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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended January 31, 2004
Commission File Number 0-2180
[COVISTA COMMUNICATIONS LOGO]
COVISTA COMMUNICATIONS, INC.
(Exact name of Company 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.)
721 Broad Street, Suite 200
Chattanooga, TN 37402
(Address of principal executive offices)(Zip Code)
(423) 648-9500
Company's telephone number, including area code:
Securities registered pursuant to Section 12 (b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.05 par value per share
Indicate by check mark whether Covista Communications, Inc. ("Covista" or the
"Company")(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 Covista 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 Company'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 $3.20 closing price) of the voting stock
held by nonaffiliates of Covista as of April 15, 2004, was approximately
$14,021,000 (calculated by excluding solely for purposes of this form,
outstanding shares owned by Directors and Executive Officers).
Number of shares of Common Stock outstanding on April 15, 2004: 17,822,025
Documents Incorporated By Reference:
None
PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS:
Certain of the statements contained in this Form 10-K Report may be
considered "forward-looking statements" for purposes of the securities laws.
From time to time, oral or written forward-looking statements may also be
included in other materials released to the public. These forward-looking
statements are intended to provide our management's current expectations or
plans for our future operating and financial performance, based on our current
expectations and assumptions currently believed to be valid. For these
statements, we claim protection of the safe harbor for forward-looking
statements provided by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements can be identified by the use of forward-looking
words or phrases, including, but not limited to, "believes," "estimates,"
"expects," "expected," "anticipates," "anticipated," "plans," "strategy,"
"target," "prospects" and other words of similar meaning in connection with a
discussion of future operating or financial performance. Although we believe
that the expectations reflected in such forward-looking statements are
reasonable, there can be no assurance that such expectations will prove to have
been correct.
All forward-looking statements involve risks and uncertainties that may
cause our actual results to differ materially from those expressed or implied in
the forward-looking statements. This Form 10-K Report includes important
information as to risk factors in the "Business" section under the headings
"Business" "Competition" and "Regulation" and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations." In addition to those
factors discussed in this Form 10-K Report, you should see our other reports on
Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission from
time to time for information identifying factors that may cause actual results
to differ materially from those expressed or implied in the forward-looking
statements.
ITEM 1. Business
General
Covista Communications, Inc. ("Covista"), a New Jersey corporation,is
a telecommunications, Internet and data services provider that operates three
distinct business segments: retail, KISSLD and wholesale. Retail is currently
the largest segment and provides local, long distance, data and Internet
services to small and medium sized businesses, principally in the Northeast
region of the United States. KISSLD is the fastest growing segment and offers
bundled local and long distance services to residential users who are located
primarily in areas supported by our long distance network facilities. The
wholesale segment provides long distance telecommunication services to other
carriers for resale. Covista utilizes its own switching equipment and leased
fiber optic transmission cable. Our products and services include a broad range
of voice, data and Internet, including local, long distance and toll-free
services, calling cards, data, Internet access, virtual private network,
directory assistance and teleconferencing services. Covista currently operates
five switches in various locations. Covista processes approximately eighty five
percent of all its call volume through its own facilities.
In the retail segment, Covista has tailored its service offerings,
sales, marketing approach and network development to provide service in a
cost-effective manner. Covista applies a dedicated team approach to soliciting
and servicing its commercial clients, with substantial involvement of sales,
customer service and technical personnel in all aspects of customer relations.
Covista intends to continue to focus its retail marketing efforts on small to
medium-sized businesses with sales of $1 million to $60 million and monthly
communications bills that range from $500 to $30,000.
The KISSLD segment offers discount local and long distance services to
residential users through direct marketing campaigns, which include mail, space
advertising and web based efforts, in addition to a variety of affinity
relationships with marketing partners. The KISSLD segment has experienced
considerable growth since its 2003 launch and the Company expects this segment
to remain the fastest growing of the three.
The Company also maintains a wholesale segment that provides primarily
domestic and international long distance services to other carriers. In recent
years, the Company has intentionally reduced its marketing and support efforts
for this wholesale segment in an effort to provide more support to the other two
segments. Both the retail and KISSLD segments offer lower financial risk in the
form of un-collectible accounts and higher gross margins than those generated
from the wholesale segment.
For Fiscal 2004, Covista had gross revenues of approximately $84
million, derived approximately 75% from retail, 20% from KISSLD, and 5% from
wholesale. This represents an approximately $17 million decrease when compared
to the approximately $101 million of gross revenue generated during the previous
fiscal year.
Covista maintains its corporate headquarters and call center facility
in Chattanooga, Tennessee. In addition, the Company operates a network
operations center in Chattanooga to monitor and control its network and to
coordinate its various services. Covista's principal executive offices are
located at 721 Broad Street, Suite 200, Chattanooga, TN, 37402, and its
telephone number is (423) 648-9500.
2
Business Strategy
Covista's strategy has been to develop a large geographic concentration
of revenue producing bundled phone service customers through the sale of
telecommunications services in areas where it has installed switching platforms.
In addition, Covista will use the wholesale operating platforms of incumbent
local exchange companies to provide local services.
Current Network
Currently, Covista operates an advanced telecommunications network,
which includes five Alcatel switches, located in New York City, Philadelphia,
Pennsylvania, Minneapolis, Minnesota, Dallas, Texas and Chattanooga, Tennessee.
The New York switch is an Alcatel Megahub DEX600E, which provides interexchange
switching capabilities and is currently being used as Covista's international
gateway switching platform. In July 2001, Covista acquired long-term access to
nationwide network facilities comprising 2,822,400,000 channel miles of
telecommunications capacity measured by length of voice-grade circuits. During
Fiscal 2004, Covista billed approximately 1.27 billion minutes, with
approximately 85% of its minutes carried over its own switches. Covista believes
that increasing the traffic carried on its own network should improve operating
margins.
Covista 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
have been a source of wholesale international traffic and revenue. Covista 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 Covista's Advanced Intelligent Network ("AIN")
capabilities throughout its network. Covista'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.
Covista has a Network Operating Center (NOC) in Chattanooga, Tennessee,
which monitors and controls Covista's network and coordinates its various
services from a central location, increasing the security, reliability and
efficiency of Covista's operations. Centralized electronic monitoring and
control of Covista's network allows Covista to avoid duplication of this
function in each switch site. The NOC also helps reduce Covista's per-customer
monitoring and customer service costs. In addition, Covista's network employs an
"authorized access" architecture. Unlike many telecommunications companies,
which allow universal access to their network, Covista utilizes an automatic
number identification security screening architecture which ensures only the
Automatic Number Identification (ANIs) of those users who have subscribed to
Covista's services and have satisfied Covista's credit and provisioning criteria
have access to the network. Covista believes that this architecture provides
Covista the ability to better control bad debt and fraud in a manner, which is
invisible and nonintrusive to the customer. This architecture also allows
Covista to better manage network capacity, as unauthorized users cannot access
the network.
3
PRINCIPAL PRODUCTS AND SERVICES
Product and Service Offerings
Retail Services. Covista provides telecommunications services to over
100,000 commercial customers, primarily small and medium-sized businesses,
located in the Northeastern region of the United States. Covista sells retail
services through its independent marketing representatives and web based
marketing programs. Retail services accounted for approximately $62.4 million or
75% of Covista's Fiscal 2004 total revenue. This compares to approximately $75.5
million of retail revenue in Fiscal 2003.
KISSLD. During Fiscal 2003, Covista introduced a new business segment,
KISSLD, a direct marketing program that targets residential customers located in
areas supported by the existing company network. At year-end, over 68,000
customers were being billed on a monthly basis. KISSLD revenues accounted for
approximately $17.3 million or 20% of Covista's Fiscal 2004 total revenue.
Wholesale Services. Covista 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.
Covista's wholesale results were severely affected by the September 11, 2001
terrorist attack. The Company suffered the temporary loss of its New York City
switch, which is situated in the immediate vicinity of the World Trade Center.
As a result, Covista incurred a significant reduction in wholesale revenues. As
described further under Managements Discussion and Analysis section, Covista
recently executed a final settlement regarding the insurance claim related to
these losses. Wholesale revenues were approximately $4.4 million and $12.5
million during Fiscal 2004 and Fiscal 2003, respectively. Future wholesale
revenues are expected to decline as management dedicates more focus and
resources to the higher margin retail and KISSLD segments.
Covista's services include the following:
o Long Distance: Covista 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 (Local Access
Terminating Area), 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: Covista 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: Covista 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: Covista offers nationwide switched access,
customized calling card services. Customers have the option of calling
cards, which are personalized, branded or generic.
o Internet: Covista currently offers high-quality, dedicated DSL and
dial-up Internet access, e-mail, IP addressing and Domain Name
Services.
o Data Services: Covista 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 Covista'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.
o Local Services: The unbundled network element platform of the incumbent
local exchange companies offer to us, in an individual or combined
form, a series of unbundled network elements, or UNEs, that comprise
the most important facilities, features, functions and capabilities of
an incumbent local exchange company's network. When offered in the
combination known as the unbundled network element platform, these
components include the loop and switching elements needed to provide
local telephone service to a customer.
Our bundled service generally includes: unlimited local usage dependent
upon the service plan, long distance service and calling cards, one
convenient invoice available both in paper and electronically, and
choices of various features such as caller ID, call waiting, voice mail
and three-way calling.
4
The unbundled network element operating platform of the incumbent local
exchange companies generally provides us with certain advantages,
including: (i) offering local telephone service to customers located
virtually anywhere without having to deploy local switching facilities;
(ii) providing the same services as the incumbent local exchange
companies; (iii) delivering higher margins than comparable service
offered through resale agreements; and (iv) eliminating the requirement
to pay certain local network access fees while collecting local network
access fees for calls delivered to our local telephone customers. In
some instances, however, such as customers having high usage volumes,
resale may provide us with a lower cost structure than the use of the
unbundled network element platform.
Information Systems
We have integrated order processing, provisioning, billing, payment,
collection, customer service and information systems that enable us to offer and
deliver high-quality, competitively priced telecommunication services to our
customers and process millions of call records each day. These operational
support systems were developed by our employees and customized for our business
and operational requirements and, due to the system's component-based
architecture, provide an extensive framework for the introduction of new
products and services. Through dedicated electronic connections with our long
distance network and the incumbent local exchange companies, we have designed
our systems to process information on a "real time" basis.
In addition, we maintain our own web sites at www.covista.com,
www.kissld.com, and others to provide for customer sign-up and to provide
customers and potential customers with information about our products and
services as well as billing information and customer service. We provide these
services and features using our web-enabled technologies that allow us to offer
our customers:
o Detailed rate schedules and product and service related information.
o Online sign-up for our telecommunication services.
o Credit card billing.
o Real-time and 24 x 7 billing services and online information, providing
customers with up to the hour billing information.
The information functions of our systems are designed to provide easy
access to all information about a customer, including volumes and patterns of
use. This information can be used to identify emerging customer trends and to
respond with services to meet customers' changing needs. This information also
allows us to identify unusual usage by an individual customer, which may
indicate fraud. FCC rules, however, may limit our use of customer proprietary
network information. See "Regulation."
Sales and Marketing
We use diverse sales and marketing channels to reach the residential
and small business markets with our service offerings. Our sales and marketing
efforts focus on marketing a bundle of local and long distance telephone
services directly to customers exclusively under our own brand. We currently
market our bundled services to customers in three states, where we can
profitably offer services at competitive prices. We intend to market in
additional states (or certain areas of a particular state) as our pricing and
cost structure permit us to profitably offer services in those areas at
competitive rates.
We employ a targeted approach to customer acquisition and use
database-marketing tools to identify and prioritize target customers. We offer
diverse calling and service plans tailored to fit the needs of the broader
residential market with low base prices and free features. Customers can switch
to us online, or through an authorized agent, each of which uses consultative
sales tools to assist the customer's selection of the right plan for its
telecommunications needs. Customers are able to keep their same phone lines and
number, can easily add features, and, generally within days of the sale, are
switched to our service and receive a personalized welcome kit explaining their
service. We market our bundled services within our targeted markets through the
following channels:
o Direct Mail: We purchase small business and residential lead databases
utilized for demographically targeted direct mail campaigns designed to
direct inbound calls to our telemarketing centers.
o Referrals: We solicit, through the use of referral promotions, the
names of potential customers or referrals from our existing customers.
o Online Marketing: We have developed an online marketing presence
through traditional online media and business relationships.
o Direct Sales: Utilizing independent agents, we solicit new customers in
targeted geographic areas.
o Media: We solicit inbound subscriber calls through advertising on
television, radio and in print.
5
We focus on targeting, acquiring and retaining profitable customers by
providing savings, simplicity and service. We continue to seek new marketing
partners and arrangements to expand both our opportunities to attract other
customers to our services and the products and services that we offer to our
customer base.
COMPETITION
The telecommunication industry is highly competitive. Major
participants in the industry regularly introduce new services and marketing
activities. Competition in the telecommunication industry is based upon pricing,
customer service, billing services and perceived quality. We compete against
numerous telecommunication companies, which offer essentially the same services
as we do. Many of our competitors, including the incumbent local exchange
companies, are substantially larger and have greater financial, technical and
marketing resources. Our success will depend upon our continued ability to
provide high quality, high value services at prices generally competitive with,
or lower than, those charged by our competitors.
The incumbent local exchange companies and the major carriers,
including SBC, Verizon, BellSouth, AT&T, Sprint and MCI Inc., have targeted
price plans at residential customers - one of our primary target markets - with
significantly simplified rate structures and with bundles of local services with
long distance, which may lower overall local and long distance prices.
Competition is also fierce for the small businesses that we serve. Additional
pricing pressure may also come from the introduction of new technologies, such
as Voice over Internet Protocol, or VoIP, which seek to provide voice
communications at a cost below that of traditional circuit-switched service. In
addition, wireless carriers have marketed their services as an alternative to
traditional long distance and local services, further increasing competition.
Reductions in prices charged by competitors may have a material adverse effect
on us.
The incumbent local exchange companies are well-capitalized, well-known
companies that have the capacity to "bundle" other services, such as local and
wireless telephone services and high speed Internet access, with long distance
telephone services. The incumbent local exchange companies' name recognition in
their existing markets, the established relationships that they have with their
existing local service customers, their ability to take advantage of those
relationships, and the possibility that interpretations of the
Telecommunications Act may be favorable to the incumbent local exchange
companies, also make it more difficult for us to compete with them.
Seasonal Nature of Business
The Company's business is not seasonal.
Patents, Trademarks, Licenses, etc.
The Company does not hold any material patents, franchises or
concessions.
GOVERNMENT REGULATIONS
General
Our provision of telecommunication services is subject to government
regulation. Generally speaking, the FCC regulates interstate and international
telecommunications, while the state commissions regulate telecommunications that
originate and terminate within the same state.
The Telecommunications Act of 1996 provided for a significant
deregulation of the domestic telecommunications industry, including the opening
of the local markets of the incumbent local exchange companies to competition
and the ability, pursuant to certain market-opening conditions, of the Regional
Bell Operating Companies, which are incumbent local exchange companies, to
reenter the long distance industry. The Telecommunications Act remains subject
to judicial review and additional FCC rulemaking, and thus it is difficult to
predict what effect the legislation and regulations will have on us and our
operations over time. As we discuss below, there are currently a number of
regulatory proceedings underway, and being contemplated by federal and state
authorities regarding the availability of the unbundled network element platform
and other unbundled network elements, interconnection, pricing and other issues
that could result in significant changes to the business conditions in the
telecommunication industry, and have a material adverse effect on our
operations. In addition, there has been discussion in Congress of modifying the
Telecommunications Act in ways that could prove detrimental to us.
6
In January 1999, the U.S. Supreme Court confirmed the FCC's role in
establishing national telecommunications policy through implementation of the
Telecommunications Act, and thereby created greater certainty regarding the
rules governing local competition going forward. The FCC's rules that permit us
to purchase the unbundled network element platform to provide local and long
distance telecommunications services to our customers are the primary rules
governing competition upon which we rely. Although the rights established in the
Telecommunications Act are a necessary prerequisite to the introduction of full
local competition, they must be properly implemented and enforced to permit
competitive telephone companies like us to compete effectively with the
incumbent carriers.
Regulation of Access to Unbundled Network Elements
Access to incumbent local exchange companies' unbundled network
elements at cost-based rates is critical to our business. Our local
telecommunications services are provided almost exclusively through the use of
combinations of unbundled network elements, and it is the availability of
cost-based rates for these elements that enables us to price our local
telecommunications services competitively. However, the obligation of incumbent
local exchange companies to provide unbundled network elements at such
cost-based rates currently is the subject of regulatory and judicial actions
that may affect their availability. Such proceedings could result in the
availability of these elements being substantially reduced or otherwise subject
to significantly higher, non-cost-based rates.
Access to incumbent local exchange companies' unbundled network
elements in a fashion in which they are combined by the incumbent local exchange
company is critical to our business. Our local telecommunications services are
provided primarily through the use of the unbundled network element platform, in
which unbundled network elements necessary to provide service to our customers
(unbundled loops, transport, and local switching) are combined by the incumbent
local exchange company and then leased to us. The existing set of unbundled
network elements were largely established by the FCC in its 1996 Local
Interconnection Order, and updated in a proceeding on remand from the Supreme
Court's Iowa Utilities Board decision in 1999. The Supreme Court held that the
FCC did not apply the correct standards when determining which network elements
must be unbundled and made available to competitive telephone companies such as
us. In November 1999, the FCC released its "UNE Remand Order", addressing the
deficiencies in the FCC's original ruling cited by the Supreme Court. The UNE
Remand Order was generally viewed as favorable to us and other competitive
carriers because it ensured that incumbent local exchange companies would be
required to make available those network elements, including the unbundled
network element platform, that are crucial to our ability to provide local and
other telecommunications services. The UNE Remand Order was appealed by the
incumbent local exchange companies and, in May 2002, the United States Court of
Appeals for the District of Columbia Circuit released an opinion reversing and
remanding the UNERemand Order to the FCC for further consideration. The Court
remanded the UNE Remand Order because (1) the FCC adopted, as to almost every
unbundled element, a uniform national rule mandating the element's unbundling in
every geographic market and customer class, without regard to the state of
competition in any particular market; and (2) the FCC's concept of the
circumstances in which cost disparities would, under the Telecommunications
Act's standards, "impair" a competitor's ability to provide service without
unbundled elements was considered too broad.
As part of its regular periodic review of the list of unbundled
elements available to competitive carriers under the Telecommunications Act and
in response to the remand of the UNE Remand Order, the FCC initiated its
so-called Unbundled Network Element Triennial Review rulemaking proceeding on
December 12, 2001. The FCC, in its Triennial Review and in response to the D.C.
Circuit Court's decision, reviewed all unbundled network elements to determine
whether incumbent local exchange companies should continue to be required to
provide them to competitors.
In the FCC's Unbundled Network Element Triennial Review Order, released
August 21, 2003 and effective as of October 2, 2003, the FCC determined that
certain network elements will no longer be subject to unbundling requirements,
while other network elements must continue to be offered subject to further,
more detailed review by the state commissions. The FCC established guidelines
for these state determinations, which are currently underway, and ordered state
commissions to complete their reviews by July 2, 2004. Among the network
elements subject to further state review is local circuit switching, which is a
critical component of the unbundled network element platform. Also subject to
further review are certain types of unbundled loops and interoffice transport.
7
The FCC's UNE Triennial Review Order was appealed by numerous parties.
The federal judicial appeals were consolidated in the U.S. Court of Appeals for
the District of Columbia. On March 2, 2004, the Court released a decision that
reversed, vacated and remanded the FCC's UNE Triennial Review Order in material
respects. Of most importance to us, the Court determined that the FCC erred in
delegating decision-making authority to state commissions, and in making
national findings of impairment with respect to the switching and dedicated
interoffice transport unbundled network elements. The Court stayed its decision
until the denial of any petitions for rehearing or for a 60-day period (i.e.,
until May 1, 2004), whichever is later. Unless the Court's decision is itself
stayed by the Court or the U.S. Supreme Court, or the FCC promulgates effective
replacement rules, the result of the Court's decision will be that the FCC's
rules requiring incumbent local telephone companies to make available the mass
market switching and dedicated interoffice transport unbundled network elements
to competitors at cost based rates pursuant to Section 251 of the
Telecommunications Act will no longer be effective. However, the Court affirmed
FCC rules that require former Regional Bell Operating Companies to make
available similar unbundled network elements pursuant to Section 271 of the
Telecommunications Act, albeit at rates that are "just and reasonable" rather
than strictly cost based. Although prices for Section 271 unbundled network
elements have not yet been established, it is probable that they will generally
be higher than those charged for Section 251 unbundled network elements.
Notably, in response to the Court's ruling, some state public utility
commissions, but not all, have suspended their state impairment proceedings.
Should local circuit switching not be available to us due to this
adverse decision or otherwise, we would be unable to offer services on an
unbundled network element platform basis and would instead have to serve
customers through total service resale agreements with the incumbent local
telephone companies, through network elements purchased from the Regional Bell
Operating Companies at "just and reasonable" rates under Section 271 of the Act
or through our own facilities or the switching facilities of other non-incumbent
carriers, any of which which could delay our service roll-out in some markets,
increase our cost, and negatively impact our business, prospects, operating
margins, results of operations, cash flows and financial condition.
A brief summary of the FCC's actions under its UNE Triennial Review
Order that would likely have a significant impact on us is provided below:
Unbundled Local Switching and the Unbundled Network Element Platform: Our
telecommunications services are provided primarily through the combination of
unbundled network elements, including unbundled local circuit switching, loop
and shared transport elements, commonly referred to as the unbundled network
element platform. The FCC's rules previously required that the incumbent local
exchange companies provide to competitors the unbundled network element
platform, including all network elements required by the competitor to provide
retail telecommunications services, in most geographic areas. Through the use of
the unbundled network element platform, we are able to provide retail local
services entirely through the use of the incumbent local exchange companies'
facilities at lower prices than those available for local resale through total
resale service agreements with the incumbent local exchange companies.
Among the network elements made subject to further state review under
the FCC's UNE Triennial Review Order is the local circuit switching unbundled
network element, which is a critical component of the unbundled network element
platform. With respect to the local circuit switching element, the FCC adopted a
national finding that competitive carriers providing telecommunications services
to "mass market" customers are impaired without access to unbundled local
circuit switching. Accordingly, under the FCC's UNE Triennial Review Order,
incumbent local exchange companies were required to provide to competitive
carriers serving the mass market access to the local circuit switching element,
except where a state commission has determined in a nine-month proceeding,
pursuant to the guidelines established by the FCC, that competitive carriers are
not impaired without access to the local circuit switching element in a
particular market, or otherwise that impairment in a particular market would be
cured by implementation of a transitional local circuit switching regime. The
state commissions could eliminate incumbent local exchange company unbundling
requirements for local circuit switching in a particular market where one of the
two "triggers" established by the FCC is satisfied: (1) three or more competing
providers (providers not affiliated with each other or the incumbent local
exchange company) serve mass market customers with the use of their own local
circuit switches; or (2) two or more competing providers (providers not
affiliated with each other or the incumbent local exchange company) offer
wholesale local circuit switching service to carriers serving mass market
customers using their own switches. In addition, where neither of the so-called
"triggers" are satisfied for a particular market, the state commissions could
nonetheless eliminate existing unbundling requirements for local circuit
switching where market conditions would permit competitive entry through the
deployment of new local circuits, or otherwise relax existing unbundling
requirements where impairment in a particular market would be cured by
implementation of a transitional local circuit switching regime. If the state
commission determined that any of these tests is satisfied, then competitors
could be foreclosed from submitting new orders for use of the local switching
network element after five months, and they would be required to submit orders
to migrate their embedded based of customers over a 13-27 month timeline.
8
However, as discussed above, the Court recently reversed, vacated and
remanded both the FCC rules that delegated decision-making with respect to
unbundled network elements to state commissions and the FCC's national findings
that competitive carriers are impaired absent the availability of the mass
market switching and dedicated interoffice transport unbundled network elements.
Thus, current FCC rules requiring incumbent telephone companies to make the mass
market switching and dedicated interoffice transport unbundled network elements
available to competitors at call-based rates could expire as soon as May 1,
2004. Although the incumbent local exchange company unbundling requirements for
local circuit switching arising under Section 251 of the Telecommunications Act
may be eliminated or limited by state commissions acting under the FCC's UNE
Triennial Review Order, or due to the Court's decision to reverse and vacate
these rules, competitive carriers' access to local circuit switching on
unbundled basis is preserved under Section 271 of the Telecommunications Act as
a condition to the Regional Bell Operating Company's ability to provide
in-region long distance services. However, the local circuit switching element,
if accessible to competitive carriers only pursuant to Section 271 of the
Telecommunications Act, may be offered at significantly higher rates, and
subject to less favorable terms and conditions imposed by the incumbent local
exchange companies, including the possibility that the incumbent local exchange
companies will not be required to combine unbundled local circuit switching
provided pursuant to Section 271 with other non-unbundled network elements or
tariffed services. Should the local circuit switching element becomes
effectively unavailable to serve a particular market, we would be unable to
provide services on an unbundled network element platform basis and would
instead have to serve customers through total service resale agreements with the
incumbent local exchange companies, through network elements purchased from the
Regional Bell Operating Companies at "just and reasonable" rates under Section
271 of the Act or through our own facilities or the switching facilities of
other non-incumbent carriers. Our transition from providing telecommunications
services on an unbundled network element platform basis may delay our service
roll-out in some markets, increase our costs and negatively impact our business,
prospects, operating margins, results of operations, cash flows and financial
condition.
Under the FCC'S UNE Triennial Review Order, the FCC preserved existing
unbundling requirements for the mass market (that is, DS0) loops used by us for
the vast majority of our unbundled network element platform and switch-based
telecommunications operations. Furthermore, those unbundling requirements are
not subject to further state review under the order, and, therefore, cannot be
eliminated or otherwise restricted by the state commissions. Accordingly, the
order should have little, if any, adverse impact on our ability to obtain the
unbundled loops facilities critical to our telecommunications operations.
Access to Broadband: The FCC'S UNE Triennial Review Order does not require the
incumbent local exchange companies to unbundle "next generation" network
facilities, including new "fiber-to-the-home" loops and hybrid copper/fiber
loops (to the extent requested for the purposes of providing broadband services
to the mass market). While the FCC's policy of restricted access to the
incumbent local exchange company's broadband network facilities may be
unfavorable to us and other competitive carriers, the adverse impact of
broadband deregulation under the order is softened by the continued availability
to competitive carriers of incumbent local exchange company-provided Time
Division Multiplexing functionality on an unbundling basis.
Unbundled Network Element Pricing: The current pricing rules for unbundled
network elements were established in the FCC's 1996 Local Competition Order, in
which the FCC ordered that the rates for unbundled network elements charged to
new entrants must be based on the forward-looking costs incurred by the
incumbent local exchange company in providing the interconnection services or
unbundled network elements ordered, as calculated using the "total element
long-run incremental cost," or TELRIC, methodology. The FCC rejected the use of
historical or embedded costs in setting rates that new entrants pay. The FCC
required that TELRIC be measured based on the use of the most efficient
telecommunications technology currently available and the lowest cost network
configuration, given the location of existing ILEC wire centers. Under the
Telecommunications Act, state commissions set the actual unbundled network
element rates based on the FCC's TELRIC methodology.
On remand from the U.S. Supreme Court in AT&T v. Iowa Utilities Board,
the Eighth Circuit Court of Appeals concluded in 2000 that the FCC's unbundled
network element pricing rules violated the terms of the Telecommunications Act.
The Eighth Circuit held that the FCC's TELRIC methodology incorrectly based
costs associated with a "hypothetical network", and not on the actual cost of
the particular facilities and equipment deployed by incumbent local exchange
company. The Eighth Circuit, however, did not vacate the FCC's decision to use a
forward-looking cost methodology. The Court determined that requiring that
forward-looking costs be used to establish unbundled network element rates is a
matter within the FCC's discretion. In 2002, the U.S. Supreme Court reversed the
decision of the Eighth Circuit and validated the FCC's TELRIC methodology in its
entirety.
Although the FCC's TELRIC methodology for establishing rates for
unbundled network elements has been upheld by the U.S. Supreme Court, it is
currently subject to comprehensive review by the FCC. On September 10, 2003, the
FCC released a Notice of Proposed Rulemaking that addressed, among other issues,
the impact of changes in ILEC unbundling obligations under the FCC's UNE
Triennial Review Order on the FCC's rules for the pricing of unbundled network
elements, or TELRIC NPRM. The FCC already has accepted Comments and Reply
Comments filed by interested parties in response to the TELRIC NPRM, and
currently is hearing ex parte presentations on matters related to this
rulemaking proceeding. The availability of incumbent local exchange company
unbundled network elements at cost-based rates is critical to our ability to
provide competitively priced local telecommunications services. Accordingly, any
change to the FCC's current TELRIC pricing methodology that would increase the
rates for unbundled network elements charged to competitive carriers could have
material adverse effect on our operations.
9
Federal Regulation of Our Rates, Terms and Conditions
The FCC has imposed numerous reporting, accounting, record keeping and
other regulatory obligations on us. We must offer interstate and international
services under rates, terms and conditions that are just, reasonable and
nondiscriminatory. We also must post publicly the rates, terms and conditions of
our interstate and international long distance service on our web site or
elsewhere, and are authorized to file interstate tariffs on an ongoing basis for
interstate access services (rates charged among carriers for access to their
networks). Although our interstate and international service rates, terms, and
conditions are subject to review by the FCC, they are presumed to be lawful and
have never been formally contested by customers or other consumers. Other FCC
rules govern the procedures we use to solicit customers, our handling of
customer information, our obligation to assist in funding the federal system of
universal service, our billing practices and the like. We may be subject to
forfeitures and other penalties if we violate the FCC's rules.
Long distance carriers pay local facilities-based carriers, including
us, interstate access charges for both originating and terminating the
interstate calls of long distance customers on the local carriers' networks and
facilities, including the unbundled network element platform. Historically, the
Regional Bell Operating Companies set access charges higher than cost and
justified this pricing to regulators as a subsidy to the cost of providing local
telephone service to higher cost customers. However, in 2000, the FCC
established regulations that dramatically decreased the rates for interstate
access charged by large incumbent local exchange companies, and, in 2001,
established regulations that dramatically decreased the rates for interstate
access charged by competitive carriers, including us. The FCC's interstate
access charge reform regimes for incumbent local exchange companies and for
competitive local exchange carriers, such as we, prescribes continuing access
charge rate reductions through 2005. The FCC's access charge rules are the
subject of ongoing rulemaking proceedings, which we believe will likely lead to
additional reductions in access charge rates or to result in the total
elimination of switched access charges.
Regulation of Advanced Services
Section 706 of the Telecommunications Act requires the FCC to encourage
the deployment of advanced telecommunications capabilities to all Americans, and
Section 10 of the Communications Act requires the FCC to forebear from applying
regulation where forbearance from regulation would be in the public interest.
Several incumbent local exchange companies have petitioned the FCC pursuant to
these provisions to modify or eliminate network unbundling obligations, or to
forbear from imposing the FCC's unbundling and interconnection rules. In
addition, incumbent telephone companies have filed similar petitions asking the
FCC to bar competitive carriers like us from billing and collecting
interexchange carrier switched access charges when providing service through the
use of the local switching unbundled network element. If any of these petitions
for waiver or forbearance are approved by action or inaction of the FCC, our
access to critical unbundled network elements could be thwarted, or our ability
to collect switched access charges could be forestalled, which could have a
material adverse effect on our operations.
Regulation of Voice Over Internet Protocol
Voice over Internet Protocol, or VoIP, is a service that manages the
delivery of voice information over data networks, using Internet Protocol.
Rather than send voice information across traditional circuits through the
public switched telephone network, VoIP sends voice information in digital form
using discrete packets that are routed in the same manner as data packets. The
regulation of VoIP is unsettled, and the FCC and numerous state commissions have
opened proceedings to determine whether VoIP should be regulated and, if so,
how. Among these proceedings, incumbent local exchange companies have petitioned
the FCC to rule that facilities over which they provide VoIP services are not
regulated. If such petitions were granted, the result could be to deny us access
to incumbent local exchange company unbundled network elements over the affected
facilities. On March 10, 2004, the FCC released a Notice of Proposed Rulemaking
to consider what regulatory framework to apply to VoIP and other IP-enabled
services in the future, including without limitation, whether such services
should be regulated by the FCC and how, and whether switched access charges
should be imposed when IP-enabled services connect to the public switched
telephone network.
Regulation of Marketing
Our current and past direct and partner marketing efforts all require
compliance with relevant federal and state regulations that govern the sale of
telecommunication services. The FCC and many states have rules that prohibit
switching a customer from one carrier to another without the customer's express
consent and specify how that consent must be obtained and verified. Most states
also have consumer protection laws that further define the framework within
which our marketing activities must be conducted. While directed at curbing
abusive marketing practices, the design and enforcement of these rules can have
the incidental effect of entrenching incumbent carriers and hindering the growth
of new competitors, such as our business.
10
Our marketing efforts are carried out through a variety of marketing
programs, including referrals from existing customers, direct sales through
independent agents, broadcast and print media, online marketing initiatives and
direct mail. Restrictions on the marketing of telecommunication services are
becoming stricter in the wake of widespread consumer complaints throughout the
industry about "slamming" (the unauthorized change of a customer's service from
one carrier to another carrier) and "cramming" (the unauthorized provision of
additional telecommunication services). The Telecommunications Act strengthened
penalties against slamming, and the FCC issued and updated rules tightening
federal requirements for the verification of orders for telecommunication
services and establishing additional financial penalties for slamming. Our
marketing activities may subject us to investigations or enforcement actions
by government authorities. The constraints of federal and state regulation, as
well as increased FCC, Federal Trade Commission and state enforcement attention,
could limit the scope and the success of our marketing efforts and subject them
to enforcement actions, which may have an adverse effect on us.
Statutes and regulations designed to protect consumer privacy also may
have the incidental effect of hindering the growth of newer telecommunication
carriers such as us. For example, the FCC rules that restrict the use of
"customer proprietary network information" (information that a carrier obtains
and uses about its customers through their use of the carrier's services) may
make it more difficult for us to market additional telecommunication services
(such as local and wireless), as well as other services and products, to our
existing customers.
Federal Legislation
Several congressmen have recently suggested that Congress should
consider rewriting substantial portions of the Telecommunications Act. Any
effort to reform the Telecommunications Act could result in changes that would
materially reduce the obligations of incumbent local exchange companies to
interconnect with, or provide unbundled network elements to, competitors. Any
such legislative change could have a material adverse impact on our operations.
Universal Service Fund Regulation
Pursuant to Section 254 of the Telecommunications Act, the FCC requires
us and other providers of telecommunication services to contribute to a
federally administered universal service fund, which helps to subsidize the
provision of local telecommunication services and other services to low-income
consumers, schools, libraries, health care providers, and rural and insular
areas that are costly to serve. The Telecommunications Act requires every
telecommunication carrier that provides interstate telecommunication services to
contribute, on an equitable and nondiscriminatory basis, to the specific,
predictable and sufficient mechanisms established by the FCC to preserve and
advance universal service. These regulations were recently amended and
contributions to the FCC's universal service funds are now assessed on
telecommunication providers' projected combined interstate and international end
user telecommunication revenues, and no longer permit telecommunication
providers to recover margin on this assessment. In a December 2002 Notice of
Proposed Rulemaking, the FCC has asked many broad-ranging questions regarding
universal service, including, whether to change its method of assessing
contributions due from carriers by basing it on the number and capacity of
connections they provide, rather than on interstate and international end user
revenues they earn. We cannot be sure that legislation or FCC rulemaking will
not increase the size of its subsidy payments, the scope of the subsidy program
or our costs of calculating, collecting and remitting the payments. Some states
have similar universal fund programs, and in those instances we may be required
to remit a portion of its intrastate revenue to such funds.
State Regulation
The vast majority of the states require us to apply for certification
to provide local and intrastate telecommunication services, or at least to
register or to be found exempt from regulation, before commencing intrastate
service. The majority of states also require us to file and maintain detailed
tariffs listing our rates for intrastate service. State law typically requires
charges and terms for our services to meet certain standards, such as requiring
that charges and practices be just, reasonable and not unreasonably
discriminatory. Many states also impose various reporting requirements and/or
require prior approval for transfers of control of certified carriers, corporate
reorganizations, acquisitions of telecommunication operations, assignments of
carrier assets, including subscriber bases, carrier stock offerings and
incurrence by carriers of significant debt obligations. Certificates of
authority can generally be conditioned, modified, canceled, terminated or
revoked by state regulatory authorities for failure to comply with state law and
the rules, regulations and policies of the state regulatory authorities. Fines
and other penalties, including the return of all monies received for intrastate
traffic from residents of a state, may be imposed for such violations. State
regulatory authorities may also place burdensome requirements on
telecommunication companies seeking transfers of control for licenses and the
like. Under the regulatory arrangement contemplated by the Telecommunications
Act, state authorities continue to regulate certain matters related to universal
service, public safety and welfare, quality of service and consumer rights. All
of these regulations, however, must be competitively neutral and consistent with
the Telecommunications Act, which generally prohibits state regulation that has
the effect of prohibiting us from providing telecommunications services in any
particular state. State commissions also enforce some of the Telecommunications
Act's local competition provisions, including those governing the arbitration of
interconnection disputes between the incumbent carriers and competitive
telephone companies and the setting of rates for unbundled network elements.
11
Compliance with Environmental Provisions
The Company 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.
12
PERSONNEL
As of the April 15, 2004, Covista and its subsidiaries employed 238
full-time and part-time employees in its telecommunication business. Covista
also utilizes the services of approximately 2,200 independent sales agents.
Covista considers its relations with its employees to be satisfactory.
ITEM 2. Properties
On November 1, 1996, Covista 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 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
proportionate share of increased operating expenses and real estate taxes over
the base year.
On February 6, 1998, Covista 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, Covista is liable for its
proportionate share of increases in real estate taxes and operating expenses
over the base year.
On September 1, 2001, Covista entered into a lease agreement for
approximately 28,000 square feet of office space in Chattanooga, Tennessee, with
Henry G. Luken III, Chairman of the Board, and a principal shareholder of
Covista. The term of the lease is for five years. The lease provides for annual
rent of $86,400 from September 1, 2001 to August 30, 2002; $115,200 from
September 1, 2002 to August 30, 2003; $144,000 from September 1, 2003 to August
30, 2004, with the last two years to be $144,000 annually adjusted for the
Consumer Price Index. Covista believes that such premises are leased on terms
not less favorable than an arm's length transaction.
On December 1, 2001, Covista entered into a lease for property located
at 806 East Main Street, Chattanooga, Tennessee, for use as a switching
facility. The lessor is Henry G. Luken III, Chairman of the Board and a
principal shareholder of Covista. The lease expires on November 30, 2006. Annual
rent is payable as follows: $22,500 from December 1, 2001 to November 30, 2002,
$27,000 from December 1, 2002 to November 30, 2003, $31,500 from December 1,
2003 to November 30, 2004, and $36,000 from December 1, 2004 to November 30,
2005. Rental amounts for months beginning after October 1, 2005 will be adjusted
upward for the U.S. Consumer Price Index. The lease may be renewed for an
additional 5 years upon 90 days' written notice prior to the lease expiration
date. Covista believes that such premises are leased on terms not less favorable
than an arm's length transaction.
On December 15, 2001, Covista entered into a lease for Suite 1350, 1201
Main Street, Dallas, TX, for use as a switching facility and expires on April
14, 2006. Annual rent is due as follows: $164,475 from April 15, 2000 to April
14, 2002, $175,440 from April 15, 2002 to April 14, 2004, and $186,405 from
April 15, 2004 to April 14, 2006. The lease has no provision for renewal.
On February 8, 2002, Covista assumed a lease for Suite 940, 401 N.
Broad Street, Philadelphia, PA, for use as a switching facility. Covista's
obligations under this lease commenced with the acquisition of Capsule
Communications. The lease expires on March 31, 2007. Base rent is $62,019
annually, with provisions for inflationary increases in operating costs. The
lease has no provision for renewal.
On February 8, 2002, Covista assumed a lease for Suite 275, 3331 Street
Road, Bensalem, PA, for use as a branch office facility. Covista's obligations
under this lease commenced with the acquisition of Capsule Communications. The
lease expires on August 31, 2004 with annual rent currently payable at the rate
of $248,448. Covista has no right to further extend or renew the term of the
lease.
On May 31, 2002, Covista entered into a lease for 2,900 useable (3,335
rentable) square feet at 511-11th Avenue South, Suite 312, Minneapolis,
Minnesota for use as a switching facility. The lease expires on May 31, 2009.
Annual rent is payable as follows: Year 1 = $86,376, Year 2 = $93,047, Year 3 =
$96,382, Year 4 = $99,717, Year 5 = $103,052, Year 6 = $106,387, and Year 7 =
$109,721. The lease may be renewed for an additional 5 years upon 4 months'
written notice prior to the lease expiration date. Covista pays its
proportionate share of real estate taxes and utilities for the leased space.
On August 15, 2002, Covista entered into a lease for approximately
3,700 square feet of the 5th Floor at 1 Mack Drive, Paramus, NJ for use as a
branch office facility. The lease expires on July 31, 2005 with annual fixed
rent due of $85,859. Additional rent of 1.07% is paid for operating costs,
subject to adjustment for escalation.
On October 1, 2002, Covista entered into a lease for Suite 200 at 721
Broad Street, Chattanooga, Tennessee, for use as offices for Corporate
Headquarters. The lessor is Henry G. Luken III, Chairman of the Board and a
principal shareholder of Covista. The lease expires on November 30, 2007. Annual
rent is payable as follows: Year 1 = $101,674, Year 2 = $111,670, Year 3 =
$120,000, Year 4 = $120,000, Year 5 = $120,000. Rental amounts for months
beginning after October 1, 2005 will be adjusted upward for the U.S. Consumer
Price Index. The lease may be renewed for an additional 5 years upon 90 days'
written notice prior to the lease expiration date. Covista believes that such
premises are leased on terms not less favorable than an arm's length
transaction.
13
ITEM 3. Pending Legal Proceedings
There are no pending legal proceedings, which could be expected to have
a material adverse effect on Covista.
ITEM 4. Submission of Matters to a Vote of Security Holders
A proxy statement dated November 13, 2003 and mailed to stockholders on
or about November 13, 2003 provided details on the election of eight directors
to serve for a term of one year and until their successors were duly elected and
qualified; Ratification of the selection of Deloitte & Touche LLP as independent
auditors of the Company for the fiscal year ending January 31, 2004; and the
transaction of such other business as properly came before the meeting or any
adjournment or postponement thereof. During the scheduled annual meeting of
stockholders on December 16, 2003, all of the foregoing matters were approved by
the requisite vote of stockholders of Covista.
14
PART II
ITEM 5. Market for Company's Common Stock and Related Security Holder Matters
Common Stock
Covista's authorized capital stock consists solely of 50,000,000 shares
of Common Stock. Holders of Covista'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 therefore. 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 Covista,
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.
As of the date of this report, there were 17,822,025 shares of Common
Stock issued and outstanding, held by approximately 860 persons.
Price Range of the Common Stock
Covista's Common Stock is traded 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 sale prices for Covista's Common
Stock in such market, as reported by the National Association of Securities
Dealers, Inc.
FISCAL 2003 HIGH LOW
----------- ---- ---
February 1, 2002 thru April 30 $8.15 $3.90
May 1 thru July 31 $5.15 $2.83
August 1 thru October 31 $4.17 $2.00
November 1 thru January 31, 2003 $3.97 $2.01
FISCAL 2004 HIGH LOW
----------- ---- ---
February 1, 2003 thru April 30 $3.62 $1.75
May 1 thru July 31 $4.10 $1.82
August 1 thru October 31 $3.55 $2.60
November 1 thru January 31, 2004 $4.00 $2.21
Covista has not paid or declared any cash dividends during the past two
fiscal years and does not anticipate paying any in the foreseeable
future.
15
Compensation Plans and Securities
The following table sets forth certain information as of January 31,
2004 with respect to compensation plans under which equity securities of the
Company are authorized for issuance:
Number of
Securities to be
Issued Upon Weighted-Average Number of Securities
Exercise of Exercise Price of Remaining Available
Outstanding Outstanding for Future Issuance
Options, Warrants Options, Warrants Under Equity
Plan Category and Rights and Rights Compensation Plans (1)
- ------------------------------------- --------------------- --------------------- -----------------------
Equity compensation plans approved 1,889,663 $3.08 795,800
by security holders
Equity compensation plans not -- -- --
approved by security holders
--------------------- --------------------- -----------------------
Total 1,889,663 $3.08 795,800
(1) Under all plans, if any shares subject to a previous award are forfeited,
or if any award is terminated without issuance of shares or satisfied with
other consideration, the shares subject to such award shall again be
available for future grants.
16
ITEM 6. Selected Financial Data
(In thousands except per share amounts)
Year ended January 31,
-------------------------------------------------------------------
RESULTS OF OPERATIONS: 2004 2003 2002 2001 2000
- ---------------------- ---- ---- ---- ---- ----
Net Revenues $ 84,056 $ 100,960 $ 95,313 $ 133,230 $ 139,760
Net Loss $ (944) $ (9,407) $ (11,970) $ (8,629) $ (9,414)
Weighted average common shares outstanding
Basic 17,796 13,283 10,204 7,324 7,069
Diluted 17,796 13,283 10,204 7,324 7,069
Loss per common and equivalent shares
Basic loss per share $ (.05) $ (0.71) $ (1.17) $ (1.18) $ (1.33)
Diluted loss per share $ (.05) $ (0.71) $ (1.17) $ (1.18) $ (1.33)
Cash dividends per common share None None None None None
Additions to property and equipment $ 277 $ 4,943(b) $ 5,465 $ 3,227 $ 3,019
Depreciation and amortization $ 5,932 $ 7,442 $ 4,569 $ 3,578 $ 2,985
FINANCIAL POSITION:
- ------------------
Working Capital $ (6,088) $ (9,536) $ (11,327) $ (7,734) $ 1,222
Property and equipment-net $ 11,654 $ 15,150 $ 12,490 $ 13,021 $ 13,317
Total assets $ 40,887 $ 51,050 $ 31,257 $ 39,097 $ 45,184
Long-term debt $ 573 $ 1,811 $ 4,400(a) $ 382 $ 997
Shareholders' Equity $ 18,833 $ 19,693 $ 1,569 $ 5,777 $ 14,007
Common shares outstanding 17,817 17,783 10,849 7,969 7,944
(a) $4,400,000 consists of a loan from Covista's Chairman of the Board, which
was converted to equity in Fiscal 2003 (see ITEM 13).
(b) Includes $3,400,000 of property contribution from Covista's Chairman of the
Board (see ITEM 13).
17
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 Covista for the fiscal years
ended January 31, 2001 (Fiscal 2001), January 31, 2002 (Fiscal 2002) and January
31, 2003 (Fiscal 2003). The following information should be read in conjunction
with the financial statements and related notes and other detailed information
regarding Covista included elsewhere in this report.
Special Note Regarding Forward-Looking Statements
Certain of the statements contained in this Form 10-K Report may be
considered "forward-looking statements" for purposes of the securities laws.
From time to time, oral or written forward-looking statements may also be
included in other materials released to the public. These forward-looking
statements are intended to provide our management's current expectations or
plans for our future operating and financial performance, based on our current
expectations and assumptions currently believed to be valid. For these
statements, we claim protection of the safe harbor for forward-looking
statements provided by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements can be identified by the use of forward-looking
words or phrases, including, but not limited to, "believes," "estimates,"
"expects," "expected," "anticipates," "anticipated," "plans," "strategy,"
"target," "prospects" and other words of similar meaning in connection with a
discussion of future operating or financial performance. Although we believe
that the expectations reflected in such forward-looking statements are
reasonable, there can be no assurance that such expectations will prove to have
been correct.
All forward-looking statements involve risks and uncertainties that may
cause our actual results to differ materially from those expressed or implied in
the forward-looking statements. This Form 10-K Report includes important
information as to risk factors in the "Business" section under the headings
"Business" "Competition" and "Regulation" and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations." In addition to those
factors discussed in this Form 10-K Report, you should see our other reports on
Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission from
time to time for information identifying factors that may cause actual results
to differ materially from those expressed or implied in the forward-looking
statements.
18
RESULTS OF OPERATIONS
FISCAL 2004 AS COMPARED TO FISCAL 2003
Revenues
Net sales of telecommunications services for the fiscal year ended
January 31, 2004 were approximately $84,056,000, a decrease of approximately
$16,904,000 or 17% from the approximately $100,960,000 of net sales in Fiscal
2003. These revenues were comprised of retail sales of approximately
$62,420,000, KISSLD revenue of approximately $17,260,000 and wholesale revenue
of approximately $4,376,000. Covista billed approximately 1,270,875,338 minutes
in Fiscal 2004 as compared to approximately 1,453,124,000 minutes in Fiscal
2003, a decrease of 182,248,662 minutes or 13%. The overall decrease is
primarily related to intense competitive pressure in the retail segment combined
with planned reductions in wholesale revenue, as discussed in further details
below.
Net retail sales for Fiscal 2004 were approximately $62,420,000, a
decrease of approximately $13,035,000, or 17% from the approximately $75,455,000
billed in Fiscal 2003. Retail billed minutes were approximately 916,532,000, a
decrease of approximately 170,763,000 minutes or 16%, versus the retail minutes
of approximately 1,087,295,000 billed in Fiscal 2003. The average blended price
per minute of $.0681 decreased approximately 1.9% versus the prior year blended
average rate per minute of $.0694 as the industry continues to experience
decreased price per minute of usage. Covista does not foresee that this trend in
pricing will abate in the near future. The current year decrease in the retail
segment is primarily attributed to intense competitive pressure from other
providers, especially those which have the ability to bundle local dial tone
with traditional long distance offerings. While the Company has recently
launched local services to the retail segment in certain markets, the Company
has experienced significant loss of former retail customers that have taken
advantage of competitive providers bundled service offerings. The Company does
not foresee this intensely competitive climate relaxing in the near future. The
Company plans to continue to support the retail channel by expanding its
competitive local and long distance product offering across multiple markets as
well as launching a competitive "win back" program.
Net KISSLD sales for Fiscal 2004 were approximately $17,261,000 for the
year, an increase of approximately $4,271,000 or 33% from the approximately
$12,990,000 billed in fiscal 2003. The Company launched local services, bundled
together with long distance, into the KISSLD segment during the current fiscal
year. Net KISSLD sales for Fiscal 2004 includes approximately $658,000 of
bundled local service revenue. KISSLD billed minutes for Fiscal 2004 were
approximately 296,102,000, an increase of approximately 100,070,000 minutes or
51% from the approximately 196,032,000 billed in the previous year. The average
blended price per minute of $.0561 decreased approximately 15.4% versus the
prior year blended average rate per minute of $.0663 as the industry continues
to experience decreased prices per minute of usage. Covista does not foresee
that this trend in pricing will abate in the near future. The current year
increase in the KISSLD segment is primarily attributed the successful launch of
local service to these residential users in selected markets in addition to
direct marketing via mail and web based affinity marketing campaigns. While the
Company has launched local services to the KISSLD segment in certain markets,
the Company plans to expand the number of markets in which it has the ability to
offer its local and long distance bundled product offering. Additionally, the
Company plans to expand its marketing resources to target new geographic market
areas where the Company has the ability to offer competitive bundled services to
residential users. These efforts will be accomplished in conjunction with
maintaining the support required for the retail segment.
Net wholesale (carrier) sales for Fiscal 2004 were approximately
$4,376,000, a decrease of approximately $8,138,000 or 65% from the approximately
$12,514,000 billed in Fiscal 2003. Billed wholesale minutes amounted to
approximately 58,241,000, a decrease of approximately 111,556,000 minutes or 66%
from the billed wholesale minutes of approximately 169,797,000 billed in Fiscal
2003. As previously stated, the Company continues its planned efforts to reduce
volume in the wholesale segment. The Company plans to maintain nominal wholesale
volume in the future, based on network capacity and gross margin opportunities,
while balancing any possible financial exposure related to un-collectable
balances.
Cost of Revenue
Cost of revenue for Fiscal 2004 was approximately $47,339,000, a
decrease of approximately $15,131,000 or 24% from the approximately $62,470,000
recorded in Fiscal 2003. The decrease in cost of revenue was favorable in
relationship to the overall revenue decrease of 17% discussed previously. The
decrease in cost of revenue is primarily a result of the decrease in lower
margin wholesale volume of approximately $7,324,000 and the combined overall
decline in retail and KISSLD volume of approximately $5,445,000. In addition,
the Company has improved its purchasing and line cost auditing functions. These
improvements have allowed the Company to generate an additional savings of
approximately $2,363,000 versus the prior year as a result of overall rate
reductions and improved auditing and dispute resolution capabilities.
In the normal course of business, billings for telco line costs are
often not received until after the period of service, Covista therefore uses
certain estimates to determine its monthly cost of revenue ("line cost") and
corresponding accounts payable to these service providers. These line costs
include fees for network transport, access, egress and facility charges. The
Company completes a detailed bill audit function, which includes a comparison of
invoices received to amounts accrued, contractual rates and applicable tariffs
and engineering data regarding usage. Accrued amounts are adjusted based on the
bill audit function and actual invoices received. These adjustments to actual
expense are typically identified within 90 days following the period of
estimate.
19
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses are comprised of
selling and marketing costs, and general and administrative costs. SG&A expenses
for Fiscal 2004 were approximately $31,403,000, a decrease of approximately
$8,811,000 or 22% versus approximately $40,215,000 in the previous year. This
decrease is also favorable in relationship to the overall sales decrease of 17%
discussed previously. The overall decrease was primarily due to an overall
decrease in payroll related costs of approximately $1,585,000; a decrease in
commission expense as a result of lower retail revenue of approximately
$1,204,000; a decrease in bad debt expense of approximately $1,058,000 due to
improved collection processes and the substantial reduction of the higher risk
wholesale business; reduced marketing expenses related to the KISSLD segment as
a result of delays needed to adequately prepare for the launch of local
services, of approximately $2,033,000; a decrease in office, telephone, postage
and building rent as a result of further consolidation of approximately
$1,451,000. In addition to other general increases of approximately $1,195,000,
during the quarter ended January 31, 2004, the Company successfully settled an
insurance claim related to losses stemming from the September 11, 2001 terrorist
attacks. Gross proceeds from this final settlement were $3,250,000. In
accordance with EITF 01-10, "Accounting for the Impact of the Terrorist Attacks
of September 11, 2001", the Company has recognized this settlement, net of
$575,000 of expenses, as income from continuing operations by reducing selling,
general and administrative expenses during the quarter.
Depreciation and Amortization
Depreciation and amortization was approximately $5,932,000 for Fiscal
2004. The decrease of approximately $1,510,000 is the result of certain
intangible assets becoming fully amortized between years.
Stock Compensation Expense
There was no stock compensation expenses recorded for the Fiscal years
ended January 31, 2004 and 2003.
Income Tax Benefit
No income tax was realized for the year ended January 31, 2004 as the
Company provided a full valuation allowance against its net operating loss
carryforwards due to uncertainty of realization. During Fiscal 2003, the Company
recorded income related to a tax refund received as a result of recent tax law
changes in the amount of approximately $511,000.
Other Income and Expense
Total other income (expense) for Fiscal 2004 was approximately
$(328,000), representing a decrease of approximately $424,000 versus the
$(752,000) of expense from previous fiscal year. The largest component of other
income (expense) is interest expense, which decreased by approximately $486,000
between years. This decrease is the result of the shareholder loan that was
outstanding for the majority of the prior fiscal year, which was converted to
equity in December 2002.
Net Loss
For the reasons set forth above, the net loss for Fiscal 2004 of
approximately $944,000 represents a decrease in net loss of approximately
$8,463,000 over the net loss of approximately $9,407,000 reported in Fiscal
2003.
20
RESULTS OF OPERATIONS
FISCAL 2003 AS COMPARED TO FISCAL 2002
Revenues
Net sales of telecommunications services for the fiscal year ended
January 31, 2003 were approximately $100,960,000, an increase of approximately
$5,647,000 or 5.9% from the approximately $95,313,000 of net sales in Fiscal
2002. These revenues were comprised of retail sales of approximately
$75,455,000, KISSLD revenue of approximately $12,990,000 and wholesale sales of
approximately $12,514,000. Covista billed approximately 1,453,124,000 minutes in
Fiscal 2003 as compared to approximately 1,075,758,000 minutes in Fiscal 2002,
an increase of 377,366,000 minutes or 35.1%.
Net retail sales for Fiscal 2003 were approximately $75,455,000, an
increase of approximately $28,031,000, or 59.1% from the approximately
$47,424,000 billed in Fiscal 2002. Retail billed minutes were approximately
1,087,295,000, an increase of approximately 468,749,000 minutes or 75.8%, over
the retail minutes of approximately 618,546,000 billed in Fiscal 2002. The
average price per minute decreased approximately 7.4% as the industry continued
to experience decreased price per minute of usage. Covista does not foresee that
this trend in pricing will abate in the near future. The current year increase
is primarily attributed to the Capsule acquisition.
Net KISSLD sales for Fiscal 2003 were approximately $12,990,000 for the
first year of this segment. KISSLD billed minutes were approximately
196,032,000.
Net wholesale (carrier) sales for Fiscal 2003 were approximately
$12,514,000, a decrease of approximately $35,375,000 or 73.9% from the
approximately $47,889,000 billed in Fiscal 2002. Billed wholesale minutes
amounted to approximately 169,797,000, a decrease of approximately 287,414,000
minutes or 62.8% from the billed wholesale minutes of approximately 457,211,000
billed in Fiscal 2002. The sales mix continued to move toward higher priced
international traffic from the lower priced domestic traffic. International
carrier traffic decreased 280,879,000 minutes or approximately 29% to
approximately 114,740,000 minutes. Domestic minutes decreased approximately
6,535,000 or approximately 10.6% to approximately 55,057,000 minutes.
Cost of Revenue
Cost of revenue for Fiscal 2003 was approximately $62,470,000; a
decrease of approximately $9,437,000 or 13.1% from the approximately $71,907,000
of cost of revenue in Fiscal 2002. The decrease in cost of revenue was primarily
due to the decrease in lower margin wholesale volume of approximately
$35,809,000, a net increase in retail cost of revenue related primarily to the
merger with Capsule Communications of approximately $18,565,000, and an increase
related to the launch of KISSLD of approximately $7,807,000.
In the normal course of business, billings for telco line costs are
often not received until after the period of service, Covista therefore uses
certain estimates to determine its monthly cost of revenue ("line cost") and
corresponding accounts payable to these service providers. These line costs
include fees for network transport, access, egress and facility charges. The
Company completes a detailed bill audit function, which includes a comparison of
invoices received to amounts accrued, contractual rates and applicable tariffs
and engineering data regarding usage. Accrued amounts are adjusted based on the
bill audit function and actual invoices received. These adjustments to actual
expense are typically identified within 90 days following the period of
estimate.
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses are comprised of
selling and marketing costs, and general and administrative costs. SG&A expenses
for Fiscal 2003 increased to approximately $40,215,000, an increase of
approximately $9,216,000 or 29.7% from the approximately $30,999,000 in Fiscal
2002. This increase was primarily due to an increase in SG&A expenses associated
with the merger with Capsule Communications of approximately $13,540,000, a
decrease in salary, wages and benefits due to the transition of corporate
headquarters from New Jersey to Tennessee of $1,888,000; a decrease in
commissions due to certain sales agents of approximately $1,052,000; a decrease
in bad debt expense of $3,437,000 due to the substantial reduction of the higher
risk wholesale business; and increased marketing expenses related to the KISSLD
segment of approximately $2,053,000.
Depreciation and Amortization
Depreciation and amortization was approximately $7,442,000 for Fiscal
2003. The increase of approximately $2,873,000 is the result of amortizing
certain intangible assets from the Capsule acquisition, in addition to
amortization expense related to the purchase of certain prepaid network
capacity.
21
RESULTS OF OPERATIONS
FISCAL 2003 AS COMPARED TO FISCAL 2002
Stock Compensation Expense
There were no stock compensation expenses for Fiscal 2003 as compared
to $12,000 in Fiscal 2002; this decrease is due to a majority of stock grants
being fully vested. The amount from Fiscal 2002 is included in Selling, General
and Administrative Expenses.
Income Tax Benefit
During Fiscal 2003, the Company recorded income related to a tax refund
received as a result of recent tax law changes in the amount of approximately
$511,000. No income was realized during Fiscal 2002.
Other Income and Expense
Total other expense, net for Fiscal 2003 increased approximately
$944,000. The components of other income and expense are interest expense,
interest income and other items. Interest income decreased approximately
$111,000 after the selling of securities; interest expense increased
approximately $588,000 due to interest on the Wells Fargo Credit Line, the Note
Payable to SunTrust, and Note Payable to a related party. Gains on sales of
securities decreased approximately $245,000.
Net Loss
For the reasons set forth above, the net loss for Fiscal 2003 of
approximately $9,407,000 represents a decrease in net loss of approximately
$2,563,000 over the net loss of approximately $11,970,000 reported in Fiscal
2002.
22
LIQUIDITY AND CAPITAL RESOURCES
Working Capital
At January 31, 2004, Covista had a working capital deficit of
approximately $6,088,000 as compared to approximately $9,536,000 at January 31,
2003, an improvement in working capital of approximately $3,448,000. The
increase in working capital in Fiscal 2004 was primarily attributable to an
increase in cash of approximately $353,000; a decrease in accounts receivable of
approximately $5,183,000 and an increase in prepaid expenses of approximately
$241,000. Also affecting the improved working capital position was the decrease
in accrued liabilities of approximately $3,439,000; a decrease in accounts
payables and accrued line cost of approximately $4,355,000 and a decrease in
current portion of long-term debt of approximately $244,000.
The current ratio at January 31, 2004 was 0.71 to 1, representing an
improvement versus the 0.67 to 1 ratio at the end of the previous fiscal year.
The Company has a credit facility in place that provides for an $8
million line of credit, based on eligible accounts receivable. The Company had
approximately $4.3 million of additional borrowing capacity under this facility
as of January 31, 2004.
Cash Flow Statement
The cash flow statement of Covista for Fiscal 2004 indicated an
increase in cash and cash equivalents of approximately $353,000. Non-cash
adjustments (depreciation, amortization, and provision for bad debt,) of
approximately $7,435,000 are added back and net changes in assets and
liabilities of approximately $4,244,000 deducted from the net loss of
approximately $944,000 resulted in net cash provided by operations of
approximately $2,247,000. Cash used in investing activities approximated
$484,000, of which approximately $277,000 was used for the purchase of capital
additions while payment for deferred line installation costs approximated
$220,000. The cash used in financing activities of approximately $1,398,000
consisted primarily of the payments on the loan to a related party of
approximately $1,248,000, the net payment of approximately $233,000 in bank
borrowing and cash received from the exercise of stock options of approximately
$84,000.
Accounts Receivable
The Company has entered into offset arrangements with certain carrier
customers, which are also vendors, allowing for the ability to offset payable
balances against the Company's receivable balances.
Covista experienced consolidated accounts receivable turnover of
approximately 46 days as of January 31, 2004, versus approximately 57 days as of
January 31, 2003. This improvement is a result of reduced wholesale volume.
23
CRITICAL ACCOUNTING POLICIES
Revenue Recognition
The Company's revenues, net of sales discounts, are recognized in the
period in which the service is provided, based on the number of minutes of
telecommunications traffic carried, and a rate per minute. Access and other
service fees charged to customers, typically monthly, are recognized in the
period in which service is provided.
Deferred Line Installation Costs
Deferred line installation costs are costs incurred by the Covista for
new facilities and costs incurred for connections from within the Covista's
network to the network of other telecommunication suppliers. Amortization of
these line installation costs is provided using the straight-line method over
the contract life of the lines ranging from three to five years.
Long-Lived Assets
Effective February 1, 2002, we adopted Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment of Disposal of
Long-Lived Assets". SFAS 144 establishes a single accounting model for the
impairment or disposal of long-lived assets, including discontinued operations.
We review the recoverability of the carrying value of long-lived
assets, including intangibles with a definite life, for impairment using the
methodology prescribed in SFAS 144 whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable.
Recent Accounting Pronouncements
In July 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that a liability for a cost that is associated
with an exit or disposal activity be recognized when the liability is incurred.
SFAS 146 also establishes that fair value is the objective for the initial
measurement of the liability. SFAS 146 is effective for exit or disposal
activities that are initiated after December 31, 2002.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN
45"), "Guarantees," an interpretation of FASB Statement No. 5, "Accounting for
Contingencies." This interpretation elaborates on the disclosures to be made by
a guarantor in its interim and annual financial statements about its obligations
under certain guarantees that it has issued. Compliance with this interpretation
has not had a material impact.
In January 2003, FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities ("FIN 46"). FIN 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a majority
of the risk of loss from the variable interest entity's activities or entitled
to receive a majority of the entity's residual returns or both. FIN 46 also
requires disclosures about variable interest entities that a company is not
required to consolidate but in which it has a significant variable interest. The
Company has no investment in variable interest entities.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS
No. 150 established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity, and
imposes certain additional disclosure requirements. The provisions of SFAS No.
150 are generally effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise if effective at the beginning of the
first interim period beginning after June 15, 2003. The Company has adopted SFAS
No. 150 and there has not been a material effect on its consolidated financial
statements.
CAPITAL EXPENDITURES
Capital expenditures for Fiscal 2004 totaled approximately $277,000.
These expenditures were financed from funds provided from Covista's working
capital. The capital expenditures were used primarily for upgrades to Covista's
switches and switch sites, software and hardware upgrades to Covista's computer
network and furniture, fixtures and equipment.
Capital expenditures for Fiscal 2005 are estimated not to exceed
approximately $500,000 and are expected to be financed from funds provided from
operations.
24
Inflation
Since inflation has slowed in recent years, Covista 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 Covista in the past, are expected to continue. Also
the telecommunications industry has recently experienced the failure of several
businesses, some of which are Covista's wholesale customer and suppliers. These
failures not only have affected Covista's FY 2004 results, but also may impact
future results.
ENVIRONMENTAL MATTERS
Covista 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
Covista
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 exposure to interest rate
risk relates primarily to the marketable securities held by Covista. Covista
only invests in instruments with high credit quality where a secondary market
exists. Covista does not hold any derivatives related to its interest rate
exposure. Covista also maintains long-term debt at fixed rates. Due to the
nature and amounts of Covista's note payable, an immediate 10% change in
interest rates would not have a material effect in Covista's results of
operations over the next fiscal year. Covista'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
15 of this Report.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
ITEM 9A. Controls and Procedures
As of January 31, 2004, we carried out an evaluation under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms. Since
the date of their evaluation, there were no significant changes in our internal
controls or in other factors that could significantly affect the disclosure
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
25
PART III
ITEM 10. Directors and Executive Officers of Covista
The directors and officers of Covista are as follows:
NAME AGE POSITION
Henry G. Luken, III 44 Chairman of the Board
A. John Leach, Jr. 41 Director, President & Chief Executive Officer
Kevin Alward 37 Director, Chief Operating Officer
Jay J. Miller 70 Director
Nicholas Merrick 41 Director
Leon Genet 72 Director
Donald Jones 68 Director
W. Thorpe McKenzie 56 Director
Thomas P. Gunning 66 Treasurer and Secretary
Frank J. Pazera 43 Executive Vice President & Chief Financial Officer
Covista'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. Luken serves as chairman of Covista Communications and has
extensive business and telecommunications experience. Prior to purchasing a
major interest in Covista, Mr. Luken founded Telco Communications and Long
Distance Wholesale Club in 1993. Telco was a pioneer in dial-around long
distance service with Dial and Save, Inc, which grew into one of the most
successful telecommunication companies of its kind in the United States. Telco
was sold to Excel Communications in 1997 for $1.2 billion. Most recently Mr.
Luken moved the company headquarters from Little Falls, New Jersey to
Chattanooga, Tennessee. Mr. Luken is intimately involved in the strategic growth
plans and operations of the company. Mr. Luken also owns interest in several TV
and radio stations.
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 Covista on the same basis as other independent sales
representatives. See "Certain Relationships and Related Transactions".
Mr. Leach has served as President and Chief Executive Officer of
Covista Communications, Inc. since May 18, 2000. Prior to Covista
Communications, Mr. Leach was Senior Vice President and General Manager of
Teleglobe, Inc. from 1998 to 2000. Prior to Teleglobe, from 1996 to 1998 Mr.
Leach worked at Telco Communications Group (a subsidiary of Teleglobe, Inc.)
where he held a number of senior management posts and played an integral role in
building a substantial wholesale and agent business that was a highly valued
part of the sale of the company to Teleglobe, Inc. Mr. Leach also held executive
and management positions with BTI and Mobilcomm (a Bell South Company). Mr.
Leach also currently serves as a Director for Covista Communications, Inc. Mr.
Leach is a graduate of Old Dominion University with a BA in Business Management.
Jay J. Miller, Esq. has served as a Director since 1983. He has
been a practicing attorney for more than 40 years in New York. He is Chairman of
the Board of AmTrust Pacific Ltd., a New Zealand real estate company. He is also
a director of Technology Insurance Company, Inc., a provider of workers'
compensation as well as various insurance products to the technology industry,
and certain of its affiliates. Mr. Miller has performed legal services on behalf
of Covista. See "Certain Relationships and Related Transactions."
26
Mr. Gunning has been with Covista since 1992 and served as the
controller and Chief Financial Officer until 2003. Currently Mr. Gunning is
focused on operations as well as legal, compliance and corporate dealings. Mr.
Gunning has played an integral role in Covista's growth, especially in the 90's
where he was one of the key management team members that drove Covista's
revenues beyond the $100 million mark. Prior to joining Covista, Mr. Gunning was
Chief Financial Officer of Flyfaire, Incorporated, a travel wholesale operator
and was senior Audit Manager at Rosenberg, Selsman & Company. Mr. Gunning has
held various positions in both public and private accounting firms. Mr. Gunning
holds a Bachelor's of Business Administration degree from Manhattan College. He
is a Certified Public Accountant licensed by the states of New York and New
Jersey and is a member of the American Institute of Certified Public Accountants
as well as the state societies of New York and New Jersey.
Donald Jones recently retired from his position as Senior Vice
President for Chapter Services of the American Red Cross, for which he worked
since 1991. Prior to joining the Red Cross, Mr. Jones was Deputy Assistant
Secretary of Defense for Military Manpower and Personnel Policy. Mr. Jones
served in the United States Army for over 35 years and retired in 1991 with the
permanent rank of Lieutenant General.
Nicholas Merrick currently serves as President of Mt Vernon
Investments, LLC, an investment company, which he has served as President since
January 2002. Mr. Merrick served as Senior Vice President and Chief Financial
Officer of Telergy, Inc., a high-speed fiber optic communications network
company, from May 2000 to July 2001. Telergy filed for reorganization under the
bankruptcy laws in October 2001 and has liquidated. Prior to joining Telergy,
Mr. Merrick was Chief Executive Officer of Up2 Technologies, Inc. and Executive
Vice President of Excel Communications, each of which was a subsidiary of
Teleglobe, Inc. (global communications, e-business services), from 1998 until
2000. From 1996 to 1997, he was Vice President and Chief Financial Officer of
Telco Communications Group, Inc., and from 1985 to 1996, he was Vice President
of Corporate Finance at the Robinson-Humphrey Company, Inc. and Managing
Director of R-H Capital Partners.
Mr. Alward joined in March of 2001 and currently serves as Chief
Operating Officer and a Director on Covista's board. He had previously served
the Company as President and Chief Operating Officer from 1994 to 1998, when he
left the company to become President of North America for Destia Communications,
Inc. (formerly known as Econophone, Inc.) and its successor by merger, Viatel,
Inc. In April 200, he co-founded Blink Data Corp., a telecommunications and data
services provider headquartered in northern New Jersey, where he was President
and Chief Executive Officer until his return to Covista.
W. Thorpe McKenzie is Managing Director of Pointer Management
Company, Chattanooga, Tennessee, which he co-founded in 1990 to invest in hedge
funds and similar types of partnerships utilizing a fund of funds approach. From
1982 until 1990, he was a private investor in New York City, and a director of
several public and private companies. From 1980 until 1982, he was founding
general partner of TIGER, a global hedge fund. From 1971 until 1980, he was a
Vice President of Kidder, Peabody, & Co., Inc. in New York. McKenzie is a
graduate of the University of North Carolina in Chapel Hill, and the Wharton
Graduate division of the University of Pennsylvania in Philadelphia. He is
currently a director of Novestra AB, a publicly traded venture capital
investment firm located in Stockholm, Sweden.
Mr. Pazera joined the company in December 2002 and was appointed to the
position of Chief Financial Officer in July 2003. Mr. Pazera brings extensive
public and private sector financial management experience to the company. Prior
to joining Covista, Mr. Pazera held a variety of Executive Financial Management
positions at companies that includes, AirGate PCS, Inc., a publicly traded
wireless services company and Network One, a privately held regional Competitive
Local Exchange Carrier. In addition, Mr. Pazera has held executive and
management positions at Turner Broadcasting, MCI Telecommunications, and Arthur
Andersen & Company. Mr. Pazera holds an MBA in Finance from the Goizueta
Business School at Emory University in Atlanta and his BBA in Accounting from
the University of Wisconsin in Milwaukee, and is a Certified Public Accountant.
Board of Directors
Covista's Board of Directors currently consists of eight persons, two
of whom are members of management and six of whom are non-management directors.
During the fiscal year ended January 31, 2004, the Board held three meetings,
each of which was attended by at least 87% of the directors then serving.
Covista'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. Nicholas Merrick, Donald Jones and W. Thorpe McKenzie. The
Committee reviews, analyzes and may make recommendations to the Board of
Directors with respect to Covista's financial statements and controls. The
Committee has met and intends to meet from time to time with Covista's
independent public accountants to monitor their activities. The Compensation
Committee consists of Messrs. Henry Luken, Jay J. Miller, Nicholas Merrick and
W. Thorpe McKenzie and is charged with reviewing and recommending the
compensation and benefits payable to Covista's senior executives. Mr. Leach is
an ex-officio member of both the Compensation and Audit Committees.
ITEM 11. Executive Compensation
The following table sets forth the compensation that Covista paid during the
fiscal years ended January 31, 2004, 2003 and 2002 to its Chief Executive
Officer and to each executive officer of Covista or person performing similar
functions whose aggregate remuneration exceeded $100,000, during Covista's
fiscal year ended January 31, 2004 (the "Named Executives").
27
Summary Compensation Table
- --------------- ----------- ------------------ ------------------ ----------------- ------------------ ------------------
NAME & FISCAL ANNUAL ANNUAL OTHER ANNUAL COMPENSATION ALL OTHER
PRINCIPAL YEAR COMPENSATION COMPENSATION COMPENSATION ($) AWARDS OPTIONS COMPENSATION ($)
POSITION ENDED SALARY ($) BONUS ($) ($)
JANUARY 31
- -----------------------------------------------------------------------------------------------------------------------
John Leach, 2004 $300,000 $150,000 $0 $0 $12,464(2)
President & 2003 $300,000 $150,000 $0 $0 $24,292(3)
Chief 2002 $300,000 $400,000(1) $0 $0 $ 5,250(4)
Executive
Officer
- -----------------------------------------------------------------------------------------------------------------------
Thomas P. 2004 $155,000 $0 $0 $0 $18,062(5)
Gunning, 2003 $155,000 $0 $0 $0 $11,320(6)
Secretary & 2002 $155,000 $15,000 $0 $0 $11,085(7)
Treasurer
- -----------------------------------------------------------------------------------------------------------------------
Kevin Alward, 2004 $250,000 $125,000 $0 $0 $16,702(8)
Chief 2003 $250,000 $125,000 $0 $0 $ 9,638(9)
Operating 2002 $235,577 $104,167 $0 $0 $ 3,567(10)
Officer
- -----------------------------------------------------------------------------------------------------------------------
Frank J. 2004 $156,731 $ 22,500 $0 $0 $ 7,648(11)
Pazera, Chief 2003 $14,423 -- -- -- --
Financial
Officer
- --------------- ----------- ------------------ ------------------ ----------------- ------------------ ------------------
(1) The amount shown includes $250,000 in bonus due to Mr. Leach for the period
from 05/01/00 to 04/30/01 but not paid until FY2002.
(2) The amount shown represents Covista's contributions under its 401(K)
Deferred Compensation and Retirement Savings Plan of $6,572 and Covista's
group major medical benefit of $5,892.
(3) The amount shown represents Covista's contributions under its 401(K)
Deferred Compensation and Retirement Savings Plan of $5,500, Covista's
group major medical benefit of $3,792 and $15,000 in reimbursement for
certain relocation expenses.
(4) The amount shown represents Covista's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan.
(5) The amount shown represents Covista's contributions under its 401(K)
Deferred Compensation and Retirement Savings Plan of $4,650 and Covista's
group major medical benefit and life insurance of $11,632 and $1,780
for use of a Company auto for non-business purposes.
(6) The amount shown represents Covista's contributions under its 401(K)
Deferred Compensation and Retirement Savings Plan of $4,740, Covista's
group major medical benefit of $4,800 and $1,780 for the use of a Company's
vehicle for non-business purposes.
(7) The amount shown represents Covista's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $4,505; Covista
company auto expenses of $1,780; and Covista's group major medical benefit
of $4,800.
(8) The amount shown represents Covista's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $7,500 and Covista's
group major medical benefit of $9,202.
(9) The amount shown represents Covista's contributions under its 401(K)
Deferred Compensation and Retirement Savings Plan of $4,518 and Covista's
group major medical benefit of $5,120.
(10) The amount shown represents Covista's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan.
(11) The amount shown represents Covista's contribution under its 401(K)
Deferred Compensation and Retirement Savings Plan of $2,994 and Covista's
group major medical benefit of $4,654.
28
Compensation Pursuant to Plans
In October, 1996, Covista adopted its 1996 Stock Option Plan; in
February 2000, its 1999 Equity Incentive Plan; in February 2002, its 2001 Equity
Incentive Plan; and in December 2002, adopted its 2002 Equity Incentive Plan
(the "Option Plans"). The Option Plans provide that certain options granted
there under 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 Covista, 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
Covista's Board of Directors. Covista has reserved 600,000 shares of Common
Stock under the 1996 Option Plan and 750,000 shares of Common Stock under its
1999 Equity Incentive Plan, 900,000 under its 2001 Equity Incentive Plan and
750,000 under its 2002 Equity Incentive Plan for issuance to employees,
officers, directors and consultants of Covista.
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. Ince