or other permission (if required), must enter into operating agreements
or other arrangements with the PTT or another international carrier in that
country or lease capacity from a carrier which already has such arrangements.
MARKET OPPORTUNITIES
As a result of the 1996 Act and other federal, state, and international
initiatives, numerous telecommunications markets have been opened to
competition. In addition, the increasing globalization of the world economy,
along with increased reliance upon data transmission and Internet access, has
expanded traditional telecommunications markets. The Registrant has targeted its
services principally to small and medium-sized businesses based upon its belief
that such customers are not aggressively targeted by Tier I providers and are
underserved with respect to customer service and support.
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COMPETITION
OVERVIEW
The Registrant operates in a highly competitive industry and estimates
that it has no greater than a 1% share of the market in which it operates. The
Registrant expects that competition will continue to intensify in the future due
to regulatory changes, including the continued implementation of the 1996 Act,
and further increases in the size, resources, and number of market participants.
In each of its markets, the Registrant will face competition from larger, better
capitalized Tier I and Tier II providers and ILECs and CLECs. While new business
opportunities may be made available to the Registrant through the 1996 Act and
other federal and state regulatory initiatives, regulators are likely to provide
ILECs with an increased degree of flexibility with regard to pricing of their
services as competition increases.
Competition for the Registrant's products and services is based upon
price, quality, the ability to bundle services, name recognition, network
reliability, service features, billing services, perceived quality and
responsiveness to customers' needs. While the Registrant believes that it
currently has certain advantages relating to price, quality, customer service
and responsiveness to customer needs, there is no assurance that the Registrant
will be able to maintain these advantages or obtain additional advantages. A
continuing trend toward business combinations and alliances in the
telecommunications industry may create significant new competitors to the
Registrant. Many of the Registrant's existing and potential competitors have
financial, technical, and other resources significantly greater than those of
the Registrant. In addition, in December, 1997, the FCC issued rules to
implement the provisions of the World Trade Organization Agreement on Basic
Telecommunications, which was drafted to liberalize restrictions on foreign
ownership of domestic telecommunications companies and to allow foreign
telecommunications companies to enter domestic markets. The new FCC rules went
into effect in February, 1998 and are expected to make it substantially easier
for many non-United States telecommunications companies to enter the United
States market, thus further increasing the number of competitors. The new rules
will also give non-United States individuals and corporations greater ability to
invest in United States telecommunications companies, thus increasing the
financial and technical resources potentially available to existing and
potential competitors as well as Registrant.
LONG DISTANCE MARKET
The long distance telecommunications industry is highly competitive and
affected by the introduction of new services by, and the market activities of,
major industry participants. The Registrant competes against various national
and regional long distance carriers, including both facilities-based providers
and switchless resellers offering essentially the same services as the
Registrant. In addition, significant competition is expected to be provided by
ILECs including, when authorized, RBOCs. The Registrant's success will depend
upon its ability to provide high-quality services at prices competitive with, or
lower than, those charged by its competitors. In addition, a high level of
customer attrition or "churn" has characterized the long distance industry. Such
attrition is attributable to a variety of factors, including initiatives of
competitors as they engage in advertising campaigns, marketing programs, and
provide cash payments or other incentives. End users are often not obligated to
purchase any minimum usage amount and can discontinue service without penalty at
any time. The Registrant's revenue has been, and is expected to continue to be,
affected by churn.
Tier I providers and other carriers have implemented new price plans
aimed at residential customers with significantly simplified rate structures,
which may have the impact of lowering overall long distance prices. There can
also be no assurance that long distance carriers will not make similar offerings
available to the small to medium-sized businesses, which the Registrant
primarily serves. While the Registrant believes that small and medium-sized
business customers are not aggressively targeted by large long distance
providers, such as the Tier I providers, there can be no assurance that the
Registrant's customers and potential customers will not be targeted by these or
other providers in the future. Additional pricing pressure may come from IP
transport, which is a developing use of packet-switched technology which can
transmit voice communications at a cost which may be below that of traditional
circuit-switched long distance service. While IP transport is not yet available
in all areas, requires the dialing of additional digits. While the service has
generally produced sound quality inferior to traditional long distance service,
it could eventually be perceived as a substitute for traditional long distance
service. This, in turn, could put further pricing pressure on long distance
rates. Any reduction in long distance prices may have a material adverse effect
on the Registrant's business, financial condition and results of operations.
Some of the Registrant's principal competitors are also major suppliers
of services to the Registrant. The Registrant both links its switching equipment
with transmission facilities and services purchased or leased from these
suppliers, and also resells services obtained from these suppliers. There can be
no assurance that these suppliers will continue to offer services to the
Registrant at competitive rates or on attractive terms, if at all, and any
failure to do so could have a material adverse effect on the Registrant.
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SEASONAL NATURE OF BUSINESS
Registrant's business is not seasonal.
PATENTS, TRADEMARKS, LICENSES, ETC.
Registrant does not hold any material patents, franchises or
concessions.
GOVERNMENT REGULATIONS
OVERVIEW
The Registrant's services are subject to regulation by federal, state
and local governmental agencies. The FCC exercises jurisdiction over all
facilities and services of telecommunications common carriers to the extent
those facilities are used to provide, originate or terminate interstate or
international communications. State regulatory agencies retain jurisdiction over
carriers' facilities and services to the extent they are used to originate or
terminate intrastate communications. Municipalities and other local government
agencies may require carriers to obtain licenses or franchises regulating use of
public rights-of-way necessary to install and operate their networks. The
networks are also subject to numerous local regulations such as building codes,
franchises, and rights of way licensing requirements. Many of the regulations
issued by these regulatory bodies may be subject to judicial review, the results
of which the Registrant is unable to predict.
FEDERAL REGULATIONS - THE 1996 ACT
Statutory Requirements. The 1996 Act requires all LECs (including ILECs
and CLECs (i) not to prohibit or unduly restrict resale of their services; (ii)
to provide local number portability; (iii) to provide dialing parity and
nondiscriminatory access to telephone numbers, operator services, directory
assistance, and directory listings; (iv) to afford access to poles, ducts,
conduits, and rights-of-way; and (v) to establish reciprocal compensation
arrangements for the transport and termination of local telecommunications
traffic. It also requires ILECs to negotiate local interconnection agreements in
good faith and to provide interconnection (a) for the transmission and routing
of telephone exchange service and exchange access, (b) at any technically
feasible point within the ILEC's network, (c) which is at least equal in quality
to that provided by the ILEC to itself, its affiliates, or any other party to
which the ILEC provides interconnection, and (d) at rates and terms and
conditions which are just, reasonable and nondiscriminatory. ILECs also are
required under the 1996 Act to provide nondiscriminatory access to network
elements on an unbundled basis at any technically feasible point, to offer their
local telephone services for resale at wholesale rates, and to facilitate
colocation of equipment necessary for competitors to interconnect with or access
Unbundled Network Elements ("UNEs").
The 1996 Act also eliminates the existing AT&T antitrust consent
decree, which barred the provision of long distance services and manufacturing
by the RBOCs. In addition, the 1996 Act requires RBOCs to comply with certain
safeguards and offer interconnection which satisfies a prescribed 14-point
competitive checklist before RBOCs are permitted to provide in-region inter-LATA
services. These safeguards are designed to ensure that the RBOCs competitors
have access to local exchange and exchange access services on nondiscriminatory
terms and that the subscribers of regulated non-competitive RBOC services do not
subsidize their provision of competitive services. The safeguards also are
intended to promote competition by preventing RBOCs from using their market
power in local exchange services in order to obtain an anti-competitive
advantage in the provision of other services. RBOCs have the ability to provide
out-of-region long-distance services and, if they obtain authorization and under
prescribed circumstances, may provide additional in-region long-distance
services. In December 1999, the FCC granted Bell Atlantic's (now Verizon)
application to offer in-region long distance services in New York, marking the
first time since the breakup of AT&T that an RBOC has been able to provide its
customers with both local and long distance service.
The 1996 Act also granted important regulatory relief to industry
segments which compete with CLECs. ILECs were given substantial new pricing
flexibility. RBOCs also were granted new rights to provide certain cable TV
services. Inter Exchange Carriers ("IXCs") were permitted to construct their own
local facilities and/or resell local services. State laws may no longer require
CATVs to obtain a franchise before offering telecommunications services nor
permit CATVs' franchise fees to be based on their telecommunications revenue. In
addition, under the 1996 Act, all utility holding companies are permitted to
diversify into telecommunications services through separate subsidiaries.
FCC Rules Implementing the Local Competition Provisions of the 1996
Act. In August 1996, the FCC released a First Report and Order, a Second Report
and Order and a Memorandum Opinion and Order (combined, the "Interconnection
Orders") which established a framework of minimum, national rules enabling state
Public Utility Commissions ("PUCs") and Public Service Commissions ("PSCs"), and
the FCC to begin implementing many of the local competition provisions of the
1996 Act. In its Interconnection Orders, the FCC prescribed certain minimum
points of interconnection necessary to permit competing carriers to choose the
most efficient points at which to interconnect with the ILECs' networks. The FCC
also adopted a minimum list of UNEs that ILECs must
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make available to competitors upon request and a methodology for states to use
in establishing rates for interconnection and the purchase of UNEs. The FCC also
adopted a methodology for States to use when applying the 1996 Act "avoided cost
standard" for setting wholesale prices with respect to retail services.
The U.S. Supreme Court affirmed the authority of the FCC to establish rules
governing interconnection. The Registrant believes that additional disputes
regarding interconnection issues and other related FCC actions are likely. In
particular, the Supreme Court remanded to the FCC issues regarding what UNEs the
FCC will require ILECs to make available to competitors. In November 1999, the
FCC released a decision modifying the list of UNEs which all ILECs must offer to
other carriers. The Eighth Circuit decisions and their reversal by the Supreme
Court continue to cause uncertainty about the rules governing the pricing, terms
and conditions of interconnection agreements. The Supreme Court's ruling and
further proceedings on remand (either at the Eighth Circuit or the FCC) may
affect the scope of the PUCs' and PSCs' authority to conduct arbitration
proceedings or to implement or enforce interconnection agreements. The ruling
could also result in new or additional rules being promulgated by the FCC. Given
the ongoing uncertainty surrounding the effect of the Eighth Circuit decisions
and the decision of the Supreme Court reversing them, the Registrant may not be
able to obtain or enforce interconnection terms acceptable to it or that are
consistent with its business plans.
OTHER FEDERAL REGULATIONS
In general, the FCC has a policy of encouraging the entry of new
competitors in the telecommunications industry and preventing anti-competitive
practices. Therefore, the FCC has established different levels of regulation for
dominant carriers and non-dominant carriers. For purposes of domestic common
carrier telecommunications regulation, large ILECs are currently considered
dominant carriers, while CLECs are considered non-dominant carriers.
o TARIFFS. As a non-dominant carrier, the Registrant may install and
operate facilities for the transmission of domestic interstate
communications without prior FCC authorization. Services of
non-dominant carriers have been subject to relatively limited
regulation by the FCC, primarily consisting of the filing of
tariffs and periodic reports. However, non-dominant carriers like
the Registrant must offer interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remain
subject to FCC complaint procedures. With the exception of
informational tariffs for operator-assisted services and tariffs
for interexchange casual calling services, the FCC has ruled that
IXCs must cancel their tariffs for domestic interstate
interexchange services. Tariffs continue to be required for
international services. Pursuant to these FCC requirements, the
Registrant has filed and maintains tariffs for its interstate
services with the FCC. All of the interstate access and retail
"basis" services (as defined by the FCC) provided by the
Registrant are described therein. "Enhanced" services (as defined
by the FCC) need not be tariffed. The Registrant believes that its
proposed enhanced voice and Internet services are "enhanced"
services which need not be tariffed. However, the FCC is
reexamining the "enhanced" definition as it relates to IP
transport and the Registrant cannot predict whether the FCC will
change the classification of such services.
o INTERNATIONAL SERVICES. Non-dominant carriers such as the
Registrant are required to obtain FCC authorization pursuant to
Section 214 of the Communications Act and file tariffs before
providing international communication services. The Registrant has
obtained authority from the FCC to engage in business as a resale
and facilities-based international carrier to provide voice and
data communications services between United States and all foreign
points.
o ILEC PRICE CAP REGULATION REFORM. In 1991, the FCC replaced
traditional rate of return regulation for large ILECs with price
cap regulation. Under price caps, ILECs can raise prices for
certain services by only a small percentage each year. In
addition, there are constraints on the pricing of ILEC services
which are competitive with those of CLECs. In September 1995, the
FCC proposed a three-stage plan which would substantially reduce
ILEC price cap regulation as local markets become increasingly
competitive and, ultimately, would result in granting ILECs
nondominant status. Adoption of the FCC's proposal to reduce
significantly its regulation of ILEC pricing would significantly
enhance the ability of ILECs to compete against the Registrant and
could have a material adverse effect on the Registrant. The FCC
released an order in December, 1996 that adopted certain of these
proposals, including the elimination of the lower service band
index limits on price reductions within the access service
category. The FCC's December 1996 order also eased the
requirements necessary for the introduction of new services by
ILECs. In May, 1997, the FCC took further action updating and
reforming its price cap plan for the ILECs. Among other things,
the changes require price cap LECs to reduce their price cap
indices by 6.5 percent annually, less an adjustment for inflation.
The FCC also eliminated rules that require ILECs earning more than
certain specified rates of return to "share" portions of the
excess with their access customers during the next year in the
form of lower access rates. In August, 1999, the FCC again took
action designed to grant greater flexibility to price cap LECs as
competition develops. These reforms should facilitate the removal
of services from price cap regulation as competition develops in
the marketplace. The order granted immediate pricing flexibility
to price cap LECs in the form of streamlined introduction of new
services, geographic
9
deaveraging of rates for services in the trunking basket, and
removal, upon implementation of toll dialing parity, of certain
interstate interexchange services from price cap regulation. These
actions could have a significant impact on the interstate access
prices charged by the ILECs with which the Registrant expects to
compete.
o ACCESS CHARGES. Over the past several years, the FCC has granted
ILECs significant flexibility in their pricing of interstate
special and switched access services. Under this pricing scheme,
ILECs may establish pricing zones based on access traffic density
and charge different prices for each zone. The Registrant
anticipates that this pricing flexibility should result in ILECs
lowering their prices in high traffic density areas, the probable
area of competition with the Registrant. The Registrant also
anticipates that the FCC will grant ILECs increasing pricing
flexibility as the number of interconnections and competitors
increases. In May, 1997, the FCC took action to reform the current
interstate access charge system. The FCC adopted an order which
makes various reforms to existing rate structures for interstate
access designed to move access charges, over time, to more
economically efficient rate levels and structures. The FCC
recently granted LECs additional pricing flexibility. As such, the
carriers may offer volume discounts which may benefit larger long
distance carriers.
The FCC has also implemented changes in interstate access rules
that result in restructuring of the access charge system and
changes in access charge rate levels. As of January 1998, access
charges incurred by the Registrant are being passed on to end
users. In May 1999, the U.S. Court of Appeals (D.C. Circuit) sent
the access rate formula back to the FCC for further explanation
regarding how certain factors were calculated. These and related
actions may change access rates. If the formula is upheld, and
access rates are reduced, the result will be a lower cost of
providing long distance service, especially to business customers.
The impact of these new changes will not be known until they are
fully implemented over the next several years. In a related
proceeding, the FCC has adopted changes to the methodology by
which access has been used in part to subsidize universal
telephone service and other public policy goals.
Telecommunications providers like the Registrant pay fees
calculated as a percentage of revenue to support these goals. The
full implications of these changes remains uncertain and subject
to change.
o PICC. As part of Access Reform mandated in the Telecommunications
Act of 1996, beginning in 1998, local phone companies were
permitted to assess the Pre-subscribed Interexchange Carrier
Charge, also known as "PICC." The "PICC" is a monthly per line
cost charged by the local telephone company to every long distance
carrier for each customer phone line that is pre-subscribed to
that carrier. These charges are passed on to the end users.
o UNIVERSAL SERVICE REFORM. In May, 1997, the FCC released an order
which reforms the current system of interstate universal service
support and implements the universal service provisions of the
1996 Act. The FCC established a set of policies and rules designed
to ensure that low-income consumers and consumers who live in
rural, insular and high-cost areas receive a defined set of local
telecommunications services at affordable rates. This was to be
accomplished in part through expansion of direct consumer subsidy
programs and in part by ensuring that rural, small and high-cost
LECs continue to receive universal service subsidy support. The
FCC also created new programs to subsidize connection of
telecommunications networks to eligible schools, libraries and
rural health care providers. These programs were to be funded by
assessment of eligible revenue of nearly all providers of
interstate telecommunications carriers, including the Registrant.
The Registrant, like other telecommunications carriers providing
interstate telecommunications services, is required to contribute
a portion of its end-user telecommunications revenue to fund
universal service programs. These contributions became due
beginning in 1998 for all providers of interstate
telecommunications services. Such contributions were to be
assessed based on intrastate, interstate and international end
user telecommunications revenue. Contribution factors vary
quarterly and carriers, including the Registrant, are billed each
month. In addition, many state regulatory agencies have instituted
proceedings to revise state universal fund contribution
requirements which will vary from state to state. Recently, the
U.S. Court of Appeals for the Fifth Circuit rejected the FCC's
effort to base contributions in part on intrastate revenues. The
FCC's universal service program may be altered as a result of
appeals, agency reconsideration of its actions, or future
Congressional legislation.
Pursuant to the Universal Service Order, all carriers are required
to submit a Universal Service Fund worksheet. The Registrant has
filed its Universal Service Fund worksheet. The amounts remitted
to the Universal Service Fund may be billed to the Registrant's
customers. If the Registrant does not bill these amounts to its
customers, its profit margin may be less than if it had elected to
do so. However, if the Registrant elects to bill these amounts to
its customers, customers may reduce their use of the Registrant's
services, or elect to use the services provided by the
Registrant's competitors, which may have a material adverse effect
upon the Registrant's business, financial condition, or results of
10
operations. The Registrant is eligible to qualify as a recipient
of universal service support if it elects to provide
facilities-based service to areas designated for universal service
support and if it complies with federal and state regulatory
requirements to be an eligible telecommunications carrier.
In October, 1999 the FCC adopted a new high-cost universal service
support mechanism for non-rural carriers. The new mechanism is
based on the forward-looking costs of providing supported services
as determined by the Commission's cost model. The forward-looking
support mechanism provides support to non-rural carriers in those
states that have a statewide average forward-looking cost per line
greater than the national benchmark, which is set at 135 percent
of the national average forward-looking cost per line. The FCC's
decisions regarding universal service could have a significant
impact on future operations of the Registrant.
o COLOCATION. In March, 1999, the FCC released its Colocation Order
which requires ILECs to permit CLECs to colocate any equipment
used for interconnection or access to unbundled network elements
even if that equipment includes switching or enhanced service
functions. Among other things, the Colocation Order also prohibits
ILECs from placing any limits on the use of switching or enhanced
features for collocated equipment, and requires ILECs to make
cageless colocation available and permit CLECs to construct their
own cross-connect facilities.
In March, 2000, the U.S. Court of Appeals for the District of
Columbia Circuit vacated limited portions of the Collocation
Order, holding certain definitions contained in FCC rules were
impermissibly broad. The Court remanded the Collocation Order, in
part, for further FCC consideration of these issues. The FCC will
be instituting proceedings to comply with the Court's remand.
o LINE SHARING. In November, 1999, the FCC adopted a new order
requiring ILECs to provide line sharing, which will allow CLECs to
offer data services over the same line the consumer uses for voice
services, without the CLECs being required to offer the voice
services. State commissions have been authorized to establish the
prices to the CLECs for such services. The decision has been
appealed.
State Regulation
The Registrant believes that most, if not all, states in which it may
operate as a local telecommunications provider, require certification or other
authorization to offer intrastate services. Many of the states in which the
Registrant may operate are in the process of addressing issues relating to the
regulation of CLECs.
In some states, existing state statutes, regulations or regulatory
policy may preclude some or all forms of local service competition. However,
Section 253 of the 1996 Act prohibits states and localities from adopting or
imposing any legal requirement which may prohibit, or have the effect of
prohibiting, the ability of any entity to provide any interstate or intrastate
telecommunications service. The FCC has the authority to preempt any such state
or local requirements to the extent necessary to enforce the 1996 Act's open
market entry requirements. States and localities may continue to regulate the
provision of interstate communications services and require carriers to obtain
certificates or licenses before providing service, if such requirements do not
constitute prohibitive barriers to market entry.
Some states in which the Registrant operates are considering
legislation which could impede efforts by new entrants in the local services
market to compete effectively with ILECs. For example, some state PSCs and PUCs
are currently considering actions to preserve universal service and promote the
public interest. Such actions may impose conditions on the certificate issued to
an operator which would require it to offer service on a geographically
widespread basis through (i) the construction of facilities to serve all
residents and business customers in such areas, (ii) the acquisition from other
carriers of network facilities required to provide such service, or (iii) the
resale of other carriers' services. The Registrant believes that state PSCs and
PUCs have limited authority to impose such requirements under the 1996 Act. The
imposition of such conditions by state PUCs, however, could increase the cost to
operating companies of providing local exchange services or otherwise affect an
operating company's flexibility to offer services.
The Registrant has obtained intrastate authority for the provision of
resold interexchange services through certification or registration in every
state where it is required. The Registrant has CLEC certifications pending in
several states. There can be no assurance that the Registrant will receive the
authorizations it may seek in the future to the extent it expands into other
states or seeks to provide additional services. In most states, the Registrant
is required to file tariffs setting forth the terms, conditions and prices for
services which are classified as intrastate.
Local Interconnection. The 1996 Act imposes a duty upon all ILECs to
negotiate in good faith with potential interconnectors to provide
interconnection to the ILEC networks, exchange local traffic, make UNEs
available and permit resale of most local services.
11
COMPLIANCE WITH ENVIRONMENTAL PROVISIONS
Registrant believes that it complies in all material respects with
current pertinent federal, state, and local provisions relating to the
protection of the environment and does not believe that continued compliance
would require any material capital expenditure.
PERSONNEL
As of the April 11, 2001, the Registrant and its subsidiaries employed
212 full-time and part-time employees in its long distance telecommunication
business, of whom 79 were engaged in sales activities, 16 in customer service
and support, 44 in technical and field services, 27 in data processing, and 46
in general and administrative activities. The Registrant also utilizes the
services of approximately 70 independent sales agents. The Registrant considers
its relations with its employees to be satisfactory.
ITEM 2. Properties
On November 15, 1993, and December 28, 1993, the Registrant entered
into leases for an aggregate of approximately 3,500 square feet of space at 744
Broad Street, Newark, New Jersey, for its switching equipment. The lease ran
from January 1, 1994 through December 31, 1998, with an option to renew the
lease through August 31, 2002, which has been exercised. The annual rental of
$63,200 also requires the tenant to pay a proportionate share of any increase in
the "Consumer Price Index", U. S. City Average over the base year.
On December 1, 1993, the Registrant entered into a five-year lease,
which expired on November 30, 1998, for approximately 20,000 square feet of
space from a partnership in which two of the partners were directors and major
shareholders of the Registrant. Both of the partners are no longer directors.
The lease was amended on August 31, 1999, whereby the space was reduced to
12,295 square feet at an annual rate of $47,980. The lease provides a 120 day
written notice by either party to terminate. This space is used for warehousing
and office space for the technical support employees. The lease requires the
payment of any increase in operating expenses and real estate taxes over the
base year.
On February 22, 1994, the Registrant entered into a lease, subsequently
modified on April 15, 1994, for approximately 17,700 square feet of space at 150
Clove Road, Little Falls, New Jersey to be used as sales, executive and
administrative offices. The lease provided for a rent holiday until July 1995,
after which the annual rental would be approximately $360,000. The lease is for
five years and ten months and has been amended by a second lease modification
agreement dated February 9, 1995 whereby the Registrant leased approximately
6,700 additional square feet of space at the same location at an additional
annual rental of $121,707 for the first four years and $138,154 for the next
year and two months. The modified agreement also extended the term of the
existing lease for an additional two years to August 14, 2002 at a then annual
rental of $563,000. The lease requires the payment of the tenant's proportionate
share of operating expenses and real estate tax increases over the base year.
There are two five year renewal options.
On January 30, 1997, the Registrant entered into a third modification
of its lease for approximately 16,640 square feet of additional office space at
its existing facility at 150 Clove Road, Little Falls, New Jersey. The annual
rental on the additional space was $357,760 per annum from July 1, 1997 through
February 14, 1998, is $366,800 per annum from February 15, 1998 through August
14, 2000, and will be $384,820 per annum from August 15, 2000 through August 14,
2002. In addition, the Registrant is obligated for its proportionate share of
increases in real estate taxes and operating expenses over the base year. There
are two five year renewal options, requiring nine months' prior notice.
On November 1, 1996, the Registrant entered into a lease for
approximately 8,300 square feet of space at 40 Rector Street, New York City, New
York, for use as a second switching facility. The term of the lease is for
fifteen years and ten months from the date of commencement, which was March 1,
1997. Rental payments are $163,918 per annum for the first five years after
commencement, $166,480 per annum for the next five years, and $183,128 per annum
for the remaining five years and ten months. The lease requires the payment of
the tenant's proportional share of increased operating expenses and real estate
taxes over the base year.
On November 8, 1996, a subsidiary of the Registrant entered into a
lease for approximately 2,300 square feet of office space in New York City, New
York at an annual rental of approximately $77,781. The lease commenced February
1, 1997 and is for sixty three (63) months. The lease requires the payment of
the tenant's proportionate share of increased operating expenses and real estate
taxes over the base year.
On February 6, 1998, the Registrant entered into a lease for
approximately 5,000 square feet of space at 28 W. Flagler Street, Miami,
Florida. The term of the lease is 15 years, commencing February 1, 1998. The
annual rental is approximately $116,160, with an annual adjustment based on the
Revised Urban Wage Earners and Clerical Workers Index, capped at a maximum of 3%
increase over the prior year's rental payment. In addition, the Registrant is
liable for its proportionate share of increases in real estate taxes and
operating expenses over the base year. The Registrant sublet this space on
January 1, 2000 for the balance of its term, to another tenant at an annual rate
of approximately $116,160, subject to adjustments.
12
On September 1, 1998, the Registrant entered into a five year lease,
commencing September 1, 1998 for 3,008 square feet of space at 500 Cypress Creek
Road, Fort Lauderdale, Florida. Rental payments were $48,128 per annum from
September 1, 1998 to August 31, 1999, $50,554 from September 1, 1999 to August
31, 2000, $53,061 from September 1, 2000 to August 31, 2001, $55,708 from
September 1, 2001 to August 31, 2002 and $58,506 from September 1, 2002 to
August 31, 2003. The lease requires the payment of the tenant's proportionate
share of increased operating expenses and real estate taxes over the base year.
In January, 2000 the Registrant entered into a modification of the lease whereby
the space was reduced to 1,200 square feet. Rental payments have been modified
to be $30,300 from February 15, 2000 to February 14, 2001, $33,033 from February
15, 2001 to February 14, 2002, $34,587 from February 15, 2002 to February 14,
2003 and $32,538 from February 15, 2003 to February 14, 2004. The Registrant has
sublet this space to another tenant.
On August 20, 1999, the Registrant entered into a three year lease,
commencing August 20, 1999 for 2,770 square feet of space at 20 Crossways Park
North, Woodbury, New York. Rental payments were $62,235 per annum from October
1, 1999 to August 31, 2000, and are $64,818 from September 1, 2000 to August 31,
2001 and $67,422 from September 1, 2001 to August 31, 2002. The lease requires
the payment of the tenant's proportionate share of increased operating expenses
and real estate taxes over the base year.
On November 17, 1999, the Registrant entered into a three year lease,
commencing November 17, 1999 for 2,186 square feet of space at One Landmark
Square, Stamford, Connecticut. Rental payments were $50,278 per annum from
November 17,1999 to November 16,2000, are $51,371 from November 17,2000 to
November 16, 2001, and $51,556 from November 17, 2000 to November 16, 2002.
There is an option to renew for three years, upon nine months' prior written
notice. The lease requires the payment of the tenant's proportionate share of
increased operating expenses and real estate taxes over the base year.
On October 11, 1999, the Registrant entered into a three year lease,
commencing October 11,1999 leasing 1,926 square feet of space at 1810 Chapel
Avenue West, Cherry Hill, New Jersey. Rental payments are $38,520 per annum from
October 11,1999 to October 31,2002. There is an option to renew for three years,
upon nine months' prior written notice. The lease requires the payment of the
tenant's proportionate share of increased operating expenses and real estate
taxes over the base year.
The renewable options generally provide for rentals to be determined by
the then prevailing fair market rental rates for similar real estate in the
area.
ITEM 3. Pending Legal Proceedings
The Registrant brought suit in Civil Court of the City of New York,
County of New York against a customer, Community Network Services, Inc. d/b/a
Telecommunity, for the recovery of an account receivable of $45,346, plus
interest, attorneys fees and damages. Defendant asserted a counter claim against
the Registrant in the Supreme Court of the State of New York, County of New York
alleging breach of contract and seeks compensatory and punitive damages of
$1,300,000. The Registrant believes the counter suit is without merit and is
vigorously defending this action.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of Fiscal 2001.
(THE REST OF THIS PAGE INTENTIONALLY LEFT BLANK)
13
PART II
ITEM 5. Market for Registrant's Common Stock and Related Security Holder Matters
COMMON STOCK
The Registrant's authorized capital stock consists solely of 50,000,000
shares of Common Stock. An increase in the number of authorized shares from
20,000,000 was approved at the Shareholder's Meeting held on February 23, 2000.
Holders of the Registrant's Common Stock are entitled to receive such dividends,
if any, as may be declared from time to time by the Board of Directors in its
discretion from funds legally available therefor. Each holder of Common Stock is
entitled to one vote for each share held. There is no right to cumulative
voting. Upon liquidation, dissolution, or winding up of the Registrant, the
holders of Common Stock are entitled to receive a pro rata share of all assets
available for distribution to stockholders. The Common Stock has no pre-emptive
or other subscription rights, and there are no conversion or redemption rights
with respect to such shares.
Effective on July 1, 1996, the Registrant distributed 1,873,420
shares of Common Stock in connection with a 2-for-1 stock split of all
outstanding shares as of June 15, 1996. Effective on July 15, 1998, the
Registrant distributed 4,207,887 shares of Common Stock in connection with a
2-for-1 stock split of all outstanding shares as of June 30, 1998. As of the
date of this report, there were 11,769,405 shares of Common Stock issued and
outstanding, inclusive of 600,000 shares held by the Registrant's ESOP which the
Registrant is seeking to cancel, held by 720 persons, as reported by the
Registrant's transfer agent.
PRICE RANGE OF THE COMMON STOCK
The Registrant's Common Stock is traded in the over-the-counter market
on the NASDAQ National Market System under the Symbol CVST. The following table
sets forth, for the quarterly fiscal periods indicated, the high and low closing
sales prices for the Registrant's Common Stock in such market, as reported by
the National Association of Securities Dealers, Inc.
FISCAL 2001 HIGH LOW
----------- ---- ---
February 1, 2000 thru April 30 15 9 3/16
May 1 thru July 31 12 6/16 6
August 1 thru October 31 9 1/2 3 5/8
November 1 thru January 31, 2001 4 15/16 5/8
FISCAL 2000
-----------
February 1, 1999 thru April 30 19 15/16 16
May 1 thru July 31 18 3/4 11 1/2
August 1 thru October 31 14 5/8 10 15/16
November 1 thru January 31, 2000 15 3/4 12
Registrant has not paid or declared any cash dividends during the past
two fiscal years and does not anticipate paying any in the foreseeable
future.
14
ITEM 6. Selected Financial Data
(In thousands except per share amounts)
Year ended January 31,
---------------------------------------------------------------------
RESULTS OF OPERATIONS: 2001 2000 1999 1998 1997
--------- ---------- --------- --------- ----------
Net sales $ 133,230 $ 139,760 $ 137,283 $ 123,286 $ 89,326
Net (Loss) earnings $ (8,629) $ (9,414) $ (3,418) $ 1,094 $ 492
Weighted average
common shares
outstanding (a)
Basic 7,324 7,069 6,818 6,213 5,883
Diluted 7,324 7,069 6,818 6,842 6,739
(Loss) earnings per common and
common equivalent shares
Basic (Loss) earnings per share $ (1.18) $ (1.33) $ (0.50) $ 0.18 $ 0.08
Diluted (Loss) earnings per share $ (1.18) $ (1.33) $ (0.50) $ 0.16 $ 0.07
Cash dividends per
common share None None None None None
Additions to property
& equipment $ 3,227 $ 3,019 $ 4,727 $ 3,268 $ 6,397
Depreciation and
amortization $ 3,578 $ 2,985 $ 2,785 $ 2,028 $ 1,382
FINANCIAL POSITION:
Working Capital $ (7,734) $ 1,222 $ 1,261 $ 7,936 $ 5,419
Property and equipment - net $ 13,021 $ 13,317 $ 14,473 $ 12,406 $ 11,066
Total assets $ 39,097 $ 45,184 $ 45,692 $ 40,245 $ 31,029
Long-term debt $ 382 $ 997 $ 1,566 $ 2,092 $ 2,940
Shareholders' Equity $ 5,777 $ 14,007 $ 16,442 $ 18,598 $ 14,772
Common shares
outstanding (a) 7,969 7,944 7,605 6,679 5,891
(a) All per share amounts have been restated to reflect the 2 for 1 stock split
distributed July 1, 1998.
15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion is presented to assist in assessing the
changes in financial condition and performance of the Registrant for the fiscal
years ended January 1, 1999 (Fiscal 1999), January 31, 2000 (Fiscal 2000) and
January 31, 2001 (Fiscal 2001). The following information should be read in
conjunction with the financial statements and related notes and other detailed
information regarding the Registrant included elsewhere in this report and
should not be construed to imply management's belief that the results, causes or
trends presented will necessarily continue in the future. Certain information
contained below and elsewhere in this annual report, including information with
respect to the Registrant's plans and strategy for its business, are
"forward-looking statements."
New Accounting Pronouncements
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting
for Derivative Instruments and Hedging Activities, is effective for all fiscal
years beginning after June 15, 2000. SFAS 133, as amended, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities.
Under SFAS 133, certain contracts that were not formerly considered derivatives
may now meet the definition of a derivative. The Company will adopt SFAS 133
effective February 1, 2001. Management does not expect the adoption of SFAS 133
to have a significant impact on the financial position, results of operation, or
cash flows of the Company.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements",
which was adopted during the quarter ending January 31, 2001. The implementation
of SAB 101 did not have a material effect on the Company's financial position
and results of operations.
RESULTS OF OPERATIONS
FISCAL 2001 AS COMPARED TO FISCAL 2000
REVENUES
Net sales of telecommunications services and systems for the fiscal
year ended January 31, 2001 were approximately $133,230,000, a decrease of
approximately $6,530,000 or 4.7% from the approximately $139,760,000 of net
sales in Fiscal 2000. These revenues were comprised of retail sales of
approximately $53,487,000 and wholesale sales of approximately $79,743,000. The
Registrant billed approximately 1,255,437,000 minutes in Fiscal 2001 as compared
to approximately 1,242,942,000 minutes in Fiscal 2000, an increase of 12,495,000
minutes or 1.0%.
Net retail sales for Fiscal 2001 were approximately $53,487,000, a
decrease of approximately $15,536,000, or 22.5% from the approximately
$69,023,000 billed in Fiscal 2000. Retail billed minutes were approximately
600,381,000, a decrease of approximately 80,333,000 minutes or 11.8%, from the
retail minutes of approximately 680,714,000 billed in Fiscal 2000. The average
price per minute has decreased approximately 13.8% as the industry continues to
experience decreased price per minute of usage. The Registrant does not foresee
that this trend in pricing will abate in the near future.
Net wholesale (carrier) sales for Fiscal 2001 were approximately
$79,743,000, an increase of approximately $9,006,000 or 12.7% over the
approximately $70,737,000 billed in Fiscal 2000. Billed wholesale minutes
amounted to approximately 655,055,000, an increase of approximately 92,828,000
minutes or 16.5% over the billed wholesale minutes of approximately 562,227,000
billed in Fiscal 2000. The sales mix continued to move toward higher priced
international traffic from the lower priced domestic traffic. International
carrier traffic increased 177,976,000 minutes or approximately 46.9% to
approximately 557,669,000 minutes. Domestic minutes decreased approximately
85,149,000 or approximately 46.6% to approximately 97,387,000 minutes. The
average wholesale price per minute fell 4.1% due to continuing competition in
the industry, a trend, which the Registrant believes, will continue.
COST OF SALES
Cost of sales consists of access fees, line installation expenses,
switch expenses, NOC expenses, depreciation, transport expenses, and local and
long-distance expenses. Cost of sales for Fiscal 2001 was approximately
$116,059,000, an increase of approximately $3,265,000 or 2.9% over the
approximately $112,794,000 of cost of sales in Fiscal 2000. Included in cost of
sales are direct line costs, usage charges and the direct costs of the
Registrant's switches and Network Operating Center ("NOC"). The increase in cost
of sales was primarily due to the increase in lower margin wholesale volume of
approximately $10,319,000; increases in salary, wages and fringe benefits of
approximately $881,000; increased consulting expense of approximately $178,000,
and an increase in depreciation expense resulting from upgrades to the switches
of approximately $239,000. This was offset by the reduced volume of retail
traffic amounting to approximately $5,297,000; an improvement in cost rates
obtained from vendors of approximately $2,924,000 and other net savings in the
NOC and switches of approximately $131,000.
ACCESS CHARGE SETTLEMENT:
In the second quarter of the fiscal year ended January 31, 2001, the
Registrant received a cash payment of $1,264,483 from certain Bell Companies in
settlement of a class action suit, to which the Registrant was a party, filed in
1992 relating to alleged overcharges by those companies. The settlement
concluded the class action with the Bell Companies. The Registrant's portion of
the settlement was not determined until the second quarter of the fiscal year.
The cash payment was recorded as a separate line item as a reduction of costs
and expenses in the quarter ended July 31, 2000.
16
SELLING, GENERAL AND ADMINISTRATIVE:
Selling, general and administrative (S, G & A) expenses are comprised
of selling and marketing costs, and general and administrative costs. S, G & A
expenses for Fiscal 2001 decreased to approximately $26,903,000, a decrease of
approximately $1,087,000 or 3.9% from the approximate $27,990,000 in Fiscal
2000. This decrease was primarily due to a reduction in commission expenses of
approximately $1,639,000 resulting from the decline in retail sales volume; a
decrease in advertising and promotions of approximately $363,000; a decrease in
data processing services resulting from bringing the billing system in house of
approximately $165,000; a decrease in salaries, fringe benefits and taxes of
approximately $311,000; a reduction of meals and entertainment expense of
approximately $63,000; a reduction of legal fees of approximately $185,000; a
reduction of selling expense of approximately $191,000, and other net savings of
approximately $256,000. These decreases were offset by additions to the bad debt
provision, due to the failure of certain wholesale accounts, of approximately
$1,272,000; increased spending for general office of approximately $302,000; an
increase in recruiting and training for new sales employees of approximately
$180,000; and an increase in depreciation expense on new ISP equipment of
approximately $332,000.
RESTRUCTURING EXPENSE
In Fiscal 2000, approximately $319,000 of a prior accrual for
restructuring expenses was reversed. This amount included an approximately
$97,000 reduction in the severance accrual; a reduction of approximately $20,000
for fringe benefits and an approximately $202,000 reduction in the accrual on
the Fort Lauderdale lease, due to revisions in the lease. There were no charges
to restructuring expense in Fiscal 2001; however, the Registrant settled, for
approximately $12,000, the balance on the lease in Fort Lauderdale, Florida,
which was charged against accrued restructuring costs.
STOCK COMPENSATION EXPENSE
Stock compensation expenses for Fiscal 2001 increased to approximately
$267,000, an increase of approximately $63,000, or 30.9%, from the approximately
$204,000 charged in Fiscal 2000. The increase is due to having fewer
cancellations of certain restricted stock grants to employees in the current
year over the prior year.
OTHER COMPENSATION
On September 21, 1999, the Registrant entered into an agreement with
Warren Feldman, the then Chairman of the Board of Directors and a shareholder of
the Registrant. As part of this agreement, a lump sum payment in the then amount
of $900,000 was made to Mr. Feldman in settlement of his employment agreement.
The Registrant paid $650,000 and Mr. Walt Anderson, a major shareholder, paid
$250,000. Mr. Feldman's Employment Agreement was to have been in effect until
December 31, 2001. The Registrant expensed $900,000 in Fiscal 2000 with $250,000
being accounted for as a capital contribution.
Simultaneously, Revision LLC and Mr. Walt Anderson ("Revision/
Anderson") and the Registrant entered into Put Option agreements with Warren
Feldman, Sol Feldman ("the Feldmans") and Leon Genet, ("Genet") a director of
the Registrant. These Put Option agreements allowed the Feldmans and Genet the
right to sell their shares of the Registrant to Revision/Anderson at a price of
$16.00 per share and obligated Revision/Anderson to purchase the shares during
an exercise period beginning on December 11, 1999 and ending on February 10,
2000. Revision/Anderson purchased the shares under the put option agreements
prior to the expiration, with the exception of 100,778 shares still held by the
Feldmans. The Registrant had no obligation to purchase any shares from the
Feldmans or Genet. The closing market price of the Registrant's shares on
September 21, 1999, the date of the agreements, was $12.25, and the total number
of shares covered by the agreements was 1,208,137. Using a binomial valuation
model with an interest rate of 5% and a volatility rate of 50%, the fair value
of the Put Option agreements was determined to be $4.03 per share or $4,870,554.
The Registrant accounted for this non-cash transaction as a charge to expense
and a credit to paid-in capital during Fiscal 2000.
There were no similar charges in Fiscal 2001.
OTHER INCOME AND EXPENSE
Total other income and expense for Fiscal 2001 increased approximately
$135,000. The components of other income and expense are interest expense,
interest income and other items. Interest income increased approximately
$52,000; interest expense decreased approximately $42,000; and approximately
$41,000 in insurance claims were received.
The net loss for Fiscal 2001 of approximately $8,629,000 represents a
decrease in net loss of approximately $785,000 from the net loss of
approximately $9,414,000 reported in Fiscal 2000. Charges included in the Fiscal
Year ended January 31, 2000, but not included in the Fiscal Year ended January
31, 2001 were charges resulting from other compensation expense of approximately
$5,770,000 and income tax expense of
17
approximately $2,700,000. Also in the Fiscal Year ended January 31, 2001 were
cost savings in S,G & A, of approximately $1,087,000 and a settlement from the
Bell companies of approximately $1,264,000. Offsetting these improvements was a
loss in margin of approximately $9,794,000. Other net items (including changes
in Restructuring costs, Stock Compensation Expense and other income and expense)
of approximately $242,000 also increased the net loss for the current year. For
the foregoing reasons, a loss per common share of $1.18 (basic and diluted) was
realized in Fiscal 2001, a decrease from the loss of $1.33 per common share
(basic and diluted) in Fiscal 2000.
RESULTS OF OPERATIONS
FISCAL 2000 AS COMPARED TO FISCAL 1999
REVENUES
Net sales of telecommunications services and systems for the fiscal
year ended January 31, 2000 were approximately $139,760,000, an increase of
approximately $2,478,000, or 1.8% over the approximately $137,283,000 of net
sales in Fiscal 1999. These revenues were comprised of retail sales of
approximately $69,023,000 and wholesales revenues of approximately $70,737,000.
The Registrant billed approximately 1,242,942,000 minutes in Fiscal 2000 as
compared to approximately 978,971,000 minutes in Fiscal 1999, an increase of
263,971,000 minutes or 27.0%. Due to the competitive nature of the long distance
communications industry, the average price for a minute of both retail and
wholesale traffic continued to decrease. In Fiscal 2000, this decrease was
approximately 20%.
Net retail sales for Fiscal 2000 were approximately $69,023,000, a
decrease of approximately $3,533,000, or 4.9%, over the approximately
$72,556,000 billed in Fiscal 1999. Retail billed minutes were approximately
680,714,000, an increase of approximately 51,934,000 minutes, or 8.3%, over the
retail minutes of approximately 628,780,000 billed in Fiscal 1999. The average
price per minute has decreased approximately 12.2% as the industry continued to
experience decreased price per minute of usage.
Net wholesale (carrier) sales for Fiscal 2000 were approximately
$70,737,000, an increase of approximately $6,010,000, or 9.3%, over the
approximately $64,727,000 billed in Fiscal 1999. Billed wholesale minutes
amounted to approximately 562,227,000, an increase of approximately 212,036,000
minutes, or 60.5%, over the billed wholesale minutes of approximately
350,191,000 billed in Fiscal 1999. The sales mix continues to move toward higher
priced international traffic, from the lower priced domestic traffic.
International carrier traffic increased 184,428,000 minutes or approximately
94.5% to approximately 379,692,000 minutes. Domestic minutes increased
approximately 27,608,000 or approximately 17.8% to approximately 182,535,000
minutes. The wholesale price per minute fell 32.2% due to the continuing
competition in the industry, a trend which the Registrant believes will
continue.
COST OF SALES
Cost of sales for Fiscal 2000 were approximately $112,794,000, an
increase of approximately $1,294,000, or 1.2%, over the approximately
$111,500,000 of cost of sales in Fiscal 1999. Included in cost of sales are
direct line costs, usage charges and the direct costs of the Registrant's
switches and Network Operating Center ("NOC"). The increase in cost of sales was
primarily due to the increased amount of retail sales minute volume, of
approximately $3,824,000 and an increase in wholesale cost of sales of
approximately $3,500,000 offset by cost reductions due to increased network
efficiencies and competitive pricing of approximately $5,240,000. The net
increase in direct line and usage costs was offset by reductions in the
operating expenses of the switches and NOC: the close out of the Miami switch, a
decrease of approximately $227,000; decrease in salary, wages and fringe
benefits of approximately $525,000; decreased recruiting expense of
approximately $74,000 and decreased consulting expenses of approximately
$127,000 were offset, in part, by increases in equipment repairs of
approximately $80,000 and general operating expenses of approximately $82,000.
SELLING, GENERAL AND ADMINISTRATIVE:
Selling, general and administrative expenses for Fiscal 2000 decreased
to approximately $27,990,000, a decrease of approximately $922,000, or 3.2%,
over the approximate $28,912,000 in Fiscal 1999. This decrease was primarily due
to a reduction in legal expenses of approximately $1,517,000 resulting from the
settlement of litigation; a decrease in consulting fees of approximately
$504,000; a decrease in data processing services of approximately $230,000
resulting from bringing the billing system in house; a reduction of travel
expenses of approximately $188,000 and a net decrease in spending on other
expenses such as office expenses, meetings contributions, telephone of
approximately $85,000. These decreases were offset by Increased spending on
salaries and wages of approximately $641,000 for the additional sales staff
needed to compete in the Northeast region; additional salary and wage expense of
approximately $267,000 resulting from an approximate 4.6% salary increases in
Fiscal 2000; increased fringe benefit and payroll taxes of approximately
$125,000 paralleling the increased salaries and wages; additional recruiting
expense of approximately $100,000 spent on hiring new sales
18
and technical personnel; an increase in depreciation and amortization expense of
approximately $278,000 related to the new ISP equipment and sales offices and
additions in the bad debt provision of approximately $196,000.
RESTRUCTURING EXPENSE
During the fourth quarter of Fiscal 1999, the Company recorded a
restructuring charge of approximately $2,368,000 related to the adoption by the
Company of a formal plan for restructuring its focus of operations. The
restructuring was adopted in an effort to concentrate the Company's efforts on
the Northeastern United States market. Elements of the Company's restructuring
plan included eliminating sales offices in Florida, Atlanta, Georgia, Washington
D.C. and the United Kingdom as well as the Miami switch.
The write downs incurred in connection with the restructuring included
a charge of approximately $1,280,000 associated with the planned disposal of the
Miami switch and switch site, a charge of approximately $723,000 associated with
the termination costs to reduce employee headcount and sales offices. A charge
of approximately $265,000 for the cost associated with the balance on the Fort
Lauderdale lease, and a charge of approximately $100,000 to write off line
installation costs associated with the Florida network. In the fiscal year
ending January 31, 1999, amounts paid included approximately $240,000 for
severance and termination costs. The balance of approximately $2,128,000 was
included on the consolidated balance sheet at January 31, 1999 as accrued
restructuring costs.
For Fiscal 2000, amounts applied against the accrual consisted of
approximately $1,280,000 for the write down of the Miami switch; approximately
$99,000 for the line installation costs; approximately $51,000 for payments made
on the Fort Lauderdale lease; approximately $327,000 for severance payments and
approximately $40,000 for payments made to shut down the U.K. operation.
Approximately $319,000 of the accrual was reversed in the Fiscal 2000. This
amount included an approximately $97,000 reduction in the severance accrual; a
reduction of approximately $20,000 for fringe benefits and an approximately
$202,000 reduction in the accrual on the Fort Lauderdale lease, due to revisions
in the lease.
STOCK COMPENSATION EXPENSE
Stock compensation expenses for Fiscal 2000 decreased to approximately
$204,000, a decrease of approximately $220,000, or 51.9%, from the approximately
$424,000 charged in Fiscal 1999. This decrease is due to the cancellation of
certain shares of Common Stock granted in prior years to employees who were
terminated in Fiscal 2000.
OTHER COMPENSATION
On September 21, 1999, the Registrant entered into an agreement with
Warren Feldman, Chairman of the Board of Directors and a shareholder of the
Registrant. As part of this agreement, a lump sum payment in the then amount of
$900,000 was made to Mr. Feldman in settlement of his employment agreement. The
Registrant paid $650,000 and Mr. Walt Anderson, a major shareholder, paid
$250,000. Mr. Feldman's Employment Agreement was to have been in effect until
December 31, 2001. The Registrant expensed the $900,000 in Fiscal 2000 with the
$250,000 being accounted for as a capital contribution.
Simultaneously, Revision LLC and Mr. Walt Anderson
("Revision/Anderson") and the Registrant entered into Put Option agreements with
Warren Feldman, Sol Feldman ("the Feldmans") and Leon Genet, ("Genet") a
director of the Registrant. These Put Option agreements allowed the Feldmans and
Genet the right to sell their shares of the Registrant to Revision/Anderson at a
price of $16.00 per share and obligated Revision/Anderson to purchase the shares
during an exercise period beginning on December 11, 1999 and ending on February
10, 2000. Revision/Anderson purchased the shares under the put option agreements
prior to the expiration. The Registrant had no obligation to purchase any shares
from the Feldmans or Genet. The closing market price of the Registrant's shares
on September 21, 1999, the date of the agreements, was $12.25, and the total
number of shares covered by the agreements was 1,208,137. Using a binomial
valuation model with an interest rate of 5% and a volatility rate of 50%, the
fair value of the Put Option agreements was determined to be $4.03 per share or
$4,870,554. The Registrant accounted for this non-cash transaction as a charge
to expense and a credit to paid-in capital during Fiscal 2000.
OTHER INCOME AND EXPENSE
Total other income and expense for Fiscal 2000 decreased approximately
$93,000. The components of other income and expense are interest expense,
interest income and other items. Interest income increased approximately $21,000
and interest expense decreased approximately $39,000. This was offset by reduced
other income of approximately $153,000, resulting from the elimination of
certain prepaid calling card activity in Fiscal 1999.
The net loss for Fiscal 2000 of approximately $9,414,000 represents an
increase in net loss of approximately $5,996,000 over the net loss of
approximately $3,418,000 reported in Fiscal 1999. The primary cause for the
additional loss was the other compensation expense of approximately $5,771,000
for the Warren
19
Feldman settlement, of which approximately $5,121,000 was for non-cash items. An
income tax provision caused by a valuation allowance on the net deferred tax
asset increased income tax expense to approximately $2,704,000; an increase of
approximately $5,145,000 over the Fiscal 1999 benefit amount of $2,441,000.
Other income and expense decreased approximately $93,000.This was offset by an
increase in gross margin of approximately $1,184,000; savings in selling,
general and administrative expense of approximately $922,000; the change in
restructuring expense of approximately $2,687,000 and decrease in stock
compensation expense of approximately $220,000. For the foregoing reasons, a
loss per share of $1.33 (basic) was realized in Fiscal 2000, an increase in the
loss of $0.83 per common share (basic and diluted) from the loss per share
(basic and diluted) $0.50 posted in Fiscal 1999.
LIQUIDITY AND CAPITAL RESOURCES
At January 31, 2001, the Registrant had negative working capital of
approximately $7,734,000 as compared to approximately $1,222,000 at January 31,
2000, a decrease of approximately $8,956,000. The decrease in working capital in
Fiscal 2001 was primarily attributable to an increase in accounts payable of
approximately $3,158,000; an increase in doubtful accounts of approximately
$2,347,000; a decrease in cash and cash equivalents of approximately $1,683,000;
a decrease in the current balance in income tax refund receivable of
approximately $1,578,000; the change in the current portion of long term debt of
approximately $47,000; a decrease in accounts receivable of approximately
$789,000; and a decrease in marketable securities of approximately $12,000. This
was offset by increases in prepaid expenses and other current assets of
approximately $238,000; and decreases in accrued expenses and other current
liabilities of approximately $420,000. The current ratio of 0.8 to 1, decreased
from the 1.0 to 1 ratio at the end of Fiscal 2000.
The cash flow statement of the Registrant for Fiscal 2001 indicated a
decrease in cash and cash equivalents of approximately $1,683,000. Non-cash
adjustments (depreciation, amortization, reserve for bad debt, restructuring,
non-cash compensation expense and the loss on disposal of property and
equipment) of approximately $6,280,000 and net changes in assets and liabilities
of approximately $4,413,000 added back to the net loss of approximately
$8,629,000 resulted in net cash provided by operations of approximately
$2,064,000. Cash used in investing activities amounted to approximately
$3,186,000, of which approximately $3,228,000 were used for the purchase of
capital additions and approximately $47,000 was used for the purchase of
additional circuits to build out the network. These additions were partially
offset by proceeds from the sale of short term investments of approximately
$87,000 and the sale of fixed assets of approximately $2,000. The cash used in
financial activities of approximately $561,000 consisted primarily of the
repayment of bank borrowings of approximately $569,000, offset by cash received
from the exercise of stock options of approximately $8,000.
Subsequent to the year end of Fiscal 2001, the Registrant increased its
cash position by $7,000,000 through the private sale of Common Stock to a group
of investors who are also officers and directors of the Registrant.
CAPITAL EXPENDITURES
Capital expenditures for Fiscal 2001 totaled approximately $3,228,000
and were financed from funds provided from Registrant's working capital and cash
derived from operations. The capital expenditures were used for the addition of
the IP network of approximately $174,000; upgrades to the Registrant's switches
and switch sites of approximately $1,098,000; software and hardware upgrades to
the Registrant's computer network of approximately $888,000; the addition of
Oracle financial and sales compensation systems of approximately $402,000;
hardware and software necessary to bring the billing system in house of
approximately $426,000; and furniture, fixtures and equipment for new sales
offices of approximately $240,000.
Capital expenditures for Fiscal 2002 are estimated at approximately
$5,000,000 and are expected to be financed from funds provided from operations,
vendor financing and a capital infusion of $7,000,000 from a group of investors
who are also officers and directors of the Registrant.
INFLATION
Since inflation has slowed in recent years, the Registrant does not
believe that its business has been materially affected by the relatively modest
rate of price increases in the economy. However, pressures in the industry to
reduce prices, which have impacted the Registrant in the past, are expected to
continue. Also the telecommunications industry has recently experienced the
failure of several businesses, some of which are the Registrant's wholesale
customer and suppliers. These failures not only have affected the Registrant's
FY 2001 results, but may impact future results. The Registrant continues to seek
improvements in operations and efficiency through capital expenditures.
Expenditures to improve the signaling system, information systems and the local
area network are expected to result in operating costs savings, which could
partially offset any future cost increases.
20
ENVIRONMENTAL MATTERS
The Registrant is not a party to any legal proceedings or the subject
of any claim regarding environmental matters generally incidental to its
business. In the opinion of Management, compliance with the present
environmental protection laws should not have a material adverse effect upon the
financial condition of the Registrant.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of changes in value of a financial
instrument, derivative or non-derivative, caused by fluctuations in interest
rates, foreign exchange rates and equity prices. The Registrant's cash and
investments exceed long-term debt; therefore, the exposure to interest rate risk
relates primarily to the marketable securities held by the Registrant. The
Registrant only invests in instruments with high credit quality where a
secondary market exists. The Registrant does not hold any derivatives related to
its interest rate exposure. The Registrant also maintains long-term debt at
fixed rates. Due to the nature and amounts of the Registrant's note payable, an
immediate 10% change in interest rates would not have a material effect in the
Registrant's results of operations over the next fiscal year. The Registrant's
exposure to adverse changes in foreign exchange rates is also immaterial to the
consolidated statements as a whole.
ITEM 8. Financial Statements and Supplementary Data
The Financial Statements and Supplementary Data are included under Item
14 of this Report.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
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21
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The directors and officers of the Registrant are as follows:
Name Age Position
- ---- --- --------
Walt Anderson 46 Chairman of the Board
Leon Genet 70 Director
A. John Leach 38 Director, President, Chief Executive Officer
Henry G. Luken III 40 Director
Jay J. Miller 68 Director
Thomas P. Gunning 63 Treasurer, Secretary and Chief Financial Officer
The Registrant's directors all serve for one year terms and until their
successors are elected and qualify. Officers serve at the pleasure of the Board
of Directors.
Mr. Henry G. Luken, III was elected a Director of the Registrant in
February, 1999, and Chairman of the Board in February, 2001. Currently, he is
President of Mont Lake Properties, Inc., a real estate development firm;a
director of Equity Broadcasting Corp., a TV network; a director of ACNTV, a home
shopping company selling through TV; Managing Agent of Henry IV LLC, an aircraft
sales company. A co-founder of Telco Communications Group inc., he served as
Chief Executive Officer and Treasurer from July, 1993 to April, 1996, and
Chairman from July, 1993 to October, 1997. Mr. Luken has also served as Chairman
of Tel-Labs, Inc., a telecommunications billing firm ("Tel-Labs") since 1991,
and as Chairman of Telco Development Group, Inc., a computer systems firm owned
by Mr. Luken, since 1987, both of which entities he founded.
Mr. Walt Anderson was elected a Director of the Registrant in February,
1999, and as Chairman of the Board in November , 1999. He stepped down as
Chairman in February, 2001. He has been Manager of Revision LLC from June 1998
to the present; President and Chairman of Entree International Ltd. (Financial
Consulting Services) from July, 1997 to the present; Chairman of Capsule
Communications, Inc, as of April 2001, Chairman of Teleport UK Ltd. (Satellite
Communications) from May, 1996 to the present; Chairman of Espirit Telecom Group
plc. (Telecom Services) from October, 1992 to November, 1998 and President and
Chairman, Mid Atlantic Telecom (Telecom Services), from May, 1984 to December,
1993. Mr. Anderson is also a director of American Technology Labs (Network
Equipment) and Aquarius Holdings Ltd. (Water Transport Systems),
Mr. Leon Genet has served as a Director since October, 1996. For more
than the past five years, he has been a partner in Genet Realty, a commercial
and industrial real estate brokerage firm. He serves as a member of the National
Commerce and Industry Board for the State of Israel Bonds Organization and is a
shareholder, director and officer of LPJ Communications, Inc., which has earned
commissions from the Registrant on the same basis as other independent sales
representatives. See "Certain Relationships and Related Transactions".
Mr. A. John Leach, Jr. was appointed President and Chief Executive
Officer and a Director of the Company on May 18,2000. He had been Senior Vice
President of Sales at BTI Telecomm, Inc., from December, 1999 to May, 2000;
Senior Vice President of Teleglobe, Inc. from June, 1996 to December, 1999,
where he assumed responsibility for US and Canadian commercial sales markets. He
was promoted to this position from Senior Vice President of Wholesale and Agent
Markets, Telco Communications (a subsidiary of Teleglobe, Inc.) June, 1996 to
February, 1999. Prior to that, Mr. Leach was Vice President of Agent Services at
BTI Telecomm, from December, 1989 to June, 1996. Regional Sales Manager of
Mobilecomm (a Bell South Company) where he started in sales and rose to a
Regional Sales Manager position May, 1985 to December, 1989.
Mr. Jay J. Miller, Esq. has served as a Director since 1983. He has
been a practicing attorney for more than 35 years in New York. He is Chairman of
the Board of AmTrust Pacific Ltd., a New Zealand real estate company. He is
22
also a director of Technology Insurance Company, Inc., a provider of various
insurance products to the technology industry, and certain of its affiliates.
Mr. Miller has performed legal services on behalf of the Registrant. See
"Certain Relationships and Related Transactions."
Mr. Thomas P. Gunning was appointed Vice President, Secretary /
Treasurer of the Registrant in May 1999. He was appointed Chief Financial
Officer in September, 1994 and served in that capacity until May 0f 1999. He was
again appointed Chief Financial Officer in May of 2000. He was appointed
Secretary of the Registrant in January of 1995. He has served as Controller of
the Registrant since September, 1992. He is a Certified Public Accountant
licensed by the States of New York and New Jersey. From 1989 until joining the
Registrant, Mr. Gunning was the Senior Audit Manager at Rosenberg Selsman &
Company, a certified public accounting firm. From 1976 to 1989, he was Chief
Financial Officer of Flyfaire, Incorporated, a travel wholesale operator. Prior
to such time, Mr. Gunning held various positions in both public and private
accounting firms.
Board of Directors
The Registrant's Board of Directors currently consists of five persons,
one of whom is a member of management. and four of whom are non-management
directors. During the fiscal year ended January 31, 2001, the Board held six
meetings, each of which was attended by all of the directors then serving.
The Company's Board of Directors has Audit and Compensation Committees,
but does not have a Nominating Committee or a committee performing a similar
function. The Audit Committee currently consists of three non-management
directors, Messrs. Henry Luken, Walt Anderson and Leon Genet. The Committee
reviews, analyzes and may make recommendations to the Board of Directors with
respect to the Company's financial statements and controls. The Committee has
met and intends to meet from time to time with the Company's independent public
accountants to monitor their activities. The Compensation Committee consists of
Messrs. Henry Luken and Jay J. Miller and is charged with reviewing and
recommending the compensation and benefits payable to the Company's senior
executives. Mr. Leach is an ex-officio member of both the Compensation and Audit
Committees.
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23
ITEM 11. Executive Compensation
The following table sets forth the compensation which the Company paid during
the fiscal years ended January 31, 2001, 2000 and 1999 to its Chief Executive
Officer and to each executive officer of the Company or person performing
similar functions whose aggregate remuneration exceeded $100,000, during the
Company's fiscal year ended January 31, 2001 (the "Named Executives").
Summary Compensation Table
Name and Fiscal Year Annual Compensation Other Compensation
Principal Ended --------------------------- Annual Awards All Other
Position anuary 31 Salary($) Bonus($) Compensation($) Options Compensation($)
- --------- --------- --------- -------- --------------- ------- ---------------
A. John Leach 2001 $210,000 $ 0 $ 0 $15,346(3)
President and
Chief Executive
Officer (2)
Thomas P 2001 $147,360 $ 0 $ 0 $11,427(4)
Gunning 2000 $140,000 $ 0 $ 0 $11,179(5)
Vice President, 1999 $124,230 $ 2,000 $ 0 $10,161(6)
Treasurer
and Secretary
Dennis Spina 2001 $ 57,692
President and 2000 $305,769 $ 2,857(8)
Chief Executive
Officer (7)
Sal Quadrino 2001 $ 72,019 $ 2,160(10)
Vice President 2000 $137,307
and Chief Financial
Officer (9)
- --------------------------------------------------------------------------------
(1) See Option Grant Table below.
(2) Mr. Leach joined the Company on May 18, 2000. See part (e) for a
discussion of Mr. Leach's employment agreement
(3) The amount shown represents the Company's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $346 and $15,000 in
reimbursement for certain relocation expenses.
(4) The amount shown represents the Company's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $4,460, $2,167 for
the use of a Company's vehicle for non-business purposes and $4,800 for
term life insurance premiums.
(5) The amount shown represents the Company's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $4,200, $2,179 for
the use of a Company's vehicle for non-business purposes and $4,800 for
term life insurance premiums.
(6) The amount shown represents the Company's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $3,837, $1,524 for
the use of a Company's vehicle for non-business purposes and $4,800 for
term life insurance premiums.
(7) Mr. Spina resigned from his position on March 17, 2000.
(8) The amount shown represents $2,857 for the use of a Company vehicle for
non-business purpose
(9) Mr. Quadrino resigned from his position on June 16, 2000.
(10) The amount shown represents the Company's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $2,160.
24
Compensation Pursuant to Plans
In October, 1987, the Registrant adopted its 1987 Stock Option Plan, in
October, 1996, adopted its 1996 Stock Option Plan and in February, 2000,adopted
its 1999 Equity Incentive Plan (the "Option Plans"). The Option Plans provide
that certain options granted thereunder are intended to qualify as "incentive
stock options" within the meaning of Section 422A of the United States Internal
Revenue Code, while non-qualified options may also be granted under the Option
Plans. Incentive stock options may be granted only to employees of the
Registrant, while non-qualified options may be granted to non-executive
directors, consultants and others as well as employees.
The Option Plans may be administered by the Compensation Committee of
the Registrant's Board of Directors. The Registrant has reserved 1,329,800
shares of Common Stock under the 1987 Option Plan, 600,000 shares of Common
Stock under the 1996 Option Plan and 750,000 shares of Common Stock under its
1999 Equity Incentive Plan for issuance to employees, officers, directors and
consultants of the Registrant. The shares underlying the options granted prior
to July 15, 1994 have been adjusted for a 10% stock dividend. The shares
underlying the options granted prior to July 1, 1996 have been adjusted to
reflect a 2-for-1 stock split, and options granted prior to July 1, 1998 have
been adjusted to reflect a 2-for-1 stock split.
No option may be transferred by an optionee other than by will or the
laws of descent and distribution, and during the lifetime of an optionee, an
option may be exercised only by him. In the event of termination of employment
other than by death or disability, the optionee will have one month (subject to
extension not to exceed an additional two months) after such termination during
which he may exercise his option. Upon termination of employment of an optionee
by reason of death or permanent total disability, his option remains exercisable
for one year thereafter to the extent it was exercisable on the date of such
termination. No similar limitation applies to non-qualified options.
Options under the Option Plans must be granted within 10 years from the
effective date of the respective Option Plan. Incentive stock options granted
under the Option Plans cannot be exercised later than 10 years from the date of
grant. Options granted under the Option Plans permit payment of the exercise
price in cash or by delivery to the Registrant of shares of Common Stock already
owned by the optionee having a fair market value equal to the exercise price of
the options being exercised, or by a combination of such methods of payment.
Therefore, an optionee may be able to tender shares of Common Stock to purchase
additional shares of Common Stock and may theoretically exercise all of his
stock options with no additional investment other than his original shares.
Any option which expires unexercised or that terminates upon an
employee's ceasing to be employed by the Registrant become available again for
issuance under the Option Plans.
OPTION GRANTS IN LAST FISCAL YEAR
Potential Realizable
Value At Assumed
Rates of Stock
Appreciation For
-----------------------
Number of Securities % of Total Option/SARs Option Term
Underlying Options/ Granted To Employees In Exercise Expiration -----------------------
Name SARs Granted(#) Fiscal Year Price Date 5% 10%
- ---- --------------- ----------------------- --------- ----------- -------- ----------
A. John Leach 288,000 (1) 61.92% $14.25 May 18, 2003 $646,893 $1,358,424
- --------------------------------------------------------------------------------
(1) Stock option granted under the 1996 Stock Option Plan. Vesting in six
equal semi-annual installments, commencing six months from the date of
grant. The market price on the date of grant was less than the exercise
price of $14.25 per share.
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The following table sets forth information concerning each exercise of
a stock option during the Registrant's fiscal year ended January 31, 2001 by
each of the Named Executives, and the number and value of unexercised options
granted by the Registrant held by each of the Named Executives on January 31,
2001.
Aggregated Option Exercises In Last Fiscal Year
And Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Underlying Unexercised In-The Money Options/SARs
Shares Acquired Options/SARs At Fiscal Year End At Fiscal Year End
Name On Exercise(#) Value Realized($) Exercisable/Unexercisable Exercisable/Unexercisable
- ---- ---------------- ----------------- ------------------------------- --------------------------
Thomas P. Gunning 16,500 $58,078 20,000/8,500 $8,325/$0
Compensation of Directors
For the fiscal year ended January 31, 2001, each director who was not
an employee of the Registrant was entitled to receive a director's fee of
$15,000 per year, and to be reimbursed for out-of-pocket expenses incurred in
connection with his attendance at meetings. However, Messrs. Anderson and Luken
waived the right to receive such compensation.
Employment Contracts,Termination of Employment and Change of Control
Arrangements
As the Registrant's Chief Executive Officer, Mr. Leach has a three year
employment agreement with the Registrant effective as of May 18, 2000, pursuant
to which Mr. Leach is paid an annual base salary of $300,000. Pursuant to this
agreement, Mr. Leach was also to receive a signing bonus in the amount of
$25,000 to cover relocation and other expenses; however, as of this date Mr.
Leach has only received $15,000 of this amount. Mr. Leach is also entitled to
receive an annual bonus in an amount not to exceed 100% of his then effective
base salary, based upon Mr. Leach's attainment of annual revenue and earning
targets as well as management goals set by the Board of Directors. Mr. Leach is
guaranteed a minimum bonus payment of $150,000 during the first year of this
agreement.
In connection with his appointment as Chief Executive Officer of the
Registrant, Mr. Leach