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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended July 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File Number 0-2180
[COVISTA COMMUNICATIONS LOGO]
COVISTA COMMUNICATIONS, INC.
(Exact name of Company as specified in its charter)
New Jersey 22-1656895
---------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
721 Broad Street, Suite 200
Chattanooga, TN 37402
(Address of principal executive offices)(Zip Code)
(423) 648-9500
Company's telephone number, including area code:
Indicate by check mark whether Covista Communications, Inc. ("Covista" or the
"Company") (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that Covista was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 30, 2004
- ----------------------------- ------------------------------
Common Share, $0.05 par value 17,822,025
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
SECOND QUARTER REPORT ON FORM 10-Q
INDEX
PAGE No.
--------
PART I - FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets 3
July 31, 2004 (unaudited), and January 31, 2004
Condensed Consolidated Statements of Operations for six months ended July 31, 2004 and 2003 4
(unaudited) and three months ended July 31, 2004 and 2003 (unaudited)
Condensed Consolidated Statements of Cash Flows for the six months ended July 31, 2004 and 2003 5
(unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited) 6 - 11
Management's Discussion and Analysis of 12 - 16
Financial Condition and Results of Operations
Critical Accounting Policies 17 - 19
PART II - OTHER INFORMATION
Items 1-5 Not Applicable 20
Items 6 20
2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
July 31, January 31,
2004 2004
---- ----
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 2,638,801 $ 3,797,245
Trade accounts receivable, (net of allowance
of $908,964 and $1,350,001 at July 31, 2004
and January 31, 2004, respectively) 10,060,244 10,532,728
Prepaid expenses and other current assets 801,369 867,670
------------ ------------
Total current assets 13,500,414 15,197,643
------------ ------------
Property and equipment, net 6,386,576 11,654,365
Property and equipment held for sale, net, see Note I 3,943,533 --
Deferred line installation costs, net 534,394 547,201
Intangible assets, net 3,716,122 4,774,324
Goodwill 8,205,850 8,205,850
Other Assets 491,260 507,449
------------ ------------
$ 36,778,149 $ 40,886,832
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued line cost $ 8,465,306 $ 10,695,055
Other accrued liabilities 7,991,782 7,609,543
Salaries and wages payable 345,601 396,925
Current portion of long term debt due to related party 1,202,183 1,258,327
Current portion of long-term debt 2,887,905 1,325,930
------------ ------------
Total current liabilities 20,892,777 21,285,780
------------ ------------
Other long-term liabilities 188,385 195,395
------------ ------------
Long-term debt due to related party -- 573,023
------------ ------------
COMMITMENTS AND CONTINGENCIES--NOTE H
SHAREHOLDERS' EQUITY: -- --
Common stock 967,922 967,672
Additional paid-in capital 52,931,049 52,916,949
Accumulated deficit (36,756,544) (33,606,547)
Treasury stock (1,445,440) (1,445,440)
------------ ------------
Total shareholders' equity $ 15,696,987 $ 18,832,634
------------ ------------
$ 36,778,149 $ 40,886,832
============ ============
See notes to condensed consolidated financial statements.
3
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Six Months Ended Three Months Ended
---------------- ------------------
July 31, July 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
NET REVENUE $ 36,548,970 $ 44,726,956 $ 18,354,665 $ 21,457,099
------------ ------------ ------------ ------------
Costs and Expenses
Cost of revenue (excluding
depreciation and amortization) 19,928,048 25,333,344 9,970,385 12,045,142
Selling, general and administrative 16,970,062 17,808,471 8,313,960 8,692,406
Depreciation and amortization 2,610,580 3,080,752 1,121,886 1,513,656
------------ ------------ ------------ ------------
Total costs and expenses 39,508,690 46,222,567 19,406,231 22,251,204
------------ ------------ ------------ ------------
OPERATING LOSS (2,959,720) (1,495,611) (1,051,566) (794,105)
------------ ------------ ------------ ------------
Other Income (Expense)
Interest income 15,758 10,412 2,623 5,503
Interest expense (206,037) (177,529) (101,281) (96,325)
------------ ------------ ------------ ------------
Total other expenses, net (190,279) (167,117) (98,658) (90,822)
NET LOSS BEFORE TAXES (3,149,999) (1,662,728) (1,150,224) (884,927)
Income tax benefit -- -- -- --
NET LOSS $ (3,149,999) $ (1,662,728) $ (1,150,224) $ (884,927)
============ ============ ============ ============
BASIC LOSS PER COMMON SHARE $ (0.18) $ (0.09) $ (0.06) $ (0.05)
------------ ------------ ------------ ------------
DILUTED LOSS PER COMMON SHARE $ (0.18) $ (0.09) $ (0.06) $ (0.05)
------------ ------------ ------------ ------------
See notes to condensed consolidated financial statements.
4
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended July 31,
2004 2003
---- ----
OPERATING ACTIVITIES:
Net loss $(3,149,999) $(1,662,728)
Depreciation and amortization 2,610,580 3,080,752
Provision for doubtful accounts 666,938 1,056,504
Changes in assets and liabilities, net of effect
of acquisition of business (2,017,801) (1,383,365)
----------- -----------
Net cash provided by (used in) operating activities (1,890,282) 1,091,163
----------- -----------
INVESTING ACTIVITIES:
Purchase of property and equipment (131,442) (118,515)
Additions to deferred line installation costs (83,861) (140,421)
----------- -----------
Net cash used in investing activities (215,303) (258,936)
----------- -----------
FINANCING ACTIVITIES:
Note payable to related party (629,167)
Exercise of stock options 14,350
Bank borrowing, net 1,561,958 (939,996)
----------- -----------
Net cash provided by (used in) financing activities 947,141 (939,996)
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (1,158,444) (107,769)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,797,245 3,444,307
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,638,801 $ 3,336,538
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $ 177,094 $ 186,914
See notes to condensed consolidated financial statements.
5
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. They do not include all information and notes
required by generally accepted accounting principles for complete financial
statements. However, except as disclosed herein, there has been no material
change from the information disclosed in the notes to the consolidated financial
statements included in the Annual Report on Form 10-K of Covista Communications,
Inc. and Subsidiaries (Covista) for the fiscal year ended January 31, 2004. In
the opinion of management, all adjustments (consisting of normal recurring
accruals only) considered necessary for a fair presentation have been included.
Operating results for the three and six-month periods ended July 31, 2004 are
not necessarily indicative of the results that may be expected for the year
ending January 31, 2005. Certain reclassifications have been made to conform
prior years' balances to the current year presentation.
Revenue Recognition
We derive our revenues from long distance and local phone services.
We recognize revenue from voice, data and other telecommunications-related
services in the period in which subscribers use the related service. Deferred
revenue represents the unearned portion of local service and features that are
billed a month in advance.
Deferred Line Installation Costs
The Company defers charges from other common carriers related to the
cost of installing telephone transmission facilities (lines). Amortization of
these costs is provided using the straight-line method over the related contract
life of the lines ranging from three to five years.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could differ
from those estimates.
Intangible Assets
Intangible assets consist of prepaid network capacity and purchased
customer and agent relationships being amortized over a straight-line basis over
periods varying between 10 and 120 months. The Company incurred amortization
expense on intangible assets of approximately $1,155,000, and $1,112,000 for the
six months ended July 31, 2004, and 2003 respectively. The Company's balance of
intangible assets with a definite life was approximately $3,716,000, net of
accumulated amortization of approximately $5,566,000 at July 31, 2004 and
approximately $4,774,000, net of accumulated amortization of approximately
$4,508,000 at January 31, 2004. Approximate amortization expense on intangible
assets for the next 5 years is as follows:
2005 $518,000
2006 $1,032,000
2007 $400,000
2008 $400,000
2009 $400,000
Thereafter $967,000
6
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Risks and Uncertainties
Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and cash flows
and cause actual results to vary materially from historical results include, but
are not limited to:
o Changes in government policy, regulation and enforcement or
adverse judicial or administrative interpretations and rulings or
legislative action relating to regulations, enforcement and
pricing, including, but not limited to, changes that affect
continued availability of the unbundled network element platform
of the local exchange carriers network and the costs associated
therewith
o Dependence on the availability and functionality of the networks
of the incumbent local exchange carriers as they relate to the
unbundled network element platform
o Increased price competition in local and long distance services,
including bundled services, and overall competition within the
telecommunications industry.
Negative developments in these areas could have a material effect on
the Company's business, financial condition and results of operations.
Concentrations of Credit Risk
The Company sells its telecommunications services and products
primarily to small to medium size businesses, residential and wholesale
customers. The Company performs ongoing credit evaluations of both its retail
and wholesale customers. The Company generally does not require collateral;
however, when circumstances warrant, deposits are required. Recent conditions in
the telecommunications industry have given rise to an increase in potential
doubtful accounts. Allowances are maintained for such potential credit losses.
The Company has entered into offset arrangements with certain of its customers,
which are also vendors, allowing for the ability to offset receivables against
the Company's payables balance.
Other
Subsequent to July 31, 2004, the Company closed a transaction whereby
it sold a significant portion of its retail customer base. See Note I for a more
detailed discussion.
NOTE B - NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities". This interpretation of Accounting
Research Bulletin 51, "Consolidated Financial Statements", addresses
consolidation by business enterprises of variable interest entities that possess
certain characteristics. The interpretation requires that if a business
enterprise has a controlling financial interest in a variable interest entity,
the assets, liabilities, and results of the activities of the variable interest
entity must be included in the consolidated financial statements with those of
the business enterprise. This interpretation applies immediately to variable
interest entities created after January 31, 2003 and to variable interest
entities in which an enterprise obtains an interest after that date. The Company
did not have any ownership in any variable interest entities as of July 31,
2004. The Company will apply the consolidation requirements of the
interpretation in future periods if the Company should own any interest in any
variable interest entity.
7
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE C - STOCK BASED COMPENSATION
The following disclosure complies with the adoption of SFAS No. 123,
amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure - an amendment of FASB Statement No. 123", and includes pro forma
net loss as if the fair value based method of accounting had been applied:
Six Months Ended July 31,
2004 2003
---- ----
Net Loss as reported (000's) $(3,150) $(1,663)
Total stock-based compensation expense determined under fair
value based method for all options (000's) (384) (143)
------- -------
Pro forma net loss (000's) $(3,534) $(1,806)
======= =======
Six Months Ended July 31,
2004 2003
---- ----
Basic Earnings Per Share:
As reported $(.18) $(.09)
Pro forma $(.20) $(.10)
Diluted Earnings Per Share:
As reported $(.18) $(.09)
Pro forma $(.20) $(.10)
For purposes of pro forma disclosures under SFAS 123, the estimated
fair value of the options is assumed to be amortized to expense over the
options' vesting periods. The fair value of the options granted has been
estimated at the various dates of the grants using the Black-Scholes
option-pricing model with the following assumptions:
o Fair market value based on the Company's closing Common Stock
price on the date the option is granted;
o Risk-free interest rate based on the weighted averaged U.S.
Treasury note rates of 3.1% and 2.0% for 2004 and 2003,
respectively;
o Volatility based on the historical stock price over the expected
term of 118% and 153% for 2004 and 2003, respectively;
o No expected dividend yield based on future dividend payment
plans.
8
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE D - EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted loss per
Common Share:
Six Months Ended July 31, Three Months Ended July 31,
2004 2003 2004 2003
---- ---- ---- ----
Numerator:
Loss available to Common Shareholders
used in basic and diluted loss per Common Share $(3,149,999) $(1,662,728) $(1,150,224) $(884,927)
Denominator:
Weighted-average number of Common Shares used
in basic loss earnings per Common Share 17,822,025 17,783,092 17,822,025 17,783,092
Effect of diluted securities:
Common share options (1) -- -- -- --
----------- ----------- ----------- ---------
Weighted-average number of Common Shares and
diluted potential Common Shares used in diluted
loss per Common Share 17,822,025 17,783,092 17,822,025 17,783,092
----------- ----------- ----------- ---------
Basic loss Per Common Share $(.18) $(0.09) $(.06) $(0.05)
----------- ----------- ----------- ---------
Diluted loss per Common Share $(.18) $(0.09) $(.06) $(0.05)
----------- ----------- ----------- ---------
(1) Common Shares subject to options are not included in the calculation of
diluted loss per Common Share as doing so would be antidilutive due to the net
loss per common share. At July 31, 2004, 723,000 Common Shares subject to
options have been excluded from this calculation.
NOTE E - SEGMENT REPORTING
The Company sells telecommunication services to three distinct
segments: KISSLD which targets residential users; a retail segment consisting
primarily of small to medium size businesses; and a wholesale segment with sales
to other telecommunications carriers.
In addition to direct costs, each segment is allocated a proportion
of the Company's operating expenses, including utilization of its switching
equipment and facilities. The allocation of expenses is based upon the minutes
of use flowing through the Company's switching network. There are no
intersegment sales. When specifically identified, assets are allocated to each
segment. All intangible assets and goodwill have been allocated to the retail
segment. Capital expenditures and other assets are allocated based on total
revenue. Management evaluates performance on operating results of the three
business segments.
9
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information (000's) concerning Covista's
reportable segments is shown in the following table:
KISSLD Retail Wholesale Total
------ ------ --------- -----
Six Months Ended July 31, 2004
Net Sales $10,235 $24,774 $1,540 $36,549
Operating profit (loss) $(765) $(1,850) $(345) $(2,960)
Assets $6,898 $28,544 $1,336 $36,778
Capital expenditures $37 $89 $5 $131
Six Months Ended July 31, 2003
Net Sales $8,589 $33,631 $2,507 $44,727
Operating profit (loss) $(361) $(482) $(653) $(1,496)
Assets $5,311 $36,601 $2,633 $44,545
Capital expenditures $23 $89 $7 $119
NOTE F - INCOME TAXES
For the fiscal year ended January 31, 2004, Covista established a
valuation allowance against its net deferred tax asset due to the uncertainty of
realizing certain tax credits and loss carryforwards. In the quarter ended July
31, 2004, Covista continued this accounting treatment and recorded a full
valuation allowance against the net tax benefit arising from the quarter's net
operating loss. The result is that the net deferred tax asset of approximately
$3,078,000 is fully offset by the valuation allowance and as such, does not
appear as an asset on the balance sheet. It will be reflected in the Company's
balance sheet when the net deferred tax asset can be utilized in future periods
or when management's assessment is substantially changed.
NOTE G - LONG TERM DEBT
Effective April 16, 2003, Covista executed a revolving credit and
security agreement with Capital Source Finance, LLC. This credit facility
provides the Company with an $8 million loan, based on eligible accounts
receivable. This thirty-six month facility allows the Company to borrow funds
based on a portion of eligible customer accounts receivable and bears interest
at the Prime Rate plus 2.00% with a floor of 6.25%. Interest, unused line and
collateral management fees are payable monthly in arrears. Covista is required
to maintain certain covenants that include cash velocity and fixed charge
coverage ratios as defined in the agreement. The Company was in compliance with
these covenants as of July 31, 2004. The loan is secured by all of the Company's
assets. The loan balance at July 31, 2004 was approximately $2,888,000, net of
origination expenses, and is included in current portion of long-term debt. This
facility was paid in full and terminated on August 19, 2004 as the result of the
PAETEC transaction, further discussed in Note I.
On June 17, 2002, Covista entered into a term loan agreement with a
major bank. The initial principal amount of this note was $3,775,000, payable in
36 monthly installments at a fixed interest rate of 4.495% for the first year
and converting to 2% over LIBOR on June 17, 2003 and thereafter or 3.1%.
Effective June 17, 2003, Covista's Chairman of the Board paid the bank in full
and assumed the remaining balance of this loan under the identical terms and
conditions. This note is secured by certain of the Company's switching
equipment. The balance on this facility was approximately $1,202,000 at July 31,
2004, all of which is classified as current.
10
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE H - COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal and administrative actions
arising in the normal course of business. While the resolution of any such
actions may have an impact on the financial results for the period in which it
is resolved, management believes that the ultimate disposition of these matters
will not have a material adverse effect upon its consolidated results of
operations, cash flows or financial position.
NOTE I - SUBSEQUENT EVENT
On May 25, 2004, the Company signed a definitive agreement to sell
selected commercial customers, switches and related facilities to PAETEC
Communications, Inc., a Fairport, New York based competitive local exchange
carrier. The long distance customer portion of this transaction, representing
approximately 90% of the total purchase price was closed on August 17, 2004.
At closing, PAETEC paid approximately $8.4 million to the Company and
is obligated to pay approximately $5 million in additional cash. The final
payment is due on May 17, 2005, subject to final adjustment. Some of the initial
proceeds from this transaction were used to repay the revolving credit facility
with CapitalSource Finance.
In addition, PAETEC has assumed leases for existing switch facilities
in New York and Philadelphia as well as office locations in Bensalem, PA and
Paramus, NJ. The approximate net book value of the long-lived assets included in
the transaction is $3.9 million. Covista has also executed a Wholesale Service
Agreement to purchase $12 million of services from PAETEC over 24 months.
Certain local commercial customers will also be sold to PAETEC in a
second transaction, where total cash consideration should approximate $1.6
million. That local transaction is expected to close during the third fiscal
quarter of 2004 and is subject to, among other conditions, obtaining necessary
regulatory approvals.
11
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS:
Certain matters discussed in this Quarterly Report on Form 10-Q are
"forward-looking statements" intended to qualify for the safe harbor from
liability provided by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements generally can be identified as such because the
context of the statement will include words such as Covista "believes",
"anticipates", "expects", or words of similar import. Similarly, statements,
which describe Covista's future plans, objectives or goals, are also
forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties, which are described in, close proximity to such
statements and which could cause actual results to differ materially from those
anticipated as of the date of this Report. Shareholders, potential investors and
other readers are urged to consider these factors in evaluating the
forward-looking statements and are cautioned not to place undue reliance upon
such forward-looking statements. The forward-looking statements included herein
are made only as of the date of this Report and Covista undertakes no obligation
to publicly update such forward-looking statements to reflect subsequent events
or circumstances, except as required under applicable laws.
Overview
We offer a bundle of long distance and local phone services to
residential and small business customers in the United States. Our current
business strategy is to build a large, profitable base of bundled phone service
customers using the wholesale operating platforms of the incumbent local
telephone companies, then migrate customers to our own networking platform, and
further increase our revenues and profitability by offering new products and
services to these customers. As a result of the decision earlier this year by
the U.S. Court of Appeals for the District of Columbia (discussed under "Other
Matters", below) that reversed important portions of the FCC's orders requiring
incumbent local telephone companies to provide unbundled network elements, the
FCC has recently issued interim rules which effectively freeze our costs until
March, 2005. The FCC eventually will issue final rules which govern the manner
in which we purchase services from the incumbent local telephone carriers,
including the unbundled network element platform. As of the date of this report,
the FCC has not issued the interim rules. While the content of the final rules
are not known, they are likely to contain provisions that would cause our costs
to significantly increase over time. These cost increases will have a negative
impact on our product pricing and our ability to add new customers and, thus,
may affect our current business strategy.
Results of Operations
Net revenue was approximately $36,549,000 for the first six months of
the current fiscal year, a decrease of approximately $8,178,000 or 18% as
compared to the approximately $44,727,000 recorded in the first six months of
the prior fiscal year. Net sales for the second quarter of the current fiscal
year were approximately $18,355,000, a decrease of approximately $3,102,000 or
14% as compared to the approximately $21,457,000 recorded in the second quarter
of the prior fiscal year. The overall decrease is primarily related to intense
competitive pressure in the retail segment combined with planned reductions in
wholesale revenue as discussed in further detail below.
12
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
KISSLD revenue for the six-month period was approximately $10,235,000,
an increase of approximately $1,646,000 or 19% over the same period from the
prior year. For the three-month period ended July 31, 2004, KISSLD revenue was
approximately $5,566,000, an increase of approximately $1,249,000 or 29% versus
the comparative quarter in the last fiscal year. Approximately $2,965,000 of the
six month total was for local services versus $0 for the comparative period from
the prior year. Approximately $2,033,000 of local service revenue was earned in
the quarter ended July 31, 2004. The total minutes sold for KISSLD for the
six-month period ended July 31, 2004 were approximately 143,345,000, a decrease
of approximately 6,578,000 or 4%, versus the comparative period in the last
fiscal year. KISSLD minutes sold for the three-month period ended July 31, 2004,
were approximately 72,931,000, a decrease of approximately 1,860,000 or 2%
versus the comparative quarter in the last fiscal year. The current year
increase in the KISSLD segment is primarily attributed the launch of local
service to these residential users in selected markets, in addition to direct
marketing via mail and web based affinity marketing campaigns. While the Company
has launched local services to the KISSLD segment in certain markets, the
Company plans to expand the number of markets in which it has the ability to
offer its local and long distance bundled product offering. Additionally, the
Company plans to expand its marketing resources to target new geographic market
areas where the Company has the ability to offer competitive bundled services to
residential users.
Retail revenue for the six-month period was approximately $24,774,000,
a decrease of approximately $8,857,000 or 26%. For the quarter ended July 31,
2004, retail revenue was approximately $11,830,000, a decrease of $4,434,000 or
27% versus the comparative quarter in the last fiscal year. Retail minutes sold
in the six-month period ended July 31, 2004 were approximately 369,225,000
minutes, a decrease of approximately 127,215,000 minutes or 26%, versus the
comparative period in the last fiscal year. Retail minutes sold in the quarter
ended July 31, 2004 were approximately 175,583,000, a decrease of approximately
68,764,000 or 28% versus the prior fiscal year. The current year decrease in the
retail segment is primarily attributed to intense competitive pressure from
other providers, especially those which have the ability to bundle local dial
tone with traditional long distance offerings. While the Company has recently
launched local services to the retail segment in certain markets, the Company
has experienced significant loss of former retail customers, which have taken
advantage of competitive providers bundled service offerings. The Company does
not foresee this intensely competitive climate abating in the near future.
Subsequent to July 31, 2004, the Company closed a transaction in which it sold
the majority of its retail customer base. As a result of that transaction,
quarterly retail revenues are expected to decrease by approximately $8,100,000
subject to final adjustment.
Wholesale revenue for the six-month period was approximately
$1,540,000, a decrease of approximately $967,000 or 39%. For the quarter ended
July 31, 2004, wholesale revenue was approximately $958,000, an increase of
approximately $82,000 or 9% versus the comparative quarter in the last fiscal
year. The increase is primarily related to the Company's Carrier Access Billing.
Wholesale minutes sold in the six-month period ended July 31, 2004 were
approximately 49,224,000 minutes, an increase of approximately 20,995,000
minutes or 74%. Wholesale minutes sold in the quarter ended July 31, 2004 were
approximately 33,974,000 minutes, an increase of approximately 21,957,000
minutes or 183%. The Company plans to maintain nominal wholesale volume in the
future, based on network capacity and gross margin opportunities, while
balancing any possible financial exposure related to un-collectible balances.
Cost of revenue for the current six-month period ended July 31, 2004
was approximately $19,928,000, a decrease of approximately $5,405,000 or 21%.
These changes were favorable in relation to the 18% decrease in net revenues for
the six-month period. The decrease in cost of revenue was primarily due to an
overall decrease in revenue volume of approximately $4,632,000. In addition, the
Company has improved its purchasing and line cost auditing functions. These
improvements have allowed the Company to generate an additional savings of
approximately $773,000 versus the prior year as a result of overall rate
reductions and improved auditing and dispute resolution capabilities.
13
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
Cost of revenue for the three-month period ended July 31, 2004, was
approximately $9,970,000, a decrease of approximately $2,075,000 or 17%. These
changes were favorable in relation to the 14% decrease in revenues in the second
quarter. The decrease in cost of revenue was primarily due to an overall
decrease in revenue volume of approximately $1,742,000. In addition, the Company
has improved its purchasing and line cost auditing functions. These improvements
have allowed the Company to generate an additional savings of approximately
$333,000 versus the prior year as a result of overall rate reductions and
improved auditing and dispute resolution capabilities.
We structure and price our products in order to maintain network and
line costs as a percentage of revenue at certain targeted levels. There are
several factors that could cause our network and line costs as a percentage of
revenue to increase in the future, including without limitation:
o Determinations by the FCC, courts or state commission(s) that make
unbundled local switching and/or combinations of unbundled network elements
effectively unavailable to us in some or all of our geographic service areas,
requiring us to provide services in these areas through other means, including
total service resale agreements with incumbent local telephone companies,
network elements purchased from the Regional Bell Operating Companies at "just
and reasonable" rates under Section 271 of the Act and the switching facilities
of other non-incumbent carriers, in any case, at significantly increased costs
or to provide services over our own switching facilities, if we were able to
deploy them. The U.S. Court of Appeals for the District of Columbia, on March 2,
2004, issued an order that reversed the FCC's Triennial Review Order in part and
remanded to the FCC with instructions to revise the Order in material ways which
may make unbundled local switching and/or combinations of unbundled network
elements effectively unavailable to us in some or all of our geographic service
areas.
o Adverse changes to the current pricing methodology mandated by the
FCC for use in establishing the prices charged to us by incumbent local
telephone companies for the use of their unbundled network elements. The FCC's
2003 Triennial Review Order, which was reversed in part and remanded to the FCC
with instructions to revise the Order in material ways, clarified several
aspects of these pricing principles related to depreciation, fill factors (i.e.
network utilization) and cost of capital, which could enable incumbent local
telephone companies to increase the prices for unbundled network elements. In
addition, the FCC released a Notice of Proposed Rulemaking on December 15, 2003,
which initiated a proceeding to consider making additional changes to its
unbundled network element pricing methodology, including reforms that would base
prices more on the actual network costs incurred by incumbent local telephone
companies than on the hypothetical network costs that would be incurred when the
most efficient technology is used. These changes could result in material
increases in prices charged to us for unbundled network elements.
o Determinations by state commissions to increase prices for unbundled
network elements in ongoing state cost dockets.
Selling, general and administrative expenses for the six-month period
were approximately $16,970,000, a decrease of approximately $838,000 or 5%. This
decrease is primarily due to commission cost decreases of approximately
$1,558,000; advertising expense increases of approximately $1,547,000; reduction
in bad debt expense of approximately $273,000; reduced equipment rent of
approximately $138,000; decreased billing cost of approximately $145,000; and
other general cost reductions of approximately $271,000. For the quarter ended
July 31, 2004, selling, general and administrative expense was approximately
$8,314,000, an approximately $378,000, or 4% decrease over the comparative
quarter in the last fiscal year. For the three month period ended July 31, 2004,
this reduction was comprised primarily of increased advertising expense of
approximately $744,000; reduced commission expense of approximately $828,000;
and net decreases in other categories of approximately $294,000.
14
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
For the reasons described above, the operating loss for the six-month
period ended July 31, 2004 was approximately $2,960,000, an increase of
approximately $1,464,000 from the six-month period ended July 31, 2003. The
operating loss for the three-month period ended July 31, 2004 was approximately
$1,052,000, an increase of approximately $258,000 over the prior year's
three-month period ended July 31, 2003.
Basic and diluted loss per Common Share was $0.18 per share for the
current six-month period ended July 31, 2004 as compared to $0.09 loss per share
for the six-months ended July 31, 2003. Basic and diluted loss per Common Share
was $0.06 per share for the current three-month period ended July 31, 2004, as
compared to earnings of $0.05 per Common Share for the three-months ended July
31, 2003.
Liquidity and Capital Resources
At July 31, 2004, Covista had a working capital deficit of
approximately $7,392,000, an unfavorable increase of approximately $1,304,000 as
compared to January 31, 2004. The ratio of current assets to current liabilities
at July 31, 2004 was .65:1, as compared to the ratio of .71:1 at January 31,
2004. Subsequent to July 31, 2004, the Company completed a transaction to sell
the majority of its commercial customer base. Upon closing, the buyer paid
approximately $8.4 million and is obligated to pay an additional approximately
$5 million, with the final payment due on May 17, 2005.
In the opinion of management, cash flows from operations as well as
cash received as a result of the transaction noted above will be sufficient to
meet the operating and capital needs of the Company for at least the next twelve
months.
Capital Expenditures
Capital expenditures for the six-month period ended July 31, 2004 were
approximately $131,000. Capital expenditures for the remainder of Fiscal 2005
are estimated not to exceed approximately $200,000 and are expected to be funded
from operations.
Prepaid Network Capacity
In July 2001, Covista purchased 2.8 billion DS-0 channel miles of
telecommunications network capacity from an unaffiliated party. The unaffiliated
party has recently emerged from Chapter 11 reorganization and, as of the date of
this report, is continuing to perform under the agreement and, therefore,
management does not believe that this asset is impaired.
As of the date hereof, Covista has used approximately 446 million DS-0
channel miles of telecommunications network capacity against the 2.8 billion
DS-0 total prepaid network capacity, of which $400,000 has been classified as a
current asset, based on anticipated usage in the next 12 months and the
remainder of the prepaid capacity amount of approximately $2,367,000 is included
in intangible assets.
Accounts Receivable and Credit Risk
Accounts receivable subjects Covista to the potential for credit risk
with customers in the retail and wholesale segments. To reduce credit risk,
Covista performs ongoing evaluations of its customers' financial condition and,
except in situations where the risk warrants it, Covista does not require a
deposit or other collateral. Accounts receivable of approximately $10,060,000,
net of the reserve for un-collectible accounts totaling approximately $909,000,
represents approximately 28% of the total assets of Covista.
15
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATIONS
No one customer accounts for greater than eight percent of the total
revenues. In the wholesale segment, which contains Covista's largest customers,
Covista has been able to reduce credit risk by using reciprocal arrangements
with certain customers, which are also Covista's suppliers, to offset
outstanding receivables. Covista has historically maintained a better than three
percent ratio of bad debts to revenues. For the six-month period ended July 31,
2004, this ratio was approximately 2.1%. Covista also measures accounts
receivable turnover (as measured in days sales outstanding). For the periods
ended July 31, 2004 and 2003, days sales outstanding were 50 days and 51 days,
respectively.
Related Party Transactions
Jay J. Miller, a Director of Covista, has provided various legal
services for Covista in Fiscal 2004. In the second quarter, Covista accrued
approximately $11,000 to Mr. Miller for services rendered. As of July 31, 2004,
Covista owed Mr. Miller approximately $11,000.
Leon Genet, a Director of Covista, has provided agent services for
Covista through his wholly owned firm, LPJ, Inc. During the second quarter,
Fiscal 2005, LPJ, Inc. was paid commissions of approximately $4,700. The
commissions paid to LPJ, Inc. were computed on the same basis as other
independent agents retained by Covista.
Jeff Alward, a relative of Kevin Alward, former Chief Operating Officer
of Covista has provided agent services for Covista through his wholly owned
firm, KTI, Inc. During the quarter ended July 31, 2004, KTI, Inc. was paid
commissions of approximately $28,000. The commissions paid to KTI, Inc. were
computed on the same basis as other independent sales agents retained by
Covista.
On June 17, 2002, Covista entered into a term loan agreement with a
major bank. The initial principal amount of this note was $3,775,000, payable in
36 monthly installments at a fixed interest rate of 4.495% for the first year
and converting to 2% over LIBOR on June 17, 2003 and thereafter or 3.1%.
Effective June 17, 2003, Covista's Chairman of the Board paid the bank in full
and assumed the remaining balance of this loan under the identical terms and
conditions. This note is secured by certain of the Company's switching
equipment. The balance on this facility was $1,202,000 at July 31, 2004, all of
which is classified as current.
16
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
Nature of Operations
Covista Communications, Inc. ("Covista"), and its wholly-owned
subsidiaries (collectively, the "Company") operates as a switch based resale
common carrier providing domestic and international long distance and local
telecommunications service to customers throughout the United States. Prior to
the Capsule acquisition, the Company's principal customers were primarily
businesses and other common carriers. On September 15, 2000, the Company changed
its name from Total-Tel USA Communications, Inc. to Covista Communications, Inc.
On February 8, 2002, Covista completed the acquisition of Capsule
Communications, Inc. As a result, Capsule became a wholly owned subsidiary of
Covista. Capsule is a switch-based interexchange carrier providing long distance
telephone communications services primarily to small and medium-size business
customers as well as residential accounts. The results of Capsule's operations
have been included in the Company's statement of operations since the
acquisition date.
Revenue Recognition
We derive our revenues from long distance and local phone services.
We recognize revenue from voice, data and other telecommunications-related
services in the period in which subscribers use the related service. Deferred
revenue represents the unearned portion of local service and features that are
billed a month in advance.
Property and Equipment
Property and equipment are stated at cost. Depreciation and
amortization is being provided by use of the straight-line method over the
estimated useful lives of the related assets. Leasehold improvements are
amortized over the shorter of the term of the lease or the useful lives of the
asset.
The estimated useful lives of the principal classes of assets and representative
carrying amounts are as follows:
Useful Life
Classification in Years July 31, 2004 January 31, 2004
-------------- ----------- -------------- ----------------
(unaudited)
Machinery and equipment 5-10 $7,845,806 $ 22,390,711
Office furniture, fixtures and equipment 5-10 1,971,700 4,780,968
Vehicles 3-5 22,512 41,812
Leasehold improvements 2-10 475,084 1,612,300
Computer equipment and software 5-7 3,376,586 10,418,781
Machinery and equipment in progress -- 2,532,344 2,512,255
----------- ------------
16,224,032 41,756,827
Less accumulated depreciation and
amortization (9,837,456) (30,102,462)
----------- ------------
$ 6,386,576 $ 11,654,365
=========== ============
Deferred Line Installation Costs
The Company defers charges from other common carriers related to the
cost of installing telephone transmission facilities (lines). Amortization of
these costs is provided using the straight-line method over the related contract
life of the lines ranging from three to five years.
Intangible Assets
Intangible assets consist of prepaid network capacity and purchased
customer and agent relationships being amortized over a straight-line basis over
periods varying between 10 and 120 months.
17
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
Goodwill
Goodwill consists of the excess purchase price over the fair value of
identifiable net assets of acquired businesses. Goodwill added subsequent to
January 1, 2002 is not being amortized in accordance to SFAS 142. The carrying
value of goodwill is evaluated for impairment on an annual basis. Management
also reviews goodwill for impairment whenever events or changes in circumstances
indicate that the carrying amount of goodwill may be impaired.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could differ
from those estimates.
Vendor Disputes
The Company records disputed line cost expenses in accordance with FASB
Statement No. 5, "Accounting for Contingencies". Billings from line cost vendors
are compared to the Company's engineering and operations data, with differences
filed with the vendors as a disputed billing. Disputed line cost billings are
recorded by the Company at the estimated liability due based upon the Company's
historical experience in settling similar disputes. Actual settlement of
disputes may differ from original estimates. Management adjusts the dispute
reserve each month. The net reserve for dispute losses at July 31, 2004 and 2003
was approximately $2.2 million and $4.0 respectively and is included in accounts
payable and accrued line cost.
Risks and Uncertainties
Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and cash flows
and cause actual results to vary materially from historical results include, but
are not limited to:
o Changes in government policy, regulation and enforcement or
adverse judicial or administrative interpretations and rulings or
legislative action relating to regulations, enforcement and
pricing, including, but not limited to, changes that affect
continued availability of the unbundled network element platform
of the local exchange carriers network and the costs associated
therewith
o Dependence on the availability and functionality of the networks
of the incumbent local exchange carriers as they relate to the
unbundled network element platform
o Increased price competition in local and long distance services,
including bundled services, and overall competition within the
telecommunications industry.
Negative developments in these areas could have a material effect on
the Company's business, financial condition and results of operations.
Concentrations of Credit Risk
The Company sells its telecommunications services and products
primarily to small to medium size businesses, residential and wholesale
customers. The Company performs ongoing credit evaluations of both its retail
and wholesale customers. The Company generally does not require collateral;
however, when circumstances warrant, deposits are required. Recent conditions in
the telecommunications industry have given rise to an increase in potential
doubtful accounts. Allowances are maintained for such potential credit losses.
The Company has entered into offset arrangements with certain of its customers
which are also vendors, allowing for the ability to offset receivables against
the Company's payables balance.
18
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
Market Risk
Market risk represents the risk of changes in value of a financial
instrument, derivative or non-derivative, caused by fluctuations in interest
rates, foreign exchange rates and equity prices. As Covista holds no marketable
securities at July 31, 2004, the exposure to interest rate risk relating to
marketable securities no longer exists. Covista does not hold any derivatives
related to its interest rate exposure. Covista also maintains long-term debt at
fixed rates. Due to the nature and amounts of Covista's note payable, an
immediate 10% change in interest rates would not have a material effect in
Covista's results of operations over the next fiscal year. Covista's exposure to
adverse changes in foreign exchange rates is also immaterial to the consolidated
statements as a whole.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash on hand, demand deposits and money market accounts.
Other Matters
Our provision of telecommunications services is subject to government
regulation. Recent changes in these regulations are likely to have a material
adverse effect on us. Our local telecommunications services are provided almost
exclusively through the use of unbundled network elements purchased from
incumbent local telephone companies, and it is primarily the availability of
unbundled network elements priced by regulators at cost-based rates that has
enabled us to price our local telecommunications services competitively. FCC
rules that were in effect until June 15, 2004 required incumbent local telephone
companies to provide an unbundled network element platform, that includes all of
the network elements required by a competitor to provide a competitive retail
local telecommunications service, in most geographic areas.
Through the use of unbundled network element platforms of the incumbent
local telephone company, we have been able to provide retail local
telecommunications services entirely through the use of the incumbent local
telephone companies' facilities at substantially lower prices than those
available for resale through total service resale agreements. However, on March
2, 2004, the U.S. Court of Appeals for the District of Columbia reversed the FCC
order that promulgated the rules requiring incumbent local telephone companies
to provide unbundled network elements in important respects. Among other things,
the Court ruled that the FCC had improperly determined that the ability of
competitive local telephone carriers such as Covista was impaired nationwide
without access to the local switching and high capacity transport unbundled
network elements, and that the FCC had erroneously delegated decision-making
authority over where particular unbundled network elements must be provided to
state commissions. Accordingly, the Court of Appeals vacated important portions
of the FCC's orders relating to the provision of unbundled network elements
effective as of June 15, 2004, including the portions that required incumbent
local telephone carriers to provide critical components of the unbundled network
element platform.
Should the unbundled network element platform become effectively
unavailable to us due to this judicial ruling or otherwise, we would be unable
to offer our telecommunications services as we have done in the past and would
instead be required to serve customers through total service resale agreements
with the incumbent local telephone companies, through the use of our own network
facilities, by migrating customers onto the networks of other facilities-based
competitive local telephone companies or, perhaps, by purchasing critical
unbundled network elements at presumably higher "just and reasonable" rates
pursuant to Section 271 of the Act. As a result, our cost of service could rise
substantially and our plans for a service roll-out for use of our own network
facilities could be delayed substantially or derailed entirely. This would have
a material adverse effect on our business, prospects, operating margins, results
of operations, cash flows and financial condition.
19
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEMS 1 - 5 Not applicable
ITEM 6 Exhibits and Reports on Form 8K
8K - Dated June 14, 2004, Press Release Regarding
First Quarter Results
8K - Dated August 20, 2004, Press Release Regarding
the Sale of Certain Assets
20
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.
COVISTA COMMUNICATIONS, INC.
(Registrant)
Date: September 10, 2004 By: /s/ A. John Leach, Jr.
------------------ -----------------------
A. John Leach, Jr.
President and Chief Executive Officer
Date: September 10, 2004 By: /s/ Frank J. Pazera
------------------ ---------------------
Executive Vice President, Chief Financial
Officer and Principal Accounting Officer
21