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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 October 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 of incorporation) (I.R.S. Employer Identification No.)
721 Broad Street, Suite 200
Chattanooga, TN 37402
(Address of principal executive offices)(Zip Code)
(423) 648-9500
(Company's telephone number, including area code)
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 December 10, 2004
- ----------------------------- --------------------------------
Common Share, $0.05 par value 17,822,025
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
THIRD QUARTER REPORT ON FORM 10-Q
INDEX
PAGE No.
--------
PART I - FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets 3
October 31, 2004 (unaudited), and January 31, 2004
Condensed Consolidated Statements of Operations for nine months ended October 31, 2004 and
2003 (unaudited) and three months ended October 31, 2004 and 2003 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine months ended October 31, 2004
and 2003 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6 - 11
Management's Discussion and Analysis of Financial Condition and Results of Operations 12 - 16
Critical Accounting Policies 17 - 20
PART II - OTHER INFORMATION
Items 1-5 Not Applicable 21
Items 6 21
2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
October 31, January 31,
2004 2004
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,504,541 $ 3,797,247
Trade accounts receivable (net of allowance of
$1,156,810 and $1,350,001 at October 31, 2004
and January 31, 2004, respectively) 6,240,076 10,532,726
Receivable from PAETEC 4,162,444 --
Prepaid expenses and other current assets 704,935 867,670
------------ ------------
Total current assets 19,611,996 15,197,643
------------ ------------
Property and equipment, net 6,158,639 11,654,365
Deferred line installation costs, net 307,302 547,201
Intangible assets, net 2,266,667 4,774,324
Goodwill 200,000 8,205,850
Other Assets 303,401 507,449
------------ ------------
$ 28,848,005 $ 40,886,832
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued line cost $ 5,940,183 $ 10,695,055
Other accrued liabilities 7,553,634 7,609,543
Deferred gain on sale of assets - Note H $ 875,749 --
Salaries and wages payable 126,987 396,925
Current portion of long term debt due to
related party 887,600 1,258,327
Current portion of long-term debt -- 1,325,930
------------ ------------
Total current liabilities 15,384,153 21,285,780
------------ ------------
Other long-term liabilities -- 195,395
------------ ------------
Long-term debt due to related party -- 573,023
------------ ------------
COMMITMENTS and CONTINGENCIES - Note G -- --
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock 967,922 967,672
Additional paid-in capital 52,931,049 52,916,949
Accumulated deficit (38,989,679) (33,606,547)
Treasury stock (1,445,440) (1,445,440)
------------ ------------
Total shareholders' equity $ 13,463,852 $ 18,832,634
------------ ------------
$ 28,848,005 $ 40,886,832
============ ============
See notes to condensed consolidated financial statements.
3
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Nine Months Ended Three Months Ended
October 31, October 31,
------------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
NET REVENUE $49,100,610 $65,063,621 $12,551,640 $20,336,665
----------- ----------- ----------- -----------
Costs and Expenses
Cost of revenue (excluding depreciation and
amortization) 26,564,470 35,945,036 6,636,422 10,611,692
Selling, general and administrative 22,460,192 26,185,252 5,490,130 8,376,781
Depreciation and amortization 3,064,612 4,534,607 454,032 1,453,855
Write down of assets - Note H 1,504,738 -- 1,504,738 --
Restructuring Expense 385,373 -- 385,373 --
----------- ----------- ----------- -----------
Total costs and expenses 53,979,385 66,664,895 14,470,695 20,442,328
----------- ----------- ----------- -----------
OPERATING LOSS (4,878,775) (1,601,274) (1,919,055) (105,663)
----------- ----------- ----------- -----------
Other Income (Expense)
Early retirement of debt (307,289) -- (307,289) --
Interest income 30,649 14,280 14,891 3,868
Interest expense (227,719) (249,167) (21,682) (71,638)
----------- ----------- ----------- -----------
Total other income (expenses), net (504,359) (234,887) (314,080) (67,770)
NET INCOME (LOSS) BEFORE TAXES (5,383,134) (1,836,161) (2,233,135) (173,433)
Income tax (provision) benefit -- -- -- --
----------- ----------- ----------- -----------
NET INCOME (LOSS) $(5,383,134) $(1,836,161) $(2,233,135) $ (173,433)
=========== =========== =========== ===========
BASIC INCOME (LOSS) PER COMMON SHARE $ (.30) $ (0.10) $ (.13) $ (0.01)
----------- ----------- ----------- -----------
DILUTED INCOME (LOSS) PER COMMON SHARE $ (.30) $ (0.10) $ (.13) $ (0.01)
----------- ----------- ----------- -----------
See notes to condensed consolidated financial statements.
4
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended October 31,
2004 2003
----------- ------------
OPERATING ACTIVITIES:
Net loss $(5,383,134) $(1,836,161)
Depreciation and amortization 3,064,612 4,534,607
Provision for doubtful accounts 840,808 1,188,800
Changes in assets and liabilities (544,355) (4,530,361)
----------- -----------
Net cash provided by (used in) operating activities (2,022,069) (643,115)
----------- -----------
INVESTING ACTIVITIES:
Proceeds from sale of assets to PAETEC 9,298,287 --
Purchase of property and equipment (210,761) (183,655)
Additions to deferred line installation costs (102,817) (146,531)
----------- -----------
Net cash used in investing activities 8,984,709 (330,186)
----------- -----------
FINANCING ACTIVITIES:
Note payable to related party (943,750) (943,749)
Exercise of stock options 14,350 46,667
Bank borrowing, net (1,325,946) (325,088)
----------- -----------
Net cash provided by (used in) financing activities (2,255,346) (1,222,170)
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 4,707,294 (2,195,471)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,797,247 3,444,307
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,504,541 $ 1,248,836
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 195,893 $ 265,559
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 nine-month periods ended October 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
Prior to the transaction with PAETEC (see Note H), intangible assets
consisted 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 $1.3 million and $4.5 million for the nine
months ended October 31, 2004, and 2003 respectively. During the quarter ended
October 31, 2004, the Company recorded a charge of approximately $1.4 million
against intangible assets related to restructuring as a result of the
PAETEC transaction. The balance of intangible assets with a definite life
was approximately $2.7 million, net of accumulated amortization of approximately
$1.3 million at October 31, 2004 and approximately $4.8 million, net of
accumulated amortization of approximately $4.5 million at January 31, 2004.
Approximate amortization expense on intangible assets for the next 5 years
and thereafter is as follows:
2005 $100,000
2006 $400,000
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.
o Outcomes unfavorable to us of the FCC's rule-making process and
of pending litigation with regards to the availability and
pricing of various network elements and bundles thereof.
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 to
residential, small and medium size businesses, 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.
7
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE B - STOCK BASED COMPENSATION
The following disclosure complies with the provisions of SFAS No. 123,
as 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:
Nine Months Ended October 31,
2004 2003
------- -------
Net Loss as reported (000's) $(5,383) $(1,836)
Total stock-based compensation expense determined under fair
value based method for all options (000's) (489) (215)
------- -------
Pro forma net loss (000's) $(5,872) $(2,051)
======= =======
Basic Earnings Per Share:
As reported $ (.30) $ (.10)
Pro forma $ (.33) $ (.12)
Diluted Earnings Per Share:
As reported $ (.30) $ (.10)
Pro forma $ (.33) $ (.12)
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 C - EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted loss per
Common Share:
Nine Months Ended October 31, Three Months Ended October 31,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Numerator:
Income (loss) available to Common Shareholders
used in basic and diluted income (loss) per
Common Share $(5,383,134) $(1,836,161) $(2,233,135) $ (173,433)
Denominator:
Weighted-average number of Common Shares used in
basic income (loss) earnings per Common Share 17,822,025 17,790,870 17,822,025 17,806,425
Effect of diluted securities:
Common share options (1) -- -- -- --
----------- ----------- ----------- -----------
Weighted-average number of Common Shares and
diluted potential Common Shares used in diluted
income (loss) per Common Share 17,822,025 17,790,870 17,822,025 17,806,425
----------- ----------- ----------- -----------
Basic income (loss) Per Common Share $ (.30) $ (.10) $ (.13) $ (.01)
----------- ----------- ----------- -----------
Diluted income (loss) per Common Share $ (.30) $ (.10) $ (.13) $ (.01)
----------- ----------- ----------- -----------
(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 October 31, 2004, 723,000 Common Shares subject to
options have been excluded from the calculation.
NOTE D - SEGMENT REPORTING
The Company sells telecommunication services to three distinct
segments: residential, formerly known as KISSLD; a retail segment consisting
primarily of small to medium size businesses; and a wholesale segment with sales
to other telecommunications carriers. As a result of the sale of selected
customers to PAETEC (discussed in Note H) the retail segment will report
lower net sales for the current and subsequent quarters.
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:
Residential Retail Wholesale Total
----------- ------- --------- -------
Nine Months Ended October 31, 2004
Net Sales $16,544 $30,182 $2,375 $49,101
Operating profit (loss) $ (368) $(3,989) $ (522) $(4,879)
Assets $10,508 $16,325 $2,015 $28,848
Capital expenditures $ 71 $ 130 $ 10 $ 211
Nine Months Ended October 31, 2003
Net Sales $12,839 $48,682 $3,543 $65,064
Operating profit (loss) $ (480) $ (282) $ (839) $(1,601)
Assets $ 5,585 $32,609 $2,049 $40,243
Capital expenditures $ 35 $ 138 $ 11 $ 184
NOTE E - 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
October 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 F - LONG TERM DEBT
Effective April 16, 2003, Covista executed a revolving credit and
security agreement with Capital Source Finance, LLC. This credit facility
provided the Company with an $8 million loan, based on eligible accounts
receivable. This thirty-six month facility allowed the Company to borrow funds
based on a portion of eligible customer accounts receivable at the Prime Rate
plus 2.00% with a floor of 6.25%. Interest, unused line and collateral
management fees were payable monthly in arrears. The loan was secured by all of
the Company's assets. This facility was paid in full and terminated on August
19, 2004 as the result of the PAETEC transaction, further discussed in Note H.
The Company recorded early termination expense of approximately $307,000 related
to this payoff.
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 re-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 $888,000 at October
31, 2004, all of which is classified as current.
10
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE G - 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. The company has also committed to
purchase $12 million of services from PAETEC as a result of the transaction
described in Note H.
NOTE H - PAETEC TRANSACTION
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. The
local customer portion of this transaction, representing approximately 10% of
the total purchase price is scheduled to close on December 31, 2004. PAETEC is
currently managing these selected local customers under the terms of a separate
agreement, until closing. Covista has also executed an agreement to purchase $12
million of services from PAETEC over 24 months. This Wholesale Service Agreement
allows the Company to procure services at market competitive rates and the
Company anticipates that it should fully utilize the commitment during the term.
The Company anticipates receiving total cash proceeds of approximately
$14.9 million from PAETEC. The net book value of the long-lived, tangible and
intangible assets sold in the transaction was approximately $13.3 million. As a
result, the pre-tax gain on the transaction will be approximately $1.6 million,
all of which has been deferred as of October 31, 2004.
As of October 31, 2004, the Company has received approximately $9.3
million. The remaining balance due is approximately $5.6 million, of which
approximately $3.4 million was received subsequent to October 31, 2004. The
final payment is due on May 17, 2005, and the amount is subject to final
adjustment based on the performance of the customer base. A portion of
the final payment will be used to repurchase shares of Common Stock from the
former Chief Operating Officer of the Company. Regardless of the amount of that
final payment, the Company is obligated to purchase a minimum of $250,000 worth
of Common Stock from this former employee at $2.00 per share. Any repurchased
shares will be recorded at cost as Treasury stock.
PAETEC has hired the majority of former Company employees responsible
for servicing the associated customers and has assumed leases for existing
switch facilities in New York and Philadelphia as well as office locations in
Bensalem, PA and Paramus, NJ. The Company incurred approximately $385,000 of
restructuring charges related to employee severance and other costs associated
with the consolidation of back office functions and other management
initiatives.
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 significant changes to the FCC rules
that require incumbent local telephone companies to provide unbundled network
elements to us (discussed under "Other Matters", below), the wholesale rates
that we are charged in order to provide our services will most likely increase
significantly in 2005 and over time. These cost increases will likely lead to
increases in our product pricing and may inhibit our ability to add new
customers as well as retain current customers. The FCC has established
interim rules that make unbundled network elements available to us on a
grandfathered basis until March 2005 and we currently plan to continue to
market our services and to build our base of bundled customers through
such date. However, in the event that either the FCC's final rules provide
for an earlier date where our pricing from the incumbent local telephone
companies significantly increases, as contemplated in the interim rules, or we
have knowledge regarding such an increase in price, we expect to reduce our
efforts to increase subscriber growth and focus on markets with potential for
deployment of our own network facilities.
Results of Operations
Net revenue was approximately $49,101,000 for the first nine months of
the current fiscal year, a decrease of approximately $15,963,000 or 25% as
compared to the approximately $65,064,000 recorded in the first nine months of
the prior fiscal year. Net revenue for the third quarter of the current fiscal
year were approximately $12,552,000, a decrease of approximately $7,785,000 or
38% as compared to the approximately $20,337,000 recorded in the third 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 and the recently completed sale of selected customers to
PAETEC as discussed further in Note H.
12
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF
OPERATIONS
Residential revenue for the nine-month period was approximately
$16,544,000, an increase of approximately $3,706,000 or 29% over the same period
from the prior year. For the three-month period ended October 31, 2004,
Residential revenue was approximately $6,309,000, an increase of approximately
$2,059,000 or 48% versus the comparative quarter in the last fiscal year. The
current year increase in the Residential segment is primarily attributed the
launch of local service. Approximately $5,888,000 of the nine month total was
for local services versus $109,000 for the comparative period from the prior
year. Approximately $2,922,000 of local service revenue was earned in the
quarter ended October 31, 2004. The total minutes sold for Residential for the
nine-month period ended October 31, 2004 were approximately 217,994,000, a
decrease of approximately 4,605,000 or 2%, versus the comparative period in the
last fiscal year. Residential minutes sold for the three-month period ended
October 31, 2004, were approximately 74,648,000, an increase of approximately
1,972,000 or 3% versus the comparative quarter in the last fiscal year.
Retail revenue for the nine-month period was approximately
$30,181,000, a decrease of approximately $18,501,000 or 38% versus the prior
year to date total. For the quarter ended October 31, 2004, retail revenue was
approximately $5,773,000, a decrease of approximately $9,278,000 or 62% versus
the comparative quarter in the last fiscal year. Retail minutes sold in the
nine-month period ended October 31, 2004 were approximately 431,744,000 minutes,
a decrease of approximately 287,298,000 minutes or 40%, versus the comparative
period in the last fiscal year. Retail minutes sold in the quarter ended
October 31, 2004 were approximately 62,519,000, a decrease of approximately
160,083,000 or 72% 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. During the quarter ended October 31, 2004, the Company closed a
transaction in which it sold the majority of its retail customer base, as
discussed further in Note H.
Wholesale revenue for the nine-month period was approximately
$2,375,000, including carrier access billing revenue of approximately $577,000,
an overall decrease of approximately $1,168,000 or 33% versus the prior year to
date total. For the quarter ended October 31, 2004, wholesale revenue was
approximately $836,000, including carrier access billing revenue of
approximately $185,000, an overall decrease of approximately $201,000 or 19%
versus the comparative quarter in the last fiscal year. 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 nine-month period ended October 31,
2004 was approximately $26,564,000, a decrease of approximately $9,381,000 or
26%. These changes were in line relative to 25% decrease in net revenues for the
nine-month period.
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 October 31, 2004, was
approximately $6,636,000, a decrease of approximately $3,975,000 or 37%. These
changes were in line relative to the 38% decrease in revenues in the third
quarter.
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
local 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 nine-month period
were approximately $22,460,000, a decrease of approximately $3,725,000 or 14%.
This decrease is primarily due to payroll reduction of approximately $944,000
as a result of fewer employees, commission decreases of approximately $2,815,000
due to less commissionable revenue; advertising expense increases of
approximately $1,847,000 attributable to the launch of our local product
in selected markets; reduction in bad debt expense of approximately $429,000
due to improved receivable collections; reduced equipment rent of approximately
$170,000; decreased billing cost of approximately $417,000 due to more efficient
billing operations; and other general cost reductions of approximately
$797,000. For the quarter ended October 31, 2004, selling, general and
administrative expense was approximately $5,490,000, a decrease of
approximately $2,887,000, or 34% versus the comparative quarter in the
last fiscal year. For the three-month period ended October 31, 2004, this
reduction was comprised primarily of payroll reductions of approximately
$1,065,000 as a result of fewer employees; commission decreases of
approximately $1,257,000 due to less commissionable revenue; increased
advertising expense of approximately $301,000; and net decreases in other
categories of approximately $866,000.
14
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF
OPERATIONS
As a result of the PAETEC transaction previously discussed, the
Company has recorded a pre-tax charge of approximately $1,505,000 during the
quarter ended October 31, 2004. In addition, as previously discussed, the
Company recorded a pre-tax restructuring charge of approximately $385,000 during
the quarter ended October 31, 2004.
For the reasons described above, the operating loss for the nine-month
period ended October 31, 2004 was approximately $4,879,000, an increase of
approximately $3,278,000 from the nine-month period ended October 31, 2003. The
operating loss for the three-month period ended October 31, 2004 was
approximately $1,919,000, an increase of approximately $1,813,000 over the
prior year's three-month period ended October 31, 2003.
Basic and diluted loss per Common Share was $.25 per share for the
current nine-month period ended October 31, 2004 as compared to $.10 loss per
share for the nine-months ended October 31, 2003. Basic and diluted loss per
Common Share was $.08 per share for the current three-month period ended October
31, 2004, as compared to a $.01 loss per Common Share for the three-months ended
October 31, 2003.
Liquidity and Capital Resources
At October 31, 2004, Covista had a positive working capital of
approximately $4,228,000, an increase of approximately $10,316,000 as compared
to January 31, 2004. The ratio of current assets to current liabilities at
October 31, 2004 was 1.27:1, as compared to the ratio of .71:1 at January 31,
2004. During the quarter ended October 31, 2004, the Company completed a
transaction to sell the majority of its commercial customer base. At October 31,
2004, the buyer has paid approximately $9.3 million and is obligated to pay an
additional approximately $5.6 million, of which approximately $3.4 million has
been received subsequent to October 31, 2004. The final payment is due on May
17, 2005, subject to final adjustment. The Company has deferred to portion of
overall gain related to the contingent future payment.
In the opinion of management, cash flow from operations as well as
cash received as a result of the transaction described 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 nine-month period ended October 31, 2004
were approximately $211,000. Capital expenditures for the remainder of Fiscal
2005 are estimated not to exceed approximately $100,000 and are expected to be
funded from cash on hand and 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 496 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 $2,667,000 is included
in intangible assets.
15
ITEM 2
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF
OPERATIONS
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 $6,240,000,
net of the reserve for un-collectible accounts totaling approximately
$1,157,000, represents approximately 22% of the total assets of Covista.
No one customer accounts for greater than one 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 nine-month period ended October
31, 2004, this ratio was approximately 2%. Covista also measures accounts
receivable turnover (as measured in days sales outstanding). For the periods
ended October 31, 2004 and 2003, days sales outstanding were 29 days and 50
days, respectively. The decrease between periods is primarily the result of
retaining a higher share of customers that pay via credit card, after the sale
of selected customers to PAETEC, as previously discussed.
Related Party Transactions
Jay J. Miller, a Director of Covista, has provided various legal
services for Covista in Fiscal 2004. In the third quarter, Covista accrued
approximately $25,000 to Mr. Miller for services rendered. As of October 31,
2004, Covista owed Mr. Miller approximately $36,000.
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 $888,000 at October 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 respective
carrying amounts are as follows:
Useful Life October 31, 2004
Classification in Years (Unaudited) January 31, 2004
- ---------------------------------------------- ----------- ---------------- ----------------
Machinery and equipment 5-10 $ 7,901,580 $ 22,390,711
Office furniture, fixtures and equipment 5-10 1,971,700 4,780,968
Vehicles 3-5 -- 41,812
Leasehold improvements 2-10 475,082 1,612,300
Computer equipment and software 5-7 4,166,645 10,418,781
Machinery and equipment in progress -- 2,579,733 2,512,255
------------ ------------
17,094,740 41,756,827
Less accumulated depreciation and amortization (10,936,101) (30,102,462)
------------ ------------
$ 6,158,639 $ 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. As a result of
the PAETEC transaction discussed further in Note H, the Company recorded a
Goodwill charge of approximately $8 million during the quarter ended October
31, 2004.
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 October
31, 2004 and 2003 was approximately $2.3 million and $2.2 million 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 adverse
effect on the Company's business, financial condition and results of
operations.
18
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
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.
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 October 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.
19
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
CRITICAL ACCOUNTING POLICIES
In response to the Court's decision, the FCC adopted interim rules
that grandfathered competitive carriers, such as we are, and enabled us to
continue until March 2005 to order all unbundled network elements that were
available to us under interconnection agreements that were in effect as of June
15, 2004. After that date, we will not be able to order any of the unbundled
networks elements vacated by the Court unless the FCC adopts replacement rules
creating such a right. The FCC is also currently considering whether to require
the incumbent local telephone companies to continue providing to competitive
carriers the local switching, high capacity loop and high capacity dedicated
transport elements. We cannot predict whether the FCC will complete work on the
proceeding prior to the expiration of its interim rules in March 2005, or if so,
whether the FCC will promulgate rules that would entitle us to continue ordering
the network elements that we currently use.
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.
20
COVISTA COMMUNICATIONS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEMS 1 - 5 Not applicable
ITEM 6 Exhibits and Reports on Form 8K
8K - Dated September 10, 2004, Press Release Regarding Second
Quarter Results
21
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: December 10, 2004 By: /s/ A. John Leach, Jr.
-------------------------------------
A. John Leach, Jr.
President and Chief Executive Officer
Date: December 10, 2004 By: /s/ Frank J. Pazera
-------------------------------------
Executive Vice President,
Chief Financial Officer and
Principal Accounting Officer
22