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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report on Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
COMMISSION FILE NUMBER: 0-29279
----------------------------
CHOICE ONE COMMUNICATIONS INC.
(Exact name of registrant as specified in its charter)
STATE OF DELAWARE 16-1550742
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
100 CHESTNUT STREET, SUITE 600, ROCHESTER, NEW YORK 14604-2417
(Address of principal executive offices) (Zip Code)
(585) 246-4231
(Registrant's telephone number, including area code)
----------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to the filing
requirements for the past 90 days. Yes X No _____
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes _______ No X
----
As of April 30, 2003, there were outstanding 44,025,164 shares of the
registrant's common stock, par value $0.01 per share.
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002.................................................................................2
Condensed Consolidated Statements of Operations for the three months ended
March 31, 2003 and March 31, 2002.................................................................3
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 and March 31, 2002.................................................................4
Notes to Condensed Consolidated Financial Statements..............................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............16
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......................................28
Item 4. Controls and Procedures..........................................................................29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................................30
Item 2. Changes in Securities and Use of Proceeds........................................................30
Item 3. Defaults Upon Senior Securities..................................................................30
Item 4. Submission of Matters to a Vote of Security Holders..............................................30
Item 5. Other Information................................................................................30
Item 6. Exhibits and Reports on Form 8-K.................................................................30
Signatures.....................................................................................................31
Certifications.................................................................................................32
(i)
PART I FINANCIAL INFORMATION
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(amounts in thousands, except share and per share data)
MARCH 31, DECEMBER 31,
2003 2002
---- ----
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents........................................................ $ 20,192 $ 29,434
Accounts receivable, net......................................................... 38,372 43,215
Prepaid expenses and other current assets........................................ 3,465 2,298
----- -------
Total current assets......................................................... 62,029 74,947
Property and equipment, net of accumulated depreciation............................... 325,256 336,711
Intangible assets, net of accumulated amortization.................................... 43,734 47,479
Other assets, net..................................................................... 4,908 4,813
---------- ----------
Total assets.......................................................................... $ 435,927 $ 463,950
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current portion of capital leases for indefeasible rights to use fiber........... $ 481 $ 461
Accounts payable.................................................................. 12,949 14,717
Accrued expenses.................................................................. 47,048 58,381
------ ------
Total current liabilities..................................................... 60,478 73,559
Long-term debt, net.................................................................... 604,488 595,941
Interest rate swaps.................................................................... 18,253 19,308
Long-term portion of capital leases for indefeasible rights to use fiber............... 33,916 31,968
Other long-term liabilities............................................................ 3,652 3,581
--------- ---------
Total long-term debt and other liabilities.................................... 660,309 650,798
Commitments and Contingencies (Note 13)
Redeemable Preferred Stock:
Series A Preferred stock, $0.01 par value, 340,000 shares authorized; 251,588 shares
issued and outstanding, at March 31, 2003 and December 31, 2002, respectively,
($306,314 liquidation value at March 31, 2003) ................................... 255,887 243,532
Stockholders' Deficit:
Undesignated preferred stock, $0.01 par value, 4,600,000 shares
authorized, no shares issued and outstanding.................................... - -
Common stock, $0.01 par value, 150,000,000 authorized; 43,721,018 and 42,478,396
shares issued as of March 31, 2003 and December 31, 2002, respectively.......... 437 425
Treasury stock, 135,415 shares, at cost, at March 31, 2003 and December 31, 2002.. (473) (473)
Additional paid-in capital........................................................ 487,199 498,439
Deferred compensation............................................................. (762) (391)
Accumulated other comprehensive loss.............................................. (18,253) (19,308)
Accumulated deficit............................................................... (1,008,895) (982,631)
---------- ----------
Total stockholders' deficit....................................................... (540,747) (503,939)
----------- ----------
Total liabilities and stockholders' deficit....................................... $ 435,927 $ 463,950
=========== ==========
The accompanying notes to condensed consolidated financial statements are
an integral part of these financial statements.
-2-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except share and per share data)
THREE MONTHS ENDED
MARCH 31,
2003 2002
---- ----
(Unaudited) (Unaudited)
Revenue $ 80,100 $ 70,595
Operating expenses:
Network costs..................................................... 40,526 42,185
Selling, general and administrative, including non-cash compensation
of $475 and $2,109 in 2003 and 2002, respectively, and non-cash management
ownership allocation charge of $0 and $5,367 in
2003 and 2002, respectively..................................... 32,371 45,196
Restructuring costs/(credits)..................................... (535) -
Loss on disposition of assets..................................... 59 245
Depreciation and amortization..................................... 17,569 16,174
------ --------
Total operating expenses.......................................... 89,990 103,800
------ -------
Loss from operations................................................... (9,890) (33,205)
Other income/(expense):
Interest and other income......................................... 103 54
Interest expense.................................................. (16,477) (14,164)
--------- ---------
Total other income/(expense), net............................. (16,374) (14,110)
--------- ---------
Net loss .............................................................. (26,264) (47,315)
Accretion of preferred stock...................................... 2,592 1,986
Accrued dividends on preferred stock.............................. 9,763 8,508
---------- ----------
Net loss applicable to common stockholders............................. $(38,619) $(57,809)
======== ========
Net loss per share, basic and diluted.................................. $ (0.72) $ (1.37)
=========== ==========
Weighted average number of shares outstanding, basic and diluted....... 53,509,878 42,107,565
========== ==========
The accompanying notes to condensed consolidated financial statements are
an integral part of these financial statements.
-3-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
THREE MONTHS ENDED
MARCH 31,
2003 2002
---- ----
Cash flows from operating activities:
Net loss................................................................ $ (26,264) $ (47,315)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on disposition of assets....................................... 59 245
Depreciation and amortization....................................... 17,569 16,174
Interest payable in-kind on long-term debt.......................... 7,583 5,794
Amortization of deferred financing costs............................ 1,141 1,016
Amortization of discount on long-term debt.......................... 268 123
Non-cash compensation and management ownership allocation charge.... 475 7,476
Changes in assets and liabilities:
Decrease/(increase) in accounts receivable, net.................. 4,843 (10,500)
Increase in prepaid expenses and other assets.................... (1,376) (783)
Decrease in accrued restructuring costs.......................... (1,001) -
(Decrease)/increase in account payable and accrued expenses...... (11,420) 605
------- ------------
Net cash used in operating activities......................... (8,123) (27,165)
Cash flows from investing activities:
Capital expenditures................................................ (1,871) (6,466)
Proceeds from sale of assets........................................ 14 872
--------- --------
Net cash used in investing activities............................ (1,857) (5,594)
Cash flows from financing activities:
Additions to long-term debt...................................... 875 62,400
Principal payments of long-term debt............................. - (41,100)
Payments under long-term capital leases for indefeasible rights
to use fiber................................................. (137) (84)
---------- -------------
Net cash provided by financing activities............................... 738 21,216
---------- ---------
Net decrease in cash and cash equivalents............................... (9,242) (11,543)
--------- ---------
Cash and cash equivalents, beginning of period.......................... 29,434 14,415
--------- ---------
Cash and cash equivalents, end of period................................ $ 20,192 $ 2,872
========= ==========
The accompanying notes to condensed consolidated financial statements are
an integral part of these financial statements.
-4-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2003
(Unaudited)
(Amounts in thousands, except share and per share data)
NOTE 1. DESCRIPTION OF BUSINESS
Choice One Communications Inc. and its wholly-owned subsidiaries (the "Company")
is an integrated communications provider offering facilities-based voice and
data telecommunications services. The Company, incorporated under the laws of
the State of Delaware on June 2, 1998, provides these services primarily to
small and medium-sized businesses in 29 second and third tier markets in the
northeastern and midwestern United States. The Company's services include local
exchange and long distance services, high-speed data and Internet services, and
web hosting and design services. The Company seeks to become the leading
integrated communications provider in each market by offering a single source
for competitively priced, high quality, customized telecommunications services.
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information required by GAAP for
complete financial statement presentation. The unaudited interim condensed
consolidated financial statements include the consolidated accounts of the
Company with all significant intercompany transactions eliminated. In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) necessary for a fair statement of the financial position, results
of operations and cash flows for the interim periods presented have been made.
These financial statements should be read in conjunction with the Company's
audited financial statements as of and for the year ended December 31, 2002. The
results of operations for the three month period ended March 31, 2003 are not
necessarily indicative of the results to be expected for other interim periods
or for the year ended December 31, 2003.
Certain amounts in the prior period's condensed consolidated financial
statements have been reclassified to conform to the current period presentation.
These reclassifications had no impact on the results of operations and cash
flows for the periods presented.
NOTE 3. GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business.
The Company has experienced net losses applicable to common stockholders of
$38.6 million, $50.5 million, and $57.8 million for the three months ended March
31, 2003, December 31, 2002 and March 31, 2002, respectively. At March 31, 2003,
the Company had $20.2 million in cash and cash equivalents and an additional
$2.6 million available under its senior credit facility. The $2.6 million is
available in equal quarterly installments and subject to no "material adverse
change" in the business, as defined in the Company's Third Amended and Restated
Credit Agreement (the "Credit Agreement"). The Company generated negative cash
flows from both operating and investing activities during the years ended
December 31, 2002 and 2001, and the three months ended March 31, 2003. The
Company has a net stockholders' deficit of $540.7 million as of March 31, 2003.
These factors raise substantial doubt about the Company's ability to continue as
a going concern.
-5-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company has completed several steps intended to increase its liquidity and
better position the Company to compete under current conditions and anticipated
changes in the telecommunications industry. These include:
o Completing an additional financing of $48.9 million in September 2002,
o Maintaining a high client retention rate,
o Completing operational initiatives to optimize the Company's network and
lower its cost structure,
o Reducing general and administrative expenses through automation and a
reduction in workforce,
o Exiting one market in 2002 that was found to be unprofitable,
o Introducing new products to improve revenue growth and profitability, and
o Redeploying assets held for use to reduce the requirement for capital
expenditures.
The Company has an operating plan for the year ended December 31, 2003 (the
"2003 plan"). Despite its net losses in prior years, if the Company is able to
substantially execute the 2003 plan, then it should have sufficient resources to
fund current operations through December 31, 2003. The Company's viability is
dependent upon its ability to continue to execute under its business strategy
and to begin to generate positive cash flows from operations during 2003. The
success of the Company's business strategy includes obtaining and retaining a
significant number of customers, generating significant and sustained growth in
its operating cash flows and managing its costs and capital expenditures to be
able to meet its debt service obligations. However, the Company's revenue and
costs may be dependent upon factors that are not within its control, including
regulatory changes, changes in technology, and increased competition. Due to the
uncertainty of these factors, actual revenue and costs may vary from expected
amounts, possibly to a material degree, and such variations could affect the
Company's future funding requirements.
The Company's continuation as a going concern is dependent on its ability to
substantially achieve its 2003 plan. While the substantial achievement of the
Company's 2003 plan should provide the Company with positive cash and cash
equivalents in excess of the $10.0 million minimum cash and committed financing
covenant established pursuant to the Credit Agreement at December 31, 2003,
there can be no assurance that the Company will be successful in executing its
business strategy or in obtaining additional debt or equity financing, if
needed, on terms acceptable to the Company, or at all. There are conditions to
the Company's ability to borrow under its senior credit facility, including the
continued satisfaction of covenants and absence of a material adverse change, as
defined in the Credit Agreement. These covenants are minimum cash and committed
financing of $10.0 million through July 1, 2004, and maximum capital
expenditures that vary annually as described in the Credit Agreement. A default
in observance of these covenants, if unremedied in three business days, could
cause the lenders to declare the principal and interest outstanding at that time
to be payable immediately and terminate any commitments. The Company can make no
assurance that it will not be required to engage in asset sales or pursue other
alternatives designed to enhance liquidity or obtain relief from its
obligations, or that it will be successful in these efforts. As of March 31
2003, the Company was in compliance with these covenants and, if the Company is
able to substantially execute its 2003 plan, the Company expects to remain in
compliance with these covenants for the remainder of 2003. The financial
statements do not include any adjustments relating to the recoverability and
classification of assets and the satisfaction and classification of liabilities
that might be necessary should the Company be unable to continue as a going
concern.
-6-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") SFAS No. 143, "Accounting for Asset
Retirement Obligations". This standard addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The standard is effective for
fiscal years beginning after June 15, 2002. The Company adopted this standard on
January 1, 2003. The adoption of SFAS No. 143 did not have a material impact on
the Company's financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This standard amends Emerging Issue Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity". This statement requires that a
liability for costs associated with an exit or disposal activity be recognized
when the liability is incurred, rather than when an entity commits to an exit
plan. The standard also established the use of fair value for the measurement of
exit liabilities. The standard is effective for exit or disposal activities
initiated after December 31, 2002, with early application encouraged. The
Company adopted this standard on January 1, 2003. The adoption of this standard
did not have an impact on the Company's financial condition or results of
operations as it will only impact the Company's future exit or disposal
activities, if any.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of FASB Statement No.
123". This standard amends SFAS No. 123, "Accounting for Stock-Based
Compensation". This statement permits two additional transition methods for
entities to apply when implementing the fair value recognition provisions of
SFAS No. 123. The standard also establishes new disclosure requirements and
requires prominent display of such disclosures. The standard is effective for
financial statements for fiscal years ending after December 31, 2002, with early
application permitted. The Company adopted this standard effective January 1,
2003. On a prospective basis, the Company changed from the intrinsic value
method under APB No. 25 to the fair value method under SFAS No. 123, and the
impact of the adoption is reflected in the Company's results of operations for
the three months ended March 31, 2003. The adoption of SFAS Nos. 123 and 148
during the three months ended March 31, 2003 resulted in the Company recording
$0.4 million of compensation expense for the fair value of options granted
during the period and deferring $0.6 million to be recognized over the remaining
vesting period of the options. Refer to Note 10 "Stock Option Plans" for
disclosures required upon adoption of this pronouncement.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". This standard amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". This
standard clarifies the accounting guidance on derivative instruments, including
certain derivative instruments embedded in other contracts, and hedging
activities. The standard is effective for contracts entered into or modified
after June 30, 2003. The Company does not expect the adoption of this standard
to have a material impact on its financial condition or results of operations.
In November 2002, the FASB issued Financial Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN No. 45 elaborates on the
existing disclosure requirements for most guarantees, and clarifies that at the
time a company issues a guarantee, the company must recognize an initial
liability for the fair value of the obligation it assumes under that guarantee
and must disclose that information in its interim and annual financial
statements. The initial recognition and measurement provisions apply on a
prospective basis to
-7-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
guarantees issued or modified after December 31, 2002. The adoption of FIN No.
45 did not have a material impact on the Company's financial condition or
results of operations.
On January 17, 2003 the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." The objective of FIN No. 46 is to improve financial
reporting by companies involved with variable interest entities. FIN No. 46
changes certain consolidation requirements by requiring 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. The
consolidation requirements apply to entities created before February 1, 2003, no
later than the beginning of the first fiscal year or interim period beginning
after June 15, 2003. The Company's adoption of the provisions of FIN No. 46 is
not expected to have a material impact on the Company's financial condition, or
results of operations.
NOTE 5. PROPERTY AND EQUIPMENT
Property and equipment, at cost, consisted of the following:
March 31, 2003 December 31, 2002
-------------- -----------------
Switch equipment................................... $ 303,106 $ 300,506
Computer equipment and software.................... 57,331 55,598
Office furniture and equipment..................... 9,904 9,950
Leasehold improvement.............................. 22,770 22,815
Indefeasible right to use fiber (IRU).............. 69,475 67,548
Assets held for use................................ 6,252 5,132
Construction in progress........................... 1,642 5,665
----------- ----------
Total property and equipment 470,480 467,214
Less: accumulated amortization on IRUs............ (6,310) (5,452)
accumulated depreciation.................... (138,914) (125,051)
----------- ----------
Property and equipment, net $ 325,256 $ 336,711
========== ==========
Depreciation expense for the three months ended March 31, 2003 and March 31,
2002, amounted to $14.0 million and $13.6 million, respectively.
-8-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6. INTANGIBLE ASSETS
The Company accounts for certain intangible assets with finite lives in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets". The
following schedule sets forth the major classes of intangible assets held by the
Company:
March 31, 2003 December 31, 2002
-------------- -----------------
Amortized intangibles:
Customer relationships.......................... $ 53,635 $ 53,635
Deferred financing costs........................ 29,813 29,785
Less: accumulated amortization.....
Customer relationships............. (28,468) (25,787)
Deferred financing costs........... (11,246) (10,154)
--------- -------
Intangible assets, net ..................... $ 43,734 $ 47,479
========= ========
Deferred financing costs are amortized to interest expense over the term of the
related debt using the effective interest rate method. The Company continues to
amortize its intangible assets that have finite lives. The estimated
amortization expense on customer relationships, which have an estimated life of
five years, is as follows for the following fiscal periods:
April to December, 2003............................ $ 8,045
2004............................................... 10,616
2005............................................... 6,027
2006............................................... 370
2007............................................... 109
Amortization expense was $3.6 million and $2.6 million for the three months
ended March 31, 2003 and 2002, respectively.
NOTE 7. ACCRUED EXPENSES
Accrued expenses consisted of the following:
March 31, 2003 December 31, 2002
-------------- -----------------
Accrued network costs.............................. $ 25,270 $ 33,936
Accrued payroll and payroll related benefits....... 3,215 2,883
Accrued collocation costs.......................... 6,034 5,723
Accrued interest................................... 1,192 1,222
Accrued restructuring costs........................ 790 1,695
Deferred revenue................................... 4,758 4,990
Other.............................................. 5,789 7,932
------------ --------------
Total accrued expenses $ 47,048 $ 58,381
============ ==============
-9-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8. DEBT
Long-term debt outstanding consists of the following:
March 31, 2003 December 31, 2002
-------------- -----------------
Senior credit facility:
Term A loan.................................... $ 125,000 $ 125,000
Term B loan.................................... 125,000 125,000
Term C loan.................................... 42,330 41,389
Term D loan.................................... 1,750 875
Revolver....................................... 100,000 100,000
Subordinated notes................................. 210,408 203,677
------- -------
$ 604,488 $ 595,941
========= =========
Included in the subordinated notes is a discount of $2.6 million and $2.8
million as of March 31, 2003 and December 31, 2002, respectively. Included in
the Term C loan is a discount of $4.0 million and $4.1 million as of March 31,
2003 and December 31, 2002, respectively, and payable-in-kind ("PIK") interest
which accreted to principal of $1.8 million and $1.0 million as of March 31,
2003 and December 31, 2002, respectively.
The discount on the subordinated notes is being amortized over the nine-year
term of the subordinated notes. For the three months ended March 31, 2003 and
2002, $0.2 million and $0.1 million of the discount on the subordinated notes
was amortized, respectively. The discount on the Term C loan is also being
amortized over its seven and one-half year term. For the three months ended
March 31, 2003, $0.1 million of the discount on the Term C loan was amortized.
The Company's Credit Agreement provides the Company with the following borrowing
limits, maturities and interest rates:
Principal
Amount Maturity
------ --------
Revolving credit facility........... $ 100,000 July 31, 2008
Term A loan - multiple draw......... 125,000 July 31, 2008
Term B loan......................... 125,000 January 31, 2009
Term C loan......................... 44,500 March 31, 2009
Term D loan......................... 4,375 January 31, 2009
Interest Rate Options Interest Terms
Revolving credit facility........... LIBOR + 4.00% or Base Rate+3.00%* Payable monthly
Term A loan - multiple draw......... LIBOR + 4.00% or Base Rate+3.00%* Payable monthly
Term B loan......................... LIBOR + 4.75% or Base Rate+3.75% Payable monthly
Term C loan......................... LIBOR + 5.75% or Base Rate+4.75% Accrues to principal
Term D loan......................... LIBOR + 4.00% or Base Rate+3.00%* Payable monthly
*- The applicable margin is determined by a grid tied to the Company's leverage
ratio. Initially, the applicable margin is 4.0% if the LIBOR rate is used or
3.0% if the Base Rate is used.
-10-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Credit Agreement contains certain covenants that are customary for credit
facilities of this nature, all of which are defined in the Credit Agreement.
These covenants require the Company to maintain an aggregate minimum amount of
cash and committed financing of $10.0 million through July 1, 2004, and limit
the Company to a maximum amount of capital expenditures that vary annually as
described in the Credit agreement. A default in observance of these covenants,
if unremedied in three business days, could cause the lenders to declare the
principal and interest outstanding at that time to be payable immediately and
terminate any commitments. The Company was in compliance with all covenants
under the Credit Agreement for the three months ended March 31, 2003.
As of March 31, 2003, the Company had principal borrowings of $202.7 million in
subordinated notes, excluding the discount of $2.6 million and PIK interest of
$10.3 million. Interest on the notes is fixed at 13% and accretes to the
principal semi-annually until November 2006. Thereafter, interest will be
payable quarterly, in cash, based on LIBOR plus an applicable margin. The
subordinated notes mature on November 9, 2010.
As of March 31, 2003, the maximum borrowings under the Term A loan, Term B loan,
Term C loan, and the revolver loan were all outstanding. There was $1.8 million
outstanding under the Term D loan at March 31, 2003. At March 31, 2003, $206.6
million was variable rate debt and $397.9 million was fixed rate debt, including
variable rate debt fixed by the interest rate swap agreements. The weighted
average floating interest rate and the weighted average fixed swapped interest
rate at March 31, 2003 were 5.71% and 11.93%, respectively.
NOTE 9. DERIVATIVE INSTRUMENTS
The Company accounts for its derivative instruments in accordance with SFAS No.
133, which requires that all derivative financial instruments, such as interest
rate swap agreements, be recognized in the financial statements and measured at
fair value regardless of the purpose or intent for holding them.
The Company uses derivative instruments to manage its interest rate risk. The
Company does not use the instruments for speculative purposes. Interest rate
swaps were employed as a requirement under the Company's Second Amended and
Restated Credit Agreement. The Third Amended and Restated Credit Agreement does
not have such a requirement. This agreement does prohibit the Company from
entering into any new interest rate swap, collar, cap, floor or forward rate
agreements without the prior written consent of the lenders. The interest
differential to be paid or received under the related interest rate swap
agreements is recognized over the life of the related debt and is included in
interest expense or income. The Company designates these interest rate swap
contracts as cash flow hedges. The fair value of the interest rate swap
agreements designated and effective as a cash flow hedging instrument is
included in accumulated other comprehensive loss. Credit risk associated with
nonperformance by counterparties is mitigated by using major financial
institutions with high credit ratings.
At March 31, 2003, the Company had interest rate swap agreements with notional
principal amounts of $62.5 million and $125.0 million expiring in May 2003 and
February 2006, respectively. The interest rate swap agreements are based on the
three-month LIBOR, which are fixed at 4.985% and 6.94%, respectively.
Approximately 47% of the underlying facility debt is being hedged with these
interest rate swap agreements. The fair value of the interest rate swap
agreements was $18.3 million and $19.3 million as of March 31, 2003 and December
31, 2002, respectively. The fair value of the interest rate swap agreements is
estimated based on quotes from brokers and represents the estimated amount that
the Company would expect to pay to terminate the agreements at the reporting
date.
-11-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The fair value of the interest rate swap agreements is included in the
accumulated other comprehensive loss on the consolidated balance sheet and the
change in the fair value of the interest rate swap agreements is the only
component of other comprehensive loss. Comprehensive loss was $25.2 million and
$45.0 million for the three months ended March 31, 2003 and March 31, 2002,
respectively.
NOTE 10. STOCK OPTION PLANS
In accordance with SFAS No. 148, the Company adopted the financial statement
measurement and recognition provisions of SFAS No. 123 effective January 1,
2003. Under SFAS No. 123, on a prospective basis, the Company recognizes
compensation expense for the fair value of all stock options granted after
December 31, 2002, over the vesting period of the options. The adoption of SFAS
Nos. 123 and 148 during the three months ended March 31, 2003 resulted in the
Company recording $0.4 million of compensation expense for the fair value of
options granted during the period and deferring $0.6 million to be recognized
over the remaining vesting period of the options.
For stock options granted prior to December 31, 2002, the Company accounts for
stock based compensation issued to its employees in accordance with the
intrinsic value method described in APB Opinion No. 25, "Accounting for Stock
Issued to Employees." Had compensation cost been determined based on the fair
value of the options at the grant dates for awards granted prior to December 31,
2002 consistent with the method prescribed in SFAS No. 123, the Company's net
loss and net loss per share would have increased to the pro forma amount
indicated below:
Three months Ended Three months Ended
March 31, March 31,
2003 2002
---- ----
Net loss as reported......................................... $ (26,264) $ (47,315)
Stock-based employee compensation expense included
in reported net loss, net of related tax effects............. 475 381
Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects.................................. (780) (13,876)
------ --------
Net loss pro forma.......................................... $ (26,569) $ (60,810)
======== =======
Net loss per share, basic and diluted:
Three months Ended Three months Ended
March 31, March 31,
2003 2002
---- ----
As reported................................................. $ (0.72) $ (1.37)
Pro forma................................................... $ (0.73) $ (1.69)
-12-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For purposes of the disclosure above, the fair value of each option grant is
estimated on the date of the grant using the Black-Scholes option-pricing model
and the following weighted average assumptions for the three month period ended:
March 31, 2003 March 31, 2002
-------------- --------------
Dividend yield................................................ 0.00 percent 0.00 percent
Expected volatility........................................... 220.93 percent 131.68 percent
Risk-free interest rate....................................... 3.00 percent 4.97 percent
Expected life.................................................. 4 years 7 years
The weighted average grant date fair value of options granted during the
three-month period ended March 31, 2003 and 2002, was $0.25 and $3.25,
respectively.
In November 2002, the Company's Board of Directors approved a voluntary stock
option exchange program for eligible employee option holders under the 1998
Employee Stock Option Plan. Options granted on or before January 2, 2002 were
eligible for the exchange program, except for the performance-based options
issued on January 1, 2002. To participate in the exchange program, employees
must have been continually employed by the Company throughout the tender offer
period and until the grant of new options. Employee participation in the program
was strictly voluntary and options issued under the Company's 1999 Plan were
excluded from the stock option exchange program. The number of new options
issued varied depending on the exercise price of the options tendered according
to the following exchange ratios:
Number of new options to be
granted as a percent of shares
For options with exercise prices: covered by tendered options
- --------------------------------- ---------------------------
$4.00 and under 80%
$4.01 to $8.00 65%
$8.01 to $20.00 40%
Over $20.00 25%
The tender offer period commenced on December 19, 2002, with 4,482,021 options
eligible for exchange, and was completed on January 21, 2003. Pursuant to the
terms of the tender offer, the outstanding current options properly tendered for
exchange by employees was 4,119,524, or approximately 92% of the current options
eligible for exchange. On January 21, 2003, the Company granted to those
eligible employees new options to purchase 2,582,986 shares of common stock with
an exercise price of $0.26 per share. All tendered options that were fully
vested on January 21, 2003 were replaced with new options that are also fully
vested. For tendered options that had not yet vested, the vesting schedule for
replacement options was extended by one year.
The Company had options and warrants to purchase 6,498,902 and 8,986,056 shares
outstanding at March 31, 2003 and 2002, respectively, that were not included in
the calculation of diluted loss per share because the effect would be
anti-dilutive.
-13-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11. RESTRUCTURING COSTS
In September 2002, the Company identified opportunities to optimize the use of
capital and company assets and committed to a plan of workforce reductions,
closing operations in its Ann Arbor and Lansing, Michigan market and reducing
reliance on certain collocation sites.
On September 5, 2002, the Company announced it had reduced its workforce by 102
operational and administrative positions. All positions were terminated by
September 30, 2002 and termination benefits for these positions were included in
the restructuring costs.
On October 9, 2002, the Company notified its customers in the communities of Ann
Arbor and Lansing, Michigan that the Company would be closing that market. The
Company stopped selling services to new customers in this market and notified
existing customers of the decision and the approximate time remaining until
services were terminated, which was in December 2002. The Company has and will
continue to redeploy certain equipment from this market to other markets to
optimize its network assets. Revenue and operating results of the Ann Arbor and
Lansing, Michigan market were not significant to the Company's consolidated
results of operations.
In connection with the above activities, the Company recorded restructuring
costs of $5.3 million, comprised of employee termination benefits of $0.6
million, contractual lease obligations of $3.4 million and network facility
costs of $1.3 million.
During February 2003, the Company modified a portion of its restructuring plan
related to reduced reliance on certain collocation sites. As the Company engaged
in its restructuring actions in the first quarter of 2003, the Company was
informed that additional costs would be charged to it by the established
telephone companies in connection with the restructuring. Based on this new
information, the Company reduced the number of collocation sites that would be
affected. As a result of this plan modification, the Company reversed
approximately $0.7 million in restructuring costs related to the collocation
sites. At the same time, the Company increased the restructuring accrual for
$0.1 million in termination benefits and other network facility costs that
became known during the three months ended March 31, 2003.
At March 31, 2003, approximately $1.0 million of the total restructuring costs
recognized had been paid and it is anticipated that the remaining charges will
be liquidated within the next calendar year, except for contractual lease
obligations of $2.9 million that extend beyond one year and are included in
other long-term liabilities. The following table highlights cumulative
restructuring activities through March 31, 2003:
Termination Lease Network
Benefits Obligations Facility Costs Total
-------- ----------- --------------- -----
Initial restructuring charge....................... $ 559 $ 3,441 $ 1,283 $ 5,283
Payment of benefits and other obligations.......... (537) (25) - (562)
------- ----------- ------------ ----------
Balance at December 31, 2002....................... 22 3,416 1,283 4,721
Payment of benefits and other obligations.......... (72) (98) (297) (467)
Adjustments due to plan modifications.............. 50 - (585) (535)
-------- ------------ --------- ----------
Balance at March 31, 2003.......................... $ - $ 3,318 $ 401 $ 3,719
======= ========== ======== ========
-14-
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES AND CASH FLOW
INFORMATION
During the three months ended March 31, 2003, the Company executed a capital
lease for the indefeasible rights to use fiber for $1.9 million under the master
facilities agreement with FiberTech Networks, LLC. The lease was for fiber
deployed in Columbus, Ohio.
Supplemental disclosures of non-cash investing activities and cash flow
information for the three months ended:
March 31, 2003 March 31, 2002
-------------- --------------
Interest paid....................................................... $ 7,511 $ 7,254
Capital lease obligations for IRUs.................................. $ 1,923 $ 372
Issuance of common stock for employer 401(k) contribution........... $ 281 $ -
NOTE 13. COMMITMENTS AND CONTINGENCIES
On January 26, 2002, the Company and its wholly owned subsidiary US Xchange Inc.
(referred to collectively for purposes of this paragraph as the Company), filed
suit against AT&T Corp ("AT&T"). This action is now pending in the United States
District Court for the Western District of New York (02-CV-6090L). The Company
is seeking damages from AT&T for breach of contract based upon AT&T's failure to
pay, either on time or in full, the Company's invoices for access services
provided to AT&T. The parties are now engaged in the discovery process.
On November 20, 2001, the Company and three of its officers were named in a
complaint filed in the United States District Court of the Southern District of
New York on behalf of a class of persons consisting of certain purchasers of the
Company's common stock in its initial public offering which was completed on
February 23, 2000. The complaint seeks damages based on allegations that the
Company's Registration Statement and Prospectus relating to the offering
contained material misstatements and/or omissions regarding the compensation
received by the underwriters of the offering and certain transactions engaged in
by the underwriters. This case, which has been consolidated with more than 300
other cases against other companies involving similar allegations, also names
six underwriters of the Company's offering and the offerings of other issuers,
and alleges that the underwriters engaged in a pattern of conduct to extract
inflated commissions in excess of the amounts disclosed in offering materials
and manipulated the post-offering markets in connection with hundreds of
offerings by engaging in stabilizing transactions and issuing misleading and
fraudulent analyst and research reports. The underwriters are also the subject
of publicly disclosed investigations by several governmental agencies. The
complaint alleges that the Company is strictly liable under Section 11 of the
Securities Act of 1933 because Item 508 of Regulation S-K allegedly required the
disclosure of commissions to be paid to underwriters and of stabilizing
transactions, and that the Company and its officers acted with scienter, or
recklessness, in failing to disclose these facts, in violation of Section 10(b)
of the Securities Exchange Act and Rule 10b-5 promulgated thereunder. The claims
against the individual defendants have been dismissed without prejudice, by an
agreement with the plaintiffs. The court recently denied motions to dismiss the
cases, and the parties are discussing a framework for conducting discovery,
including a process for limiting discovery involving issuers such as the Company
in all but a few test cases. Settlement discussions with the plaintiffs are
ongoing under the guidance of a mediator, but it is not possible to predict
whether and when, and on what terms, any settlement might eventually be
finalized.
-15-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
From time to time, we make oral and written statements that may constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. We desire to take advantage of the "safe harbor"
provisions in the Private Securities Litigation Reform Act of 1995 for
forward-looking statements made by us from time to time, including, but not
limited to, the forward-looking information contained in "Management's
Discussion and Analysis of Financial Condition and Results of Operations", and
elsewhere in this Form 10-Q and in other filings with the Securities and
Exchange Commission ("SEC"). The words or phrases "believes", "expects",
"estimates", "anticipates", "will", "will be", "could", "may" and "plans" and
the negative or other similar words or expressions identify forward-looking
statements made by or on behalf of the Company.
Forward-looking statements may discuss our future expectations, as well as
certain projections of our results of operations and financial condition. We
caution readers that any such forward-looking statements made by or on behalf of
us involve risks, uncertainties and other unknown factors. Actual results,
levels of activity and performance could differ materially from those expressed
or implied in the forward-looking statements.
Factors that could impact our Company include, but are not limited to:
o Successful marketing of our services to current and new customers;
o The ability to generate positive working capital by timely collections from
customers and obtaining favorable payment terms from our vendors;
o The availability of additional financing;
o Compliance with covenants for borrowing under our bank credit facility;
o Technological, regulatory or other developments in the Company's business;
and
o Shifts in market demand and other changes in the competitive
telecommunications sector.
These and other applicable risks are summarized under the caption "Risk Factors"
and elsewhere in the Company's Annual Report on Form 10-K, filed on March 31,
2003. You should consider all of our subsequent written and oral forward-looking
statements only in light of such cautionary statements. You should not place
undue reliance on these forward-looking statements and you should understand
that they represent management's view only as of the dates we make them.
OVERVIEW
We are an integrated communications provider offering facilities-based voice and
data telecommunications services primarily to small and medium-sized businesses
in 29 second and third tier markets in 12 states in the northeastern and
midwestern United States. Our services include:
o local exchange and long distance service; and
o high-speed data and Internet services.
Our principal competitors are incumbent local exchange carriers, such as the
regional Bell operating companies, as well as other integrated communications
providers.
-16-
We seek to become the leading integrated communications provider in each of our
markets by offering a single source for competitively priced, high quality,
customized telecommunications services. A key element of our strategy has been
to be one of the first integrated communications providers to provide
comprehensive network coverage in each of the markets we serve. We are achieving
this market coverage by installing both voice and data equipment in multiple
established telephone company central offices. As of March 31, 2003, we have
connected 93% of our clients directly to our own switches, which allows us to
more efficiently route traffic, ensure a high quality of service and control
costs.
We evaluate the growth of our business by focusing on various operational data
in addition to financial data. Lines in service represent the lines sold that
are now being used by our clients subscribing to our services. Although the
number of lines we service for each client may vary, our primary focus is on the
small- to medium-sized business customer. On average, our clients have 5 lines.
We plan to continue to focus primarily on small- to medium-sized business
clients.
The table below provides selected key operational data as of:
March 31, 2003 March 31, 2002
-------------- --------------
Markets served 29 30
Number of switches-voice 25 26
Number of switches-data 63 63
Total central office collocations 517 528
Markets with operational fiber 19 14
Estimated addressable market (Business lines) 5.7 million 5.7 million
Lines in service-total 510,818 430,095
Lines in service-voice 493,307 416,302
Lines in service-data 17,511 13,793
Total employees 1,410 1,820
Direct sales employees 292 541
In this filing, we include references to and analyses of adjusted earnings
before interest, income taxes, depreciation, amortization and other non-cash
charges ("Adjusted EBITDA") amounts. Adjusted EBITDA is used by management and
certain investors as an indicator of a company's liquidity and should not be
substituted for net cash provided by/(used in) operating activities determined
in accordance with accounting principles generally accepted in the United States
of America ("GAAP"), the most directly comparable financial measure under GAAP.
Management believes that the presentation of adjusted EBITDA is meaningful
because it is an indicator of our ability to service existing debt, to sustain
potential increases in debt, and to satisfy capital requirements. Adjusted
EBITDA is also used in the calculation of management's variable compensation.
Adjusted EBITDA as presented may not be comparable to other similarly titled
measures used by other companies.
-17-
The following table shows the differences between our cash flow from operations
as determined in accordance with GAAP and our adjusted EBITDA:
(in thousands)
Three Months Ended
------------------
March 31, December 31, March 31,
2003 2002 2002
--------- ------------ ----------
Net cash used in operating activities...................... $ (8,123) $ (5,091) $ (27,165)
Adjustments to reconcile:
Changes in assets and liabilities....................... 8,954 (3,932) 10,678
Less: Net interest expense currently payable
Other (income)/expense, net........................... 16,374 16,799 14,110
Amortization of deferred financing costs.............. (1,141) (1,404) (1,016)
Amortization of discount on long-term debt............ (268) (261) (123)
Interest payable in-kind on long-term debt............ (7,583) (7,756) (5,794)
------- ------ -------
Net interest expense currently payable 7,382 7,379 7,177
----- ------ -----
Adjusted EBITDA............................................ $ 8,213 $ (1,645) $ 9,310)
======== ========== =========
In September 2002, we identified opportunities to optimize the use of capital
and company assets and committed to a plan of workforce reductions, closing
operations in our Ann Arbor and Lansing, Michigan market and reducing reliance
on certain collocation sites. In connection with these activities, we recorded
restructuring costs of $5.3 million in the three-month period ended September
30, 2002, comprised of employee termination benefits of $0.6 million,
contractual lease obligations of $3.4 million and network facility costs of $1.3
million.
As we engaged in our restructuring actions in the first quarter of 2003, we were
informed that additional costs would be charged to us by the established
telephone companies in connection with the restructuring. Based on this new
information, we modified a portion of the restructuring plan and reduced the
number of collocation sites that would be affected. As a result of this plan
modification, we reversed approximately $0.7 million in restructuring costs
related to the collocation sites. At the same time, we increased the
restructuring accrual for $0.1 million in termination benefits and other network
facility costs that became known during the three months ended March 31, 2003.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003 AS COMPARED TO
MARCH 31, 2002
REVENUE
We generated $80.1 million in revenue during the three months ended March 31,
2003. This represents a 13.5% increase compared to revenue for the three months
ended March 31, 2002, and a 10.4% increase compared to the revenue for three
months ended December 31, 2002. Of our total revenue increase from the three
months ended March 31, 2002, approximately $9.7 million was attributable to
increases in voice revenue and $1.5 million was attributable to increases in
data revenue. These increases were offset by a $1.7 million decrease in access
revenue. The favorable changes in voice and data revenue from the same quarter a
year ago are primarily attributable to an increase in the average number of
lines in service. The average number of voice lines
-18-
increased by approximately 101,000 and the average number of data lines
increased by approximately 5,100 lines. Our lines in service at March 31, 2003
increased 18.8% from March 31, 2002.
Access revenue decreases resulted from regulatory changes adopted by the Federal
Communications Commission "(FCC") that became effective on July 1, 2002, which
set the amount that we may charge other carriers for access service, were offset
by the increase in our average number of lines previously noted.
Average revenue per line for the three months ended March 31, 2003 as compared
to March 31, 2002, declined by 5.1% for voice service, by 6.8% for data service,
and by 29.9% for access service. Average revenue per line as compared to the
three months ended December 31, 2002 did not fluctuate materially. Revenue in
subsequent quarters is expected to increase from the level realized during the
three months ended March 31, 2003 and prior year quarters due to projected
increases in the number of lines in service, anticipated increases in our
penetration in existing markets, and the introduction and sales of additional
value added services to our existing customers. Average revenue per line during
the remainder of 2003 will be impacted by Federal Communications Commission
mandated reductions in access rates, negotiated contract rates for reciprocal
compensation and access, and our ability to succeed in selling services in a
competitive environment.
Our churn of facilities-based business clients for the three months ended March
31, 2003 decreased slightly to an average of 1.5% per month. Our churn levels
continue to compare favorably to the churn experienced by other comparable
companies within the telecommunications industry. We seek to minimize churn by
providing superior client care, by offering a competitively priced portfolio of
local, long distance and data services, by signing a significant number of
clients to multi-year service agreements, and by focusing on offering our own
facilities-based services.
NETWORK COSTS
Network costs for the three months ended March 31, 2003 were $40.5 million
representing a 3.9% decrease compared to network costs for the three months
ended March 31, 2002, and a 1.1% decrease compared to network costs for the
three months ended December 31, 2002. Network costs as a percentage of total
revenues were 50.6% at March 31, 2003, down from 59.8% at March 31, 2002 and
56.5% at December 31, 2002. Network costs, as a percentage of revenue, are
anticipated to continue to decrease reflecting the benefits of our fiber network
implementation and other network efficiencies realized from the increased number
of installed lines.
Additionally, we have continued with initiatives introduced in 2002 to optimize
our existing network. During the three months ended March 31, 2003, our average
cost per line declined approximately 24% as compared to the three months ended
March 31, 2002, and approximately 1.9% as compared to the three months ended
December 31, 2002, which highlights the effectiveness of our network
optimization initiatives, economies of scale, and the benefits of leasing fiber.
The cost of leasing fiber is included in depreciation and amortization expense.
Our network costs include:
o Leases of high-capacity digital lines that interconnect our network with
established telephone company networks;
o Leases of our inter-city network;
o Leases of local loop lines which connect our clients to our network;
o Leased space in established telephone company central offices for
collocating our transmission equipment;
-19-
o Completion of local calls originated by our clients, and
o Completion of originating (1+ calling) and terminating (inbound 800
calling) long distance calls by our clients.
We lease fiber capacity in certain markets when economically justified by
traffic volume growth in order to reduce the overall cost of local transport and
reduce our reliance on the established telephone company. Fiber deployment
provides the bandwidth necessary to support substantial incremental growth and
allows us to reduce network costs and enhance the quality and reliability of our
network, which strengthens our competitive advantage in our markets.
During the three months ended March 31, 2003, we took possession of fiber
network in Columbus, Ohio under a 20 year lease with Fibertech Networks, LLC
("FiberTech") bringing to 19 the number of markets where we have intra-city
fiber connecting our collocations. We plan to activate fiber in an additional 3
markets across our footprint. Our fiber network now consists of 2,483 route
miles of intra- and inter-city fiber miles, of which 2,215 miles is operational.
Once complete, our planned fiber network will consist of approximately 3,418
fiber miles.
Our revenues exceeded our network costs by $39.6 million, or 49.4% of revenue,
for the three months ended March 31, 2003, compared to $28.4 million, or 40.2%
of revenue, for the three months ended March 31, 2002, and $31.6 million or
43.5% of revenue for the three months ended December 31, 2002. We expect that
our revenue in excess of network costs, as a percentage of revenue, will improve
as our revenue increases and we realize additional cost efficiencies in our
network costs during 2003.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months ended March
31, 2003 were $32.4 million compared to selling, general and administrative
expenses of $45.2 million and $33.4 million during the three months ended March
31, 2002 and December 31, 2002, respectively. Excluding the non-cash
compensation and management ownership allocation charges, the selling, general
and administrative expenses decreased 15.4% from $37.7 million during the three
months ended March 31, 2002 to $31.9 million during the three months ended March
31, 2003. For the three months ended December 31, 2002 selling, general and
administrative expenses excluding non-cash compensation and management
allocation was $33.2 million.
Selling, general and administrative expenses, excluding non-cash compensation
and management ownership allocation charges, as a percentage of revenue was
39.8% for the three months ended March 31, 2003 as compared to 53.4% for the
three months ended March 31, 2002 and 45.8% for the three months ended December
31, 2002. The changes in selling, general and administrative expenses resulted
primarily from changes in the number of employees and offset by the growth of
our operations and systems support services. During the three months ended March
31, 2003, salary, commissions and benefits decreased approximately $5.1 million,
directly related to headcount decreases as compared to the three months ended
March 31, 2002.
The number of individuals we employed decreased to approximately 1,410 at March
31, 2003. We employed 1,820 and 1,539 individuals at March 31, 2002 and December
31, 2002, respectively.
Our selling, general and administrative expenses include:
o Costs associated with sales and marketing, client care, billing, corporate
administration, personnel and network maintenance;
o Network maintenance costs;
-20-
o Administrative overhead and office lease expense; and
o Bad debt expense.
Also included in selling, general and administrative expenses for the three
months ended March 31, 2003, are non-cash charges for management ownership
allocation and compensation amortization of $0.5 million. This compares to the
non-cash charges of $7.5 million for the three months ended March 31, 2002.
Non-cash compensation expense for the three months ended March 31, 2003 includes
the expense associated with our adoption of SFAS No. 148. Prospectively,
beginning on January 1, 2003, we changed from the intrinsic value method under
APB No. 25 to the fair value method under SFAS No. 123. Non-cash compensation
was recorded in connection with membership units of Choice One Communications
L.L.C. sold to certain management employees, grants to employees under our 1998
Employee Stock Option Plan, and the issuance of restricted shares to the former
employees of US Xchange, which we acquired in 2000. The management ownership
allocation charge was fully amortized at December 31, 2002.
RESTRUCTURING COSTS
In September 2002, we identified opportunities to optimize the use of capital
and company assets and committed to a plan of workforce reductions, closing
operations in our Ann Arbor and Lansing, Michigan market and reducing reliance
on certain collocation sites.
On September 5, 2002, we announced we had reduced our workforce by 102
operational and administrative positions. All positions were terminated by
September 30, 2002 and termination benefits for these positions were included in
the restructuring costs.
On October 9, 2002, we notified our customers in the communities of Ann Arbor
and Lansing, Michigan that we would be closing that market. We stopped selling
services to new customers in this market and notified existing customers of the
decision and the approximate time remaining until services were terminated,
which was in December 2002. We have and will continue to redeploy certain
equipment from this market to other markets to optimize our network assets.
Revenue and operating results of the Ann Arbor and Lansing, Michigan market were
not significant to our consolidated results of operations.
In connection with the above activities, we recorded restructuring costs of $5.3
million in the three-month period ended September 30, 2002, comprised of
employee termination benefits of $0.6 million, contractual lease obligations of
$3.4 million and network facility costs of $1.3 million.
During February 2003, we modified a portion of our restructuring plan related to
reduced reliance on certain collocation sites. As we engaged in our
restructuring actions in the first quarter of 2003, we were informed that
additional costs would be charged to us by the established telephone companies
in connection with the restructuring. Based on this new information, we reduced
the number of collocation sites that would be affected. As a result of this plan
modification, we reversed approximately $0.7 million in restructuring costs
related to the collocation sites. At the same time, we increased the
restructuring accrual for $0.1 million in termination benefits and other network
facility costs that became known during the three months ended March 31, 2003.
-21-
For the three months ended March 31, 2003, approximately $0.5 million of the
restructuring costs were paid and it is anticipated that the remaining charges
will be liquidated within the next calendar year, except for contractual lease
obligations of $2.9 million that extend beyond one year and are included in
other long-term liabilities. The following table highlights cumulative
restructuring activities through March 31, 2003:
Termination Lease Network
Benefits Obligations Facility Costs Total
-------- ----------- -------------- -----
Initial restructuring charge....................... $ 559 $ 3,441 $ 1,283 $ 5,283
Payment of benefits and other obligations.......... (537) (25) - (562)
------- --------- ----------- ---------
Balance at December 31, 2002....................... 22 3,416 1,283 4,721
Payment of benefits and other obligations.......... (72) (98) (297) (467)
Adjustments due to plan modifications.............. 50 - (585) (535)
------- --------- --------- ----------
Balance at March 31, 2003.......................... $ - $ 3,318 $ 401 $ 3,719
======= ======= ======== ========
DEPRECIATION AND AMORTIZATION
Depreciation and amortization for the three months ended March 31, 2003 was
$17.6 million. This represents an 8.6% increase compared to the three months
ended March 31, 2002 and an 11.8% decrease from the three months ended December
31, 2002. The increase in depreciation expense as compared to the three months
ended March 31, 2002 was related to the deployment of network assets and other
general business assets. Depreciation expense for the three months ended
December 31, 2002 was higher than the three months ended March 31, 2003 as a
result of non-recurring charges incurred during the original construction of
collocations. Our depreciation and amortization expense includes depreciation of
switch related equipment, non-recurring charges and equipment collocated in
established telephone company central offices, network infrastructure equipment,
information systems, furniture and fixtures, indefeasible rights to use fiber
and amortization of customer relationships.
INTEREST EXPENSE AND INCOME
Interest expense for the three months ended March 31, 2003 and 2002 was
approximately $16.5 million and $14.2 million, respectively. Interest expense
for the three months ended December 31, 2002 was approximately $17.0 million.
Interest expense includes interest payments on borrowings under our senior
credit facility, non-cash interest on the subordinated notes, amortization of
deferred financing costs related to these facilities, amortization of the
discount on the subordinated notes and Term C loan under the senior credit
facility, commitment fees on the unused senior credit facility, and interest
expense related to IRUs. Interest expense on the subordinated notes is payable
in-kind (PIK) through November 2006.
Interest expense increased from the same quarter a year ago due to an increase
in the amount of borrowings, offset by favorable declines in LIBOR rates that
impacted our borrowing rates. We expect interest expense to remain stable over
the next three quarters due to additional borrowings under the Term D loan that
may be drawn down quarterly between June 30, 2003 and December 31, 2003 and the
expiration of the $62.5 million notional amount interest rate swap agreement in
May 2003. Interest expense, currently payable in cash, was $7.5 million and $7.2
million for the three months ended March 31, 2003 and March 31, 2002,
respectively, and $7.8 million for the three months ended December 31, 2002. We
expect interest expense payable in cash to remain stable during 2003.
Interest income for the three months ended March 31, 2003 and 2002 was
approximately $0.1 million. Interest income for the three months ended December
31, 2002 was approximately $0.2 million. Interest
-22-
income results from the investment of cash and cash equivalents, mainly from the
cash proceeds generated from the borrowings under our senior credit and
subordinated debt facilities. We expect interest income to decrease slightly in
the remaining three quarters of 2003 as cash balances decrease.
INCOME TAXES
We have not generated any taxable income to date, and did not incur any income
tax liability as a result. Further, we do not expect to generate taxable income
during the remainder of 2003.
NET LOSS
The net loss was $26.3 million and $47.3 million for the three months ended
March 31, 2003 and 2002, respectively. The improvement in net loss was
attributable to the factors previously discussed.
The net loss applicable to common stockholders was $38.6 million and $57.8
million for the three months ended March 31, 2003 and 2002, respectively. The
decrease in net loss applicable to common stockholders was attributable to the
factors previously discussed, offset by non-cash accretion and dividends on
preferred stock. The non-cash accretion and dividends on our preferred stock
increased $1.9 million, or 17.7%, for the three months ended March 31, 2003 to
$12.4 million as compared to the three months ended March 31, 2002. This change
was primarily driven by the increase in dividends on preferred stock, which are
determined based on dividends in arrears and outstanding preferred stock during
2003.
LIQUIDITY AND CAPITAL RESOURCES
The accompanying financial statements of the Company have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. Our independent
accountants have noted in their report dated March 27, 2003 concerning our
financial statements for the year ended December 31, 2002, included in the our
annual report filed on Form 10-K, that we had suffered recurring losses from
operations and had a net capital deficiency that raised substantial doubt about
our ability to continue as a going concern.
We have experienced net losses applicable to common stockholders of $38.6
million, $50.5 million, and $57.8 million for the three months ended March 31,
2003, December 31, 2002 and March 31, 2002, respectively. Adjusted EBITDA was
positive $8.2 million for the three months ended March 31, 2003, negative $1.6
million for the three months ended December 31, 2002 and negative $9.3 million
for the three months ended March 31, 2002. Net cash used for operating
activities was approximately $8.1 million, $5.1 million and $27.2 million for
the three months ended March 31, 2003, December 31, 2002 and March 31, 2002,
respectively. Assuming we substantially meet our 2003 plan, we expect our
operating losses and net losses to decline as our operations mature and we
achieve greater operating efficiencies. Our viability is dependent upon our
ability to continue to execute under our business strategy and to begin to
generate positive cash flows from operations. The success of our business
strategy includes obtaining and retaining a significant number of customers,
generating significant and sustained growth in our operating cash flows, and
managing our costs and capital expenditures to be able to meet our debt service
obligations. Significant operating cash flow would be in an amount sufficient to
fully satisfy our operating expenses, meet our debt service obligations and fund
our capital expenditures.
-23-
We have completed several steps intended to increase our liquidity and better
position our company to compete under current conditions and anticipated changes
in the telecommunications industry. These include:
o Completing an additional financing of $48.9 million in September 2002,
o Maintaining a high client retention rate,
o Completing operational initiatives to optimize our network and lower its
cost structure,
o Reducing general and administrative expenses through automation and a
reduction in workforce,
o Exiting one market in 2002 that was found to be unprofitable,
o Introducing new products to improve revenue growth and profitability, and
o Redeploying assets held for use to reduce the requirement for capital
expenditures.
Our 2003 plan is predicated upon the following assumptions:
o sustained growth due to increased penetration for data and voice offerings
in our operational markets,
o continued improvement in operational efficiencies through economies of
scale that translates into lower network costs and lower selling, general
and administrative expenses as a percentage of revenue; and
o decreased capital expenditures.
Our revenue and costs may be dependent upon factors that are not within our
control, including regulatory changes, changes in technology, and increased
competition. Due to the uncertainty of these factors, actual revenue and costs
may vary from expected amounts, possibly to a material degree, and such
variations could affect our future funding requirements. Additional financing
may also be required in response to changing conditions within the industry or
unanticipated competitive pressures. We can make no assurances that we would be
successful in raising additional capital, if needed, on favorable terms or at
all. Due to current adverse conditions in the general economy and specifically
the telecommunications industry, it likely will be difficult to obtain
public/private financing, bank financing or vendor financing to continue our
business. Failure to raise sufficient funds may require us to engage in asset
sales or pursue other alternatives designed to enhance liquidity or obtain
relief from its obligations, as to which success cannot be assured.
There are conditions to our ability to borrow under the senior credit facility,
including the continued satisfaction of covenants. These covenants are minimum
cash and committed financing of $10.0 million through July 1, 2004, and maximum
capital expenditures that vary annually as described in the Third Amended and
Restated Credit Agreement (the "Credit Agreement"). A default in observance of
these covenants, if unremedied in three business days, could cause the lenders
to declare the principal and interest outstanding at that time to be payable
immediately and terminate any commitments. If that event should occur, we can
make no assurance that we will not be required to engage in asset sales or
pursue other alternatives designed to enhance liquidity or obtain relief from
our obligations, or that we will be successful in these efforts. As of March 31
2003, we were in compliance with these covenants and if we are able to
substantially execute our 2003 plan, we expect to remain in compliance with
these covenants for the remainder of 2003.
-24-
At March 31, 2003, we had $20.2 million in cash and cash equivalents and $2.6
million available under our senior credit facility which is available in equal
quarterly installments through December 31, 2003, and subject to no "material
adverse change" in the business, as defined in our Credit Agreement. If we
substantially achieve the 2003 plan, we should have positive cash and cash
equivalents, in excess of the $10.0 million minimum cash and committed financing
covenant established pursuant to the Credit Agreement, at December 31, 2003. The
amount of cash available as of December 31, 2003 is dependent upon factors that
could differ materially from the estimates. Should factors assumed in the 2003
plan differ materially, management may delay some of its future capital
expenditures, reduce selling, general and administrative expenses, or seek
alternative financing for future capital expenditures.
Our estimates of when we will have positive cash flows from operations may be
inaccurate due to a variety of factors including:
o delays in the timely collection of amounts owed to us;
o shorter payment terms given to us by our vendors;
o changes in number of customers and penetration of new services;
o changes in cost of our networks in each of our markets;
o regulatory changes;
o changes in technology;
o changing conditions within the industry and the general economy; and
o increased competition.
Our collections from interexchange carriers and established telephone companies
have been slower than those from end-users. Currently, we have commenced a legal
action against AT&T for contract termination resulting from delays in the
remittance of access payments owed to us. Due to the uncertainty of all of these
factors, actual funding available from operations and other sources may vary
from expected amounts, possibly to a material degree, and such variations could
affect our funding needs and could result in a default under our credit
facilities.
Our failure to comply with the covenants and restrictions contained in our
senior credit facility and subordinated note agreements could lead to default
under those agreements. If such default were to occur, our lenders could declare
all amounts owed to them immediately due and payable. If that event should
occur, we can make no assurances that we would be able to make payments on our
indebtedness, meet our working capital or capital expenditure requirements, or
that we would be able to obtain additional financing, any of which would have a
material adverse effect on our business, financial condition and results of
operations.
Our continuation as a going concern is dependent on our ability to substantially
achieve the 2003 plan. While the substantial achievement of our 2003 plan should
provide us with positive cash and cash equivalents, in excess of the $10.0
million minimum cash and committed financing covenant established pursuant to
the Credit Agreement, at December 31, 2003, there can be no assurance that we
will be successful in executing our business strategy or in obtaining additional
debt or equity financing, if needed, on terms acceptable to us, or at all, or
that management's estimate of additional funds required is accurate. The
financial statements do not include any adjustments relating to the
recoverability and classification of assets and the satisfaction and
classification of liabilities that might be necessary should we be unable to
continue as a going concern.
-25-
FINANCING FACILITIES
Our Bridge Agreement, as amended, permits us to incur up to $425.0 million in
borrowings under the senior credit facility, subject to approval from a majority
of our lenders. We have $398.9 million that has been committed, subject to
various conditions, covenants and restrictions, including those described in
Note 8 to the condensed consolidated financial statements. As of March 31, 2003,
there was $125.0 million outstanding under the Term B loan, $125.0 million
outstanding under the Term A loan, $100.0 million outstanding under the
revolving credit facility, $44.5 million outstanding under the Term C loan, and
$1.8 million outstanding under the Term D loan. There was $2.6 million available
under the senior credit facility at March 31, 2003, which is subject to no
"material adverse change" in the business, as defined in our Credit Agreement.
The senior credit facility, which is secured by liens on substantially all of
our and our subsidiaries' assets and a pledge of our subsidiaries' common stock,
contains covenants and events of default that are customary for credit
facilities of this nature.
The senior credit facility requires us to notify our lenders of a material
adverse change in our business. Failure to timely notify our lenders of a
material adverse change would be an event of default under the Credit Agreement
permitting our lenders to accelerate the loan. Notice to our lenders of a
material adverse change does not create an event of default under the Credit
Agreement. However, our lenders are not required to advance further funds under
such circumstances. As of March 31, 2003, we were in compliance with these
covenants.
We also have $202.7 million of subordinated notes outstanding, excluding the
discount of $2.6 million and accrued PIK interest of $10.3 million, which are
subordinate to the senior credit facility. The interest expense on the
subordinated notes is PIK at a fixed rate of 13.0%, accreting to principal
semi-annually, until November 2006. Thereafter, until maturity on November 9,
2010, interest will be payable in cash quarterly. The subordinated notes contain
covenants related to capital expenditures and events of default that are similar
to those within our senior credit facility.
CASH FLOWS
We have incurred significant operating and net losses since our inception. We
generated positive adjusted EBITDA during the three months ended March 31, 2003.
While we expect to continue to generate positive adjusted EBITDA, we expect to
continue to have operating losses as we penetrate our markets. As of March 31,
2003, we had an accumulated deficit of $1.0 billion. Net cash used for operating
activities was approximately $8.1 million and $27.2 million for the three months
ended March 31, 2003 and 2002, respectively. The net cash used for operating
activities during the three months ended March 31, 2003 was primarily due to net
losses from operations, negative net working capital changes of $9.0 million,
and cash paid for interest of $7.5 million. Net cash paid for interest increased
$0.3 million, or 4.0%, as a result of additional borrowings, offset by lower
LIBOR rates.
Net cash provided by financing activities was $0.7 million and $21.2 million for
the three months ended March 31, 2003 and 2002, respectively. Net cash provided
by financing activities for the three months ended March 31, 2003 was related to
borrowings under the Term D loan of the senior credit facility. Net cash
provided by financing activities for the three months ended March 31, 2002 was
also related to borrowings under the senior credit facility. Funds received were
used for general corporate purposes.
Net cash used in investing activities was $1.9 million and $5.6 million for the
three months ended March 31, 2003 and 2002, respectively. Net cash used in
investing activities for the three months ended March 31, 2003 related to
capital expenditures in support of growth in existing markets, offset slightly
by the proceeds from the sale of non-essential corporate assets. Net cash used
in investing activities for the three months ended March 31, 2002, also related
to capital expenditures, offset by the proceeds from the sale of non-essential
corporate assets.
-26-
CAPITAL REQUIREMENTS
Capital expenditures were $1.9 million and $6.5 million for the three months
ended March 31, 2003 and 2002, respectively. We expect that our capital
expenditures will remain below the level of 2002. The actual amount and timing
of our future capital requirements may differ materially from our estimates as a
result of the demand for our services and regulatory, technological and
competitive developments, including new opportunities in the industry.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for
the year ended December 31, 2002.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset
Retirement Obligations". This standard addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The standard is effective for
fiscal years beginning after June 15, 2002. We adopted this standard on January
1, 2003. The adoption did not have a material impact on our financial condition
or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This standard amends Emerging Issue Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity". This statement
requires that a liability for costs associated with an exit or disposal activity
be recognized when the liability is incurred, rather than when an entity commits
to an exit plan. The standard also established the use of fair value for the
measurement of exit liabilities. The standard is effective for exit or disposal
activities initiated after December 31, 2002, with early application encouraged.
We adopted this standard on January 1, 2003. The adoption of this standard did
not have an impact on our financial condition or results of operations as it
will only impact the Company's future exit or disposal activities, if any.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of FASB Statement No.
123". This standard amends SFAS No. 123, "Accounting for Stock-Based
Compensation". This statement permits two additional transition methods for
entities to apply when implementing the fair value recognition provisions of
SFAS No. 123. The standard also establishes new disclosure requirements and
requires prominent display of such disclosures. The standard is effective for
financial statements for fiscal years ending after December 31, 2002, with early
application permitted. We adopted this standard effective January 1, 2003. On a
prospective basis, we changed from the intrinsic value method under APB No. 25
to the fair value method under SFAS No. 123, and the impact of the adoption is
reflected in our results of operations for the three months ended March 31,
2003. The adoption of SFAS Nos. 123 and 148 during the three months ended March
31, 2003 resulted in us recording $0.4 million of compensation expense for the
fair value of options granted during the period and deferring $0.6 million to be
recognized over the remaining vesting period of the options.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". This standard amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". This
standard clarifies the accounting guidance on derivative instruments, including
certain derivative instruments embedded in other contracts, and hedging
activities. The standard is effective for contracts entered into or modified
after June 30, 2003. We do not expect the adoption of this standard to have a
material impact on our financial condition or results of operations.
-27-
In November 2002, the FASB issued Financial Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN No. 45 elaborates on the
existing disclosure requirements for most guarantees, and clarifies that at the
time a company issues a guarantee, the company must recognize an initial
liability for the fair value of the obligation it assumes under that guarantee
and must disclose that information in its interim and annual financial
statements. The initial recognition and measurement provisions apply on a
prospective basis to guarantees issued or modified after December 31, 2002. The
adoption of FIN No. 45 did not have a material impact on our financial condition
or results of operations.
On January 17, 2003 the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." The objective of FIN No. 46 is to improve financial
reporting by companies involved with variable interest entities. FIN No. 46
changes certain consolidation requirements by requiring 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. The
consolidation requirements apply to entities created before February 1, 2003, no
later than the beginning of the first fiscal year or interim period beginning
after June 15, 2003. Our adoption of the provisions of FIN No. 46 is not
expected to have a material impact on our financial condition or results of
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At March 31, 2003 and December 31, 2002, the carrying value of our debt
obligations, excluding capital lease obligations, was $604.5 million and $595.9
million, respectively. The fair value of those obligations at March 31, 2003 and
December 31, 2002 was $612.8 million and $602.4 million, respectively. The
weighted average interest rate of our debt obligations at March 31, 2003 and
December 31, 2002 was 8.10% and 8.21%, respectively. A hypothetical decrease of
approximately 100 basis points from prevailing interest rates at March 31, 2003
would have resulted in an increase in fair value of long-term debt by
approximately $8.3 million.
Also, a hypothetical increase of approximately 100 basis points from prevailing
interest rates at March 31, 2003, would have resulted in an approximate increase
in cash required for interest on variable rate debt during the remaining fiscal
year of $1.6 million, increasing to $2.1 million in the next fiscal year, and
then declining to $2.0 million, $1.7 million, and 1.2 million, in the third,
fourth and fifth years, respectively.
As a result of our operating and financing activities, we are exposed to changes
in interest rates that may adversely affect our results of operations and
financial position. In seeking to minimize the risks and/or costs associated
with such activities, we may enter into derivative contracts. However, we do not
use derivative financial instruments for speculative purposes. Interest rate
swaps were employed as a requirement under the Company's Second Amended and
Restated Credit Agreement. The Third Amended and Restated Credit Agreement does
not have such a requirement. This agreement does prohibit the Company from
entering into any new interest rate swap, collar, cap, floor or forward rate
agreements without the prior written consent of the lenders. Interest rate swap
agreements are used to reduce our exposure to risks associated with interest
rate fluctuations. By their nature, these instruments would involve risk,
including the risk of nonperformance by counterparties, and our maximum
potential loss may exceed the amount recognized in our balance sheet. We attempt
to control our exposure to counterparty credit risk through monitoring
procedures and by entering into multiple contracts. At March 31, 2003, the
weighted average pay rate for the interest rate swap agreement was 6.29% and the
average receive rate was 1.35%.
At March 31, 2003, we had interest rate swap agreements for a notional amount of
$187.5 million. Based on the fair value of the interest rate swaps, to terminate
the agreements it would have cost us $18.3
-28-
million and $19.3 million at March 31, 2003 and December 31, 2002, respectively.
A hypothetical decrease of 100 basis points in the swap rate would have
increased the cost to terminate these agreements by approximately $3.7 million.
In a declining interest rate market, the benefits of the hedge position are
minimized, however, we continue to monitor market conditions.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation within 90 days prior to the date of the filing of this
Quarterly Report on Form 10-Q, the principal executive officer and principal
financial officer of Choice One Communications Inc., with the participation and
assistance of the Company's management, concluded that the Company's disclosure
controls and procedures as defined in Rules 13a-14(c) and 15d-14(c) promulgated
under the Securities Exchange Act of 1934, were effective in design and
operation. There have been no significant changes in the Company's system of
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation.
-29-
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports for Form 8-K
A. Exhibits
See Exhibit Index
B. Reports on Form 8-K
Not applicable.
-30-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHOICE ONE COMMUNICATIONS INC.
Registrant
DATE: May 14, 2003 By:/s/Steve M. Dubnik
--------------------------------
Steve M. Dubnik, Chairman and
Chief Executive Officer
(Principal Executive Officer)
By:/s/Ajay Sabherwal
--------------------------------
Ajay Sabherwal, Executive Vice President,
Finance and Chief Financial Officer
(Principal Financial Officer)
-31-
I, Steve M. Dubnik, the Chairman and Chief Executive Officer, Choice One
Communications Inc. (the "registrant"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Choice One
Communications Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/Steve M. Dubnik
-------------------------------
Steve M. Dubnik
Chairman and Chief Executive Officer
May 14, 2003
-32-
I, Ajay Sabherwal, Executive Vice President, Finance and Chief Financial
Officer, Choice One Communications Inc. (the "registrant"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Choice One
Communications Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/Ajay Sabherwal
------------------------------------
Ajay Sabherwal
Executive Vice President, Finance and Chief Financial Officer
May 14, 2003
-33-
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION LOCATION
------ ----------- --------
3.1 Amended and Restated Certificate of Incorporation. Incorporated by reference from Exhibit 3.1 to
Choice One Communication Inc.'s Registration
Statement on Form S-1 declared effective on
February 16, 2000 located under Securities and
Exchange Commission File No. 333-91321
("February 2000 Registration Statement").
3.2 Amended and Restated Bylaws. Incorporated by reference from Exhibit 3.2 to
the February 2000 Registration Statement.
3.3 Certificate of Designations for Series A Senior Incorporated by reference from Exhibit 3.1 to
Cumulative Preferred Stock. the August 10, 2000 8-K filing located under
the Securities and Exchange Commission File
No. 29279.
3.4 Certificate of Amendment of Certificate of Incorporated by reference from Exhibit 10.25 to
Designations for Series A Senior the Company's 10-K filed on April 1, 2002.
Cumulative Preferred Stock of Choice One
Communications Inc.
3.5 Certificate of Amendment of Certificate of Incorporated by reference from Exhibit 3.4 to
Incorporation with Certificate of the Company's 10-Q filed on May 15, 2002.
Designations, Preferences and Rights of Series
A Senior Cumulative Preferred Stock dated March
30, 2002.
3.6 Certificate of Amendment of Certificate of Incorporated by reference from Exhibit 4.6 to
Designations for Series A Senior the Company's 8-K filed on September 27, 2002.
Cumulative Preferred Stock.
99.1 Certification by Chief Executive Officer Filed herewith
filed herewith pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification by Chief Financial Officer Filed herewith
filed herewith pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-34-