UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report on Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
COMMISSION FILE NUMBER: 0-29279
----------------------------
CHOICE ONE COMMUNICATIONS INC.
(Exact name of registrant as specified in its charter)
STATE OF DELAWARE 16-1550742
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
100 CHESTNUT STREET, SUITE 600, ROCHESTER, NEW YORK 14604-2417
(Address of principal executive offices) (Zip Code)
(585) 246-4231
(Registrant's telephone number, including area code)
----------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to the filing
requirements for the past 90 days. Yes X No _____
As of November 12, 2002, there were outstanding 42,342,981 shares of the
registrant's common stock, par value $0.01 per share.
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001..........................................2
Condensed Consolidated Statements of Operations for the three
months ended September 30, 2002 and September 30,2001..........3
Condensed Consolidated Statements of Operations for the nine
months ended September 30, 2002 and September 30, 2001.........4
Condensed Consolidated Statements of Cash Flow for the nine
months ended September 30, 2002 and September 30, 2001.........5
Notes to Condensed Consolidated Financial Statements............6
Cautionary Statement On Forward-Looking Statements.............20
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations... ......................................20
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....39
Item 4. Disclosure Controls and Procedures.............................39
PART II. OTHER INFORMATION
Item 1. Legal
Proceedings....................................................40
Item 2. Changes in Securities and Use of Proceeds......................40
Item 3. Defaults Upon Senior Securities............... ................40
Item 4. Submission of Matters to a Vote of Security Holders............40
Item 5. Other Information..............................................41
Item 6. Exhibits and Reports on Form 8-K...............................41
Signatures...................................................................42
Certifications...............................................................43
PART I FINANCIAL INFORMATION
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED Consolidated Balance Sheet
(amounts in thousands, except share and per share data)
SEPTEMBER 30, DECEMBER 31,
2002 2001
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents..................... $ 42,327 $ 14,415
Accounts receivable, net...................... 40,914 40,239
Prepaid expenses and other current assets..... 2,435 1,910
---------- ---------
Total current assets.................... 85,676 56,564
Property and equipment, net...................... 334,990 361,768
Goodwill, net.................................... -- 282,905
Intangible assets, net........................... 51,341 58,922
Other assets, net................................ 6,905 6,419
---------- ---------
Total assets............................ $478,912 $766,578
========== =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT)/EQUITY
Current Liabilities:
Current portion of capital leases for indefeasible
rights to use fiber $ 474 $ 310
Accounts payable.............................. 16,983 12,629
Accrued expenses.............................. 50,609 49,962
---------- ---------
Total current liabilities............... 68,066 62,901
Long-Term Debt and Other Liabilities:
Long-term debt................................ 587,243 473,432
Interest rate swaps........................... 20,082 13,484
Other long-term liabilities................... 3,026 --
Long-term capital leases for indefeasible
rights to use fiber.......................... 21,461 12,550
---------- ---------
Total long-term debt and other liabilities. 631,812 499,466
Commitments and Contingencies (Note 13)
Redeemable Preferred Stock:
Series A preferred stock, $0.01 par value, 340,000
shares authorized, 251,588 and 200,000 shares
issued and outstanding as of September 30, 2002
and December 31, 2001, respectively, ($269,199
liquidation value).......................... 231,420 200,780
Stockholders' (Deficit)/Equity:
Undesignated preferred stock, $0.01 par value,
4,600,000 shares authorized, no shares issued
and outstanding............................. -- --
Common stock, $0.01 par value, 150,000,000 shares
authorized, 41,795,080 and 40,431,583 shares
issued as of September 30, 2002 and December
31, 2001, respectively...................... 418 404
Additional paid-in capital.................... 512,755 537,059
Deferred compensation......................... (788) (16,896)
Treasury stock, 135,415 and 132,328 shares as of
September 30, 2002 and December 31, 2001,
respectively, at cost....................... (473) (480)
Accumulated deficit........................... (944,216) (503,172)
Accumulated other comprehensive loss.......... (20,082) (13,484)
------------ ----------
Total stockholders' (deficit)/equity.... (452,386) 3,431
------------ ----------
Total liabilities and stockholders'
(deficit)/equity....................... $ 478,912 $766,578
============ ==========
The accompanying notes to condensed consolidated financial statements are
an integral part of these financial statements.
2
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except share and per share data)
THREE MONTHS ENDED
SEPTEMBER 30,
2002 2001
----------- -----------
(unaudited) (unaudited)
Revenue.................................... $ 74,439 $ 48,792
Operating expenses:
Network costs......................... 40,304 31,005
Selling, general and administrative,
including non-cash deferred
compensation of $762 and $2,350 in
2002 and 2001, respectively, and
non-cash management ownership allocation
charge of $ 200 and $6,040 in 2002
and 2001, respectively.............. 38,469 43,190
Impairment loss on long-lived assets.. 11,273 --
Loss on disposition of assets......... 36 --
Restructuring costs................... 5,283 --
Depreciation and amortization......... 18,427 22,544
---------- ----------
Total operating expenses........ 113,792 96,739
---------- ----------
Loss from operations....................... (39,353) (47,947)
Other income/(expense):
Interest income....................... 108 827
Interest expense...................... (15,473) (13,761)
---------- ----------
Total other income/(expense), net.......... (15,365) (12,934)
---------- ----------
Net loss................................... (54,718) (60,881)
Accretion on preferred stock............... 2,125 1,778
Accrued dividends on preferred stock....... 9,114 7,942
---------- ----------
Net loss applicable to common stockholders. $(65,957) $ (70,601)
========== ==========
Net loss per share, basic and diluted...... $ (1.47) $ (1.78)
========== ==========
Weighted average number of shares outstanding,
basic and diluted..................... 44,974,102 39,594,628
============ ============
Adoption of Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets"
Net loss .................................. $(54,718) $ (60,881)
Goodwill amortization...................... -- 8,262
---------- ----------
Adjusted net loss ......................... (54,718) (52,619)
Accretion and accrued dividends on
preferred stock.......................... 11,239 9,720
---------- ----------
Adjusted net loss applicable to common
stock holders............................ $ (65,957) $ (62,339)
============ ===========
Net loss per share, basic and diluted,
as reported............................... $ (1.47) $ (1.78)
Goodwill amortization per share............ -- 0.21
----------- ----------
Adjusted net loss per share, basic and
diluted................................... $ (1.47) $ (1.57)
=========== ===========
The accompanying notes to condensed consolidated financial statements are an
integral part of these financial statements.
3
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except share and per share data)
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
----------- -----------
(unaudited) (unaudited)
Revenue..................................... $ 218,225 $ 125,394
Operating expenses:
Network costs.......................... 122,923 86,562
Selling, general and administrative,
including non-cash deferred
compensation of $4,909 and $7,193 in
2002 and 2001, respectively, and
non-cash management ownership
allocation charge of $10,915
and $19,146 in 2002 and 2001,
respectively......................... 140,218 126,076
Impairment loss on long-lived assets... 294,524 --
Loss on disposition of assets.......... 814 801
Restructuring costs.................... 5,283 --
Depreciation and amortization.......... 51,135 64,675
----------- ----------
Total operating expenses......... 614,897 278,114
----------- ----------
Loss from operations....................... (396,672) (152,720)
Other income/(expense):
Interest income....................... 239 4,606
Interest expense........................... (44,611) (42,404)
----------- ----------
Total other income/(expense), net.......... (44,372) (37,798)
----------- ----------
Net loss................................... (441,044) (190,518)
Accretion on preferred stock............... 6,122 5,129
Accrued dividends on preferred stock....... 26,427 23,030
----------- ----------
Net loss applicable to common stockholders $(473,593) $(218,677)
=========== ===========
Net loss per share, basic and diluted...... $ (10.94) $ (5.52)
=========== ===========
Weighted average number of shares
outstanding, basic and diluted.......... 43,305,779 39,593,485
============ ============
Adoption of Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets"
Net loss .................................. $(441,044) $(190,518)
Goodwill amortization...................... -- 24,747
------------ -----------
Adjusted net loss ......................... (441,044) (165,771)
Accretion and accrued dividends on
preferred stock......................... 32,549 28,159
------------ -----------
Adjusted net loss applicable to common
stockholders............................ $(473,593) $(193,930)
============ ===========
Net loss per share, basic and diluted,
as reported............................. $ (10.94) $ (5.52)
Goodwill amortization per share............ -- 0.63
------------ -----------
Adjusted net loss per share, basic
and diluted............................. $ (10.94) $ (4.89)
============ ===========
The accompanying notes to condensed consolidated financial statements are an
integral part of these financial statements.
4
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
(unaudited) (unaudited)
Cash flows from operating activities:
Net loss............................... $ (441,044) $(190,518)
Adjustments to reconcile net loss to net
cash used in operating activities:
Loss on disposition of assets....... 814 801
Depreciation and amortization....... 51,135 64,675
Impairment loss on long-lived assets. 294,524 --
Non-cash interest on subordinated notes..... 18,188 --
Amortization of deferred financing
costs.............................. 3,096 2,598
Amortization of discount on debt.... 422 --
Deferred compensation and management
ownership allocation charge........ 15,824 26,338
Changes in assets and liabilities:
Accounts receivable, net......... (675) (12,853)
Prepaid expenses and other assets (538) (1,798)
Accounts payable and accrued
expenses........................ 8,236 9,590
--------- ---------
Net cash used in operating
activities........................ (50,019) (101,167)
Cash flows from investing activities:
Capital expenditures.................... (19,958) (65,953)
Decrease in restricted cash............. -- 18,369
Proceeds from sales of investments...... -- 7,602
Proceeds from sale of assets............ 1,002 --
--------- ----------
Net cash used in investing
activities........................ (18,956) (39,982)
Cash flows from financing activities:
Additions to long-term debt............. 198,200 62,000
Principal payments of long-term debt.... (98,700) (34,000)
Payments under long-term capital leases
for indefeasible rights to use fiber.. (231) (48)
Proceeds from capital contributions
and issuance of common stock.......... -- 106
Repurchase of treasury stock............ -- (12)
Payments of financing costs............. (2,382) (2,512)
--------- ----------
Net cash provided by financing
activities......................... 96,887 25,534
--------- ----------
Net increase/(decrease) in cash and cash
equivalents............................... 27,912 (115,615)
Cash and cash equivalents, beginning
of period................................. 14,415 173,573
---------- ----------
Cash and cash equivalents, end of period..... $ 42,327 $ 57,958
=========== ==========
The accompanying notes to condensed consolidated financial statements are an
integral part of these financial statements.
5
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2002
(Unaudited)
(All amounts in thousands, except share and per share data)
NOTE 1. DESCRIPTION OF BUSINESS
Choice One Communications Inc. and its wholly-owned subsidiaries (the
"Company") is an integrated communications provider offering facilities-based
voice and data telecommunications services and web services. The Company,
incorporated under the laws of the State of Delaware on June 2, 1998, markets
and provides these services primarily to small and medium-sized businesses in 30
second and third tier markets in the northeastern and midwestern United States.
The Company's services include local exchange and long distance services,
high-speed data and Internet services, and web hosting and design services. The
Company seeks to become the leading integrated communications provider in each
market by offering a single source for competitively priced, high quality,
customized telecommunications and web-based services.
At September 30, 2002, the Company has $42.3 million in cash and cash
equivalents. The Company also has available funding of $4.375 million under its
Term D loan facility, beginning on December 31, 2002 in five equal quarterly
installments. Borrowings under the credit facility are subject to compliance
with covenants, including the requirement for Minimum Available Cash and capital
expenditures, as defined in the amended credit agreement dated September 13,
2002. See Note 8 for further details on the Company's debt financing.
The Company has experienced net losses applicable to common
stockholders of $66.0 million, $349.8 million and $57.8 million during the
three-month periods ended September 30, 2002, June 30, 2002 and March 31, 2002.
The Company's viability is dependent upon its ability to continue to execute
under its business strategy, to begin to generate positive cash flows from
operations during 2003 and to remain in compliance with the covenants under the
credit facilities. The execution of the Company's business strategy requires
obtaining and retaining a significant number of customers, and generating
significant and sustained growth in its operating cash flows to be able to meet
its debt service obligations and fund working capital and capital expenditures;
see Note 1 to the Company's Consolidated Financial Statements as filed in the
Company's Form 10-K for the fiscal year ended December 31, 2001, with respect to
the Company's 2002 plan.
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information required by GAAP
for complete financial statement presentation. The unaudited interim condensed
consolidated financial statements include the consolidated accounts of the
Company with all significant intercompany transactions eliminated. In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) necessary for a fair statement of the financial position, results
of operations and cash flows for the interim periods presented have been made.
These financial statements should be read in conjunction with the Company's
audited financial statements as of and for the year ended December 31, 2001. The
results of operations for the three and nine month periods ended September 30,
2002 are not necessarily indicative of the results to be expected for other
interim periods or for the year ended December 31, 2002.
6
Certain amounts in the prior period's condensed consolidated financial
statements have been reclassified to conform to the current period presentation.
These reclassifications had no impact on the results of operations and cash
flows for the periods presented.
Unless otherwise stated, all amounts are in thousands except share and
per share data.
NOTE 3. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations". This standard addresses the financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The standard is
effective for fiscal years beginning after June 15, 2002. The Company expects to
adopt this standard effective January 1, 2003. The Company's management does not
expect the adoption of SFAS No. 143 to have a material impact on the Company's
financial statements or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". This standard rescinds FASB No. 4 and an amendment to that
Statement, FASB No. 64, which related to extinguishment of debt. It rescinds
FASB No. 44, which related to accounting for intangible assets of motor
carriers. This standard also amends FASB No. 13 as it relates to certain
sale-leaseback transactions. The Company adopted this standard on April 1, 2002.
The adoption did not have a material impact on the Company's financial
statements or results of operations.
In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No.144, (SFAS No. 144), "Accounting
for the Impairment or Disposal of Long-Lived Assets". This standard addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. The standard is effective for fiscal years beginning after December 15,
2001. The Company adopted this standard effective January 1, 2002. The adoption
did not have a material impact on the Company's financial results.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This standard amends Emerging
Issue Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity". This
statement requires that a liability for costs associated with an exit or
disposal activity be recognized when the liability is incurred, rather than when
an entity commits to an exit plan. The standard also established the use of fair
value for the measurement of exit liabilities. The standard is effective for
exit or disposal activities initiated after December 31, 2002, with early
application encouraged. The Company expects to adopt this standard effective
January 1, 2003. Management does not expect adoption to have a material impact
on the Company's financial statements or results of operations.
7
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment, at cost, consisted of the following:
September 30, 2002 December 31, 2001
Switch equipment..................... $293,345 $293,765
Computer equipment and software...... 54,265 49,393
Office furniture and equipment....... 9,907 11,203
Leasehold improvement................ 22,784 25,585
Indefeasible right to use fiber...... 57,327 47,893
Construction in progress............. 10,707 6,309
--------- ----------
Total property and equipment 448,335 434,148
Less: accumulated depreciation....... (113,345) (72,380)
---------- ----------
Property and equipment, net $334,990 $361,768
========== ==========
During the three months ended September 30,2002, the Company committed
to a plan to exit its Ann Arbor and Lansing, Michigan market and reduce reliance
on certain collocation sites within other markets through network optimization
initiatives as more fully described in Note 11. In conjunction with the plan,
the Company evaluated the related long-lived assets for impairment. The Company
recorded an impairment charge of approximately $7.3 million for the value of
unrecoverable leasehold improvements and other general equipment that will be
abandoned, which is reported in impairment loss on long-lived assets on the
Consolidated Statement of Operations. The restructuring plan and related asset
impairment required the Company to evaluate for impairment its equipment held
for use and reported as construction in progress. It was determined that a
portion of this equipment would not be used. The Company recorded an impairment
charge of $4.0 million related to this equipment that will be abandoned which is
reported in impairment loss on long-lived assets on the Consolidated Statement
of Operations.
NOTE 5. ACCOUNTING FOR GOODWILL AND INTANGIBLE ASSETS
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 addresses financial accounting and reporting
for acquired goodwill and other intangible assets, and is effective for fiscal
years beginning after December 15, 2001. Effective January 1, 2002, the Company
adopted SFAS No. 142, which requires that goodwill not be amortized, but instead
be tested at least annually for impairment and expensed against earnings when
the implied fair value of a reporting unit, including goodwill, is less than its
carrying amount. The Company completed the required impairment evaluation of
goodwill in conjunction with its adoption of SFAS No. 142 during the three-month
period ended March 31, 2002. Based on an analysis that considered the future
cash flows of the Company and market capitalization information, the evaluation
noted no impairment of goodwill at that time.
8
As outlined in SFAS No. 142, certain intangible assets with a finite
life, however, are required to continue to be amortized. The following schedule
sets forth the major classes of intangible assets held by the Company:
September 30, 2002 December 31, 2001
Amortized intangibles:
Customer relationships........... $ 53,635 $52,285
Deferred financing costs......... 29,655 27,769
Less: accumulated amortization..
Customer relationships....... (23,103) (15,350)
Deferred financing costs..... (8,846) (5,782)
---------- ---------
Intangible assets, net ...... $51,341 $58,922
========== =========
Deferred financing costs are amortized to interest expense over the
life of the related debt using the effective interest rate method. The Company
continues to amortize its intangible assets that have finite lives.
Additionally, the Company no longer amortizes its goodwill as a result of the
adoption of SFAS No. 142. The estimated amortization expense on customer
relationships, which have an estimated life of five years, is as follows for the
following fiscal periods:
October to December, 2002............... 2,683
2003.................................... 10,727
2004.................................... 10,617
2005.................................... 6,026
2006.................................... 370
2007.................................... 109
Amortization expense was $2.7 million and $11.3 million for the three
months ended September 30, 2002 and September 30, 2001, respectively, and $8.0
million and $34.0 million for the nine months ended September 30, 2002 and
September 30, 2001, respectively.
During the three months ended June 30, 2002, the Company noted a
significant adverse change in the business climate of the Company and the
telecommunications industry in general. These circumstances required the Company
to perform an interim goodwill impairment test. As a result, the Company
recorded an impairment charge of $283.0 million. The amount of the impairment
charge was determined utilizing a combination of market-based methods to
estimate the fair value of the assets in accordance with SFAS No. 142. In
addition, the Company recorded a $0.3 million charge to write-down the value of
acquired customer relationships related to the Company's web hosting and design
services in accordance with the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". Both charges are reported in
impairment loss on long-lived assets on the Consolidated Statement of
Operations.
9
A summary of the changes in the Company's net goodwill by reporting
unit at September 30, 2002:
Web Hosting
Telecommunications and Design Total
Balance at December 31, 2001 $280,148 $2,757 $282,905
Additions to goodwill............ 79 -- 79
Impairment charge................ (280,227) (2,757) (282,984)
----------- -------- ---------
Balance at September 30, 2002 $ -- $ -- $ --
=========== ======== =========
NOTE 6. OTHER ASSETS
Other assets consisted of the following:
September 30, 2002 December 31, 2001
Investment in FiberTech, LLC..... $3,943 $3,943
Notes receivable - officers...... 2,496 2,392
Other assets, net................ 466 84
------ -------
Total other assets $6,905 $6,419
====== =======
The Company has a minority equity investment in FiberTech, LLC
("FiberTech") which is accounted for using the cost method. FiberTech designs,
constructs and leases high performance fiber networks in second and third tier
markets in the Northeast and Mid-Atlantic regions of the United States. As a
minority investor, the Company has the right to appoint one representative to
FiberTech's board of managers, and has a vote in determining the new markets in
which FiberTech will develop and build local loops. The Company has a master
facilities agreement with FiberTech that provides the Company with a 20-year
indefeasible right to use (IRU) fiber without electronics in 13 of Choice One's
market cities.
In August 2001, the Company loaned an aggregate of $2.2 million to its
chief executive officer and top four executives. The loans bear interest at a
rate of 5.72% and have a term of three years (subject to acceleration in the
event of termination of employment). The loans are non-recourse and are secured
by 100% of the common stock owned by the respective executives. The collateral
for these loans is tested for impairment based on trends in the Company's stock
price, among other factors, on a quarterly basis. No impairment was identified
during the three-month period ended September 30, 2002.
10
NOTE 7. ACCRUED EXPENSES
Accrued expenses consisted of the following:
September 30, 2002 December 31, 2001
Accrued network costs.................. $ 31,706 $ 32,657
Accrued payroll and payroll
related benefits..................... 3,333 2,905
Accrued collocation costs.............. 2,488 2,815
Accrued interest....................... 1,324 3,228
Other.................................. 11,758 8,357
------------ --------------
Total accrued expenses $ 50,609 $ 49,962
============ ==============
NOTE 8. DEBT
Debt consisted of the following:
September 30, 2002 December 31, 2001
Term A loan........................... $ 125,000 $ 125,000
Term B loan........................... 125,000 125,000
Term C loan........................... 40,243 --
Term D loan........................... 0 --
Revolver.............................. 100,000 45,000
Subordinated notes, under the
Bridge Agreement.................... 197,000 178,432
---------- ----------
Total debt $ 587,243 $ 473,432
========== ==========
Included in the subordinated notes is a discount on the notes of $2.9
million and $3.3 million as of September 30, 2002 and December 31, 2001,
respectively and interest payable in-kind (PIK) of $9.9 million and $3.4 million
as of September 30, 2002 and December 31, 2001, respectively. Included in the
Term C loan is a discount of $4.3 million as of September 30, 2002.
The Company's Third Amended and Restated Credit Agreement (the "Credit
Agreement") provides the Company with an eight-year revolving credit facility of
$100.0 million, an eight-year multiple draw Term A loan of $125.0 million, an
eight and one-half year Term B loan of $125.0 million, a seven and one-half year
Term C loan of $44.5 million, and a seven and one-quarter year Term D loan of
$4.375 million. As of September 30, 2002, the maximum borrowings available under
the Term A loan, Term B loan and Term C loan, and the revolver loan were all
outstanding. There were no outstanding balances under the Term D loan at
September 30, 2002. The weighted average floating interest rate and the weighted
average fixed swapped interest rate at September 30, 2002 were 6.17% and 10.79%,
respectively.
11
The Credit Agreement contains certain covenants that are customary for
credit of this nature, all of which are defined in the Agreement, as amended.
The Company was in compliance with all covenants under the agreement for the
three months ended September 30, 2002.
As of September 30, 2002, the Company had principal borrowings of
$190.0 million in subordinated notes, excluding the discount of $2.9 million and
PIK interest of $9.9 million. Interest on the notes is fixed at 13% and accretes
to the principal semi-annually until November 2006. Thereafter, interest will be
payable quarterly, in cash, based on LIBOR plus an applicable margin. During the
three-month period ended June 30, 2002, $11.7 million in PIK interest accreted
to principal.
The discount on the subordinated notes is being amortized over the
nine-year term of the subordinated notes. For the three and nine month periods
ended September 30, 2002, $0.1 million and $0.4 million of the discount was
amortized, respectively. The discount on the Term C loan is also being amortized
over its seven and one-half year term. Amortization expense associated with the
Term C loan for the three and nine months ended September 30, 2002, was $0.1
million.
On September 13, 2002, the Company completed new debt financing of
$48.875 million, a waiver of the default of the revenue covenant at June 30,
2002 from its lending institutions, and an amendment to the Company's existing
senior credit facility. Morgan Stanley Capital Partners and the lenders of the
Company's subordinated notes provided the Company with a $44.5 million senior
secured term loan facility (the Term C loan). Additionally, certain of the
Company's existing senior lenders have made available a separate term loan
facility of $4.375 million (the Term D loan) to be drawn in five equal quarterly
installments commencing on December 31, 2002 and maturing on February 1, 2009.
The Company intends to use the net proceeds from these loans for its general
corporate purposes.
The following is a summary of the principal terms of the new
facilities:
o Provides a Term C loan facility of $44.5 million. Such loan is secured on
an equivalent basis with the same collateral that secures the Company's existing
senior credit facility. Interest on this term loan accrues at LIBOR plus 5.75%
or at a base rate, as defined in the Credit Agreement, plus 4.75%, at the option
of the Company. Interest on the Term C loan that would otherwise be payable from
September 13, 2002 through March 31, 2004 will accrue monthly and be added to
the principal amount of the loan (the "Term C Loan Deferred Interest").
Thereafter, interest accruing on the Term C loan is payable in cash at the end
of each month. All Term C Loan Deferred Interest and principal amount of the
Term C loan is due at maturity on March 31, 2009. The Term C loan was drawn down
in full at closing of the Credit Agreement.
12
o Provides a Term D loan facility in an aggregate principal amount of
$4.375 million and is available to the Company in five equal quarterly
installments commencing on December 31, 2002. Interest on the Term D loans will
accrue at the same rate applicable to the outstanding revolving loans and Term A
loans under the Credit Agreement. The applicable interest rate is determined by
a grid and is tied to the Company's leverage ratio as calculated pursuant to the
terms of the Credit Agreement. Initially, the applicable interest rate will be
LIBOR plus 4.00% or the base rate, as defined in the Credit Agreement, plus
3.00%, at the option of the Company. Interest accruing on the Term D loans is
payable in cash at the end of each month. The outstanding principal under Term D
loan shall be repaid quarterly commencing on June 30, 2004 through September 30,
2008 at the rate of 0.25 % of the aggregate principal amount, then at the rate
of 47.5% on December 30, 2008. Any remaining unpaid principal and accrued
interest is due in full at the maturity date of January 31, 2009.
In addition to establishing the Term C loan and Term D loan facilities
as described above, the prior terms of the Company's credit agreement were
amended to provide for, among other things, the following:
o Deferring principal payments originally due on December 31, 2003 and
March 31, 2004 on the outstanding Term A and Term B loans until
maturity at July 31, 2008 and January 31, 2009, respectively.
o Amending a financial covenant to require the Company to have cash and
available committed financing of not less than $10,000,000 at any time
prior to July 1, 2004.
o Amending a financial covenant to limit the Company to maximum annual
capital expenditures of $35 million, $39 million, $43 million, $52
million, $59 million, $66 million and $74 million during each fiscal
year ending December 31, 2002 through December 31, 2008, respectively.
o Beginning with the quarter ended September 30, 2004, requiring the
Company to comply with amended financial covenants pertaining to the
Company's leverage ratio, fixed charges coverage ratio and interest
coverage ratio until the final maturity of the outstanding loans.
o Eliminating minimum revenue and maximum EBITDA losses/minimum EBITDA
financial covenants for all periods.
o Permitting certain business and operating practices as defined in the
Credit Agreement.
13
On September 13, 2002, the Company also entered into a Third
Amendment to the Bridge Agreement with Morgan Stanley Senior Funding,
Inc., as administrative agent, Wachovia Investors, Inc. and CIBC Inc.
(the "Bridge Agreement Amendment"). The Bridge Agreement Amendment, among
other things:
o Permits the Company to incur the additional debt under the Credit
Agreement comprised of the Term C and Term D loan facilities.
o Extends by one year to November 9, 2006 the period during which the
Company may pay interest in-kind, rather than in cash, on the
subordinated notes issued under the Bridge Agreement.
o Limits the maximum annual capital expenditures that the Company and its
subsidiaries may make to the same amounts permitted under the Credit
Agreement.
In consideration for the loans extended to the Company under the Credit
Agreement and the other amendments and waivers effected pursuant to the Credit
Agreement and for amendments to the Bridge Agreement, the Company has issued
warrants to purchase shares of the Company's common stock to the lenders under
the Term C loan facility. These warrants are exercisable for up to 10,596,137
shares of common stock, representing 20% of the issued and outstanding common
stock of the Company on September 13, 2002, on a fully diluted basis after
giving effect to the issuance of the new warrants. These warrants may be
exercised until September 13, 2007 at an exercise price of $0.01 per
share. Of these, warrants to purchase 7,944,700 shares of common stock
are immediately exercisable. Warrants to purchase 2,651,437 shares of common
stock issued to those lenders under the Term C loan facility who are also
lenders under the Bridge Agreement will not become exercisable prior to
September 13, 2004. If the Company satisfies its outstanding obligations under
the Bridge Agreement in full, including payment of accrued and unpaid interest,
prior to September 13, 2004, the warrants to purchase 2,651,437 shares of
common stock will expire;otherwise they will become exercisable on September
13, 2004.
In addition, the Company has issued additional warrants to the lenders
under the Bridge Agreement that may, upon the occurrence of certain events as
summarized below and more fully described in the Form of Warrant for the
Purchase of Common Stock (the "Form of Warrant"), become exercisable for up to
an additional 4,851,872 shares of common stock, representing 10% of the issued
and outstanding common stock of the Company on September 13, 2002, on a fully
diluted basis after giving effect to the issuance of such new warrants. These
new warrants, which are not currently exercisable and will only become
excersisable under limited circumstances as described in the Form of Warrant,
have an exercise price of $0.01 per share.
14
As more fully set forth in the Form of Warrant, these warrants will
only become exercisable in the event that the holders of the warrants present to
the Company a proposal for a qualified capital markets transaction and the
Company rejects the proposal (or accepts the proposal but fails to use good
faith reasonable best efforts to consummate the proposal transaction). In
addition to additional specific terms and conditions contained in the Form of
Warrant, in order for a transaction to be a "qualified capital markets
transaction" it must:
o relate to the issuance and sale of subordinated notes with a market rate
of interest not greater than 13.5%, convertible debt with an interest rate not
greater than 8%, or equity at a price not less than $6.25 per share of the
Company's common stock (subject to adjustment as provided in the Form of
Warrant);
o contain customary terms for an issuance of the relevant type of
securities which, in the case of convertible debt or equity, would be comparable
to the terms of comparable securities issued in a transaction registered under
the Securities Act or consummated pursuant to Rule 144A or another exemption
thereunder; and
o generate net cash proceeds to the Company of at least $100 million,
taking into account the proceeds from multiple qualifying transactions if
proposed as part of a single financing.
If they have not already become exercisable, these warrants will automatically
expire when the Company has satisfied its obligations under the Bridge Agreement
in full.
All of these newly issued warrants are entitled to anti-dilution
protection and the warrant holders have been granted rights with respect to the
registration of the shares issuable upon exercise thereof under the Securities
Act. The anti-dilution protection includes provisions that will increase the
number of shares of common stock issuable upon exercise of the warrants under
certain circumstances such as a subsequent below market issuance of common stock
(or warrants to purchase common stock), a stock split, recapitalization or
similar event. The issuance of the new warrants to the Company's lenders as
described above triggered the anti-dilution provisions in the Company's
previously issued warrants. As a result of the issuance of the new warrants on
September 13, 2002, the number of shares of common stock issuable upon exercise
of these previously issued outstanding warrants increased by 595,430 shares,
resulting in potential dilution to the Company's existing stockholders in
addition to the potential dilution resulting from the issuance of the new
warrants to the Company's lenders in the current transaction. The previously
issued outstanding warrants were increased as follows:
o the holders of the Series A preferred stock originally received, at the
time of purchase of those preferred shares, warrants to purchase 1,747,454
shares of common stock at $0.01 per share and, pursuant to the anti-dilution
provisions in such warrants, are now entitled to purchase upon exercise thereof
an additional 259,735 shares of common stock at $0.01 per share for a total of
warrants to purchase 2,007,189 shares of common stock;
15
o the lenders under the Bridge Agreement originally received, at the time
of the issuance of the subordinated notes thereunder, warrants to purchase
1,890,294 shares of common stock at $2.25 per share and, pursuant to the
anti-dilution provisions in such warrants, are now entitled to purchase upon
exercise thereof an additional 265,716 shares of common stock and the exercise
price for all 2,156,010 of these warrants has been adjusted to $1.97 per share;
and
o the holders of the Series A preferred stock originally received, at the
time of their waiver of certain rights thereunder, warrants to purchase
1,177,015 shares of common stock at $1.64 per share, of which 470,806 had vested
as of September 13, 2002 and, pursuant to the anti-dilution provisions in such
warrants, are now entitled to purchase upon exercise thereof an additional
69,979 shares of common stock and the exercise price for all 540,785 of these
exercisable warrants has been adjusted to $1.43 per share. The remaining
warrants to purchase 706,209 shares of common stock expired at September 30,
2002.
If the warrants to purchase 2,651,437 and 4,851,872 shares of common
stock issued to the lenders under the Bridge Agreement, that are not currently
exercisable, become exercisable in accordance with their terms, additional
anti-dilution adjustments will be required with respect to all issued and
outstanding warrants with the exception of these warrants issued to the lenders
under the Bridge Agreement.
Morgan Stanley Capital Partners, lenders of the Term C loan, are
related parties to the Company and holders of the Company's Series A preferred
stock. Morgan Stanley Senior Funding, a lender of the Term C and D loans, was
also sole lead arranger and one of the lenders for the Company's subordinated
notes.
NOTE 9. DERIVATIVE INSTRUMENTS
The Company accounts for its derivative instruments in accordance with
SFAS No. 133, which requires that all derivative financial instruments, such as
interest rate swap agreements, be recognized in the financial statements and
measured at fair value regardless of the purpose or intent for holding them.
The Company uses derivative instruments to manage its interest rate
risk. The Company does not use the instruments for speculative purposes.
Interest rate swaps were employed as a requirement under the Company's Second
Amended and Restated Credit Agreement. The Third Amended and Restated Credit
Agreement does not have such a requirement. This agreement does prohibit the
Company from entering into any new interest rate swap, collar, cap, floor or
forward rate agreements without the prior written consent of the lenders. The
interest differential to be paid or received under the related interest rate
swap agreements is recognized over the life of the related debt and is included
in interest expense or income. The Company designates these interest rate swap
contracts as cash flow hedges. The fair value of the interest rate swap
agreements designated and effective as a cash flow hedging instrument is
included in accumulated other comprehensive loss. Credit risk associated with
nonperformance by counterparties is mitigated by using major financial
institutions with high credit ratings.
16
At September 30, 2002, the Company had interest rate swap agreements
with a notional principal amount of $187.5 million expiring in 2003 and 2006.
The interest rate swap agreements are based on the three-month LIBOR, which are
fixed at 4.985% and 6.94%, respectively. Approximately 48 percent of the
underlying facility debt is being hedged with these interest rate swaps. The
fair value of the swap agreements was $20.1 million and $13.5 million as of
September 30, 2002 and December 31, 2001, respectively. The fair value of the
interest rate swap agreements is estimated based on quotes from brokers and
represents the estimated amount that the Company would expect to pay to
terminate the agreements at the reporting date.
The fair value of the interest rate swap agreements is included in the
Accumulated Other Comprehensive Loss on the Consolidated Balance Sheet and the
change in the fair value of the interest rate swap agreements is the only
component of other comprehensive loss. Comprehensive loss was $59.7 million and
$447.6 million for the three months and nine months ended September 30, 2002,
respectively.
NOTE 10. STOCKHOLDERS' EQUITY
In December 2001, the Company purchased certain assets from FairPoint
Communications Solutions Corp. The purchase price included contingent
consideration payable in common stock of the Company based on the achievement of
certain operational metrics within 120 days of the closing date. In May 2002,
based on the achievement of operational metrics, 1,000,000 shares were issued to
FairPoint Communications Solutions Corp. as additional consideration for these
assets.
In March 2002, the holders of the Company's Series A senior cumulative
preferred stock agreed to irrevocably waive certain of their redemption rights
with respect to 60,000 shares of Series A preferred stock (shares covered by
such waiver are described herein as non-redeemable Series A preferred stock and
all other shares are described as redeemable Series A preferred stock). The
redemption rights waived included the mandatory redemption on the maturity date
of August 1, 2012 and the mandatory redemption for cash upon a change in
control.
In consideration for the holders' irrevocable waiver of redemption
rights (and for no other consideration), the holders of the non-redeemable
Series A preferred stock were granted warrants to purchase shares of the
Company's common stock. The Company issued to the holders warrants to purchase
1,177,015 shares of common stock at an exercise price of $1.64 per share. The
warrants vest 40 percent on the date of issuance, March 31, 2002, and then, if
the waiver has not been terminated, 20 percent each on October 1, 2002, January
1, 2003 and April 1, 2003. The Company may elect, at its sole discretion, to
terminate the waiver at any time. The Company terminated the waiver in September
2002.
As a result, approximately 706,209 unvested warrants expired and
470,806 vested warrants will expire on September 25, 2007. Pursuant to
anti-dilution provisions in such warrants, triggered with the issuance of new
warrants to the Company's lenders under the Term C loan facility, the holders
are now entitled to warrants to purchase 540,785 shares of common stock at $1.43
per share. The 60,000 shares of non-redeemable Series A preferred stock at June
30, 2002 were converted to shares of redeemable Series A preferred stock at
September 30, 2002.
In March 2002, the Company declared the dividends due on its redeemable
Series A preferred stock through March 31, 2002 and issued such dividends in the
form of 51,588 shares of redeemable Series A preferred stock. These 51,588
shares of redeemable Series A preferred stock and additional shares of 8,412
aggregate to the 60,000 shares of Series A preferred stock for which the Company
received the waiver as described above, the non-redeemable Series A preferred
stock. The fair value of the non-redeemable Series A preferred stock was
included in stockholder's equity until the Company terminated the waiver in
September 2002, and the fair value of the related warrants was included in
additional paid-in capital.
17
In conjunction with the closing of the Company's new debt financing,
the Company issued to its lenders warrants to purchase 15,448,009 shares of the
Company's common stock of which 7,944,700 are immediately exercisable, 2,651,437
will not become exercisable prior to September 13, 2004, and 4,851,872 which
will not become exercisable until the occurrence of certain events as more fully
described in Note 8. The relative fair value of the warrants of $4.3 million was
included in additional paid-in capital.
Diluted earnings per share reflect the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock. No reconciliation of basic and diluted is needed,
as the effect of dilutive securities would be antidilutive. The Company had
options and warrants to purchase 16,414,220 and 6,472,188 shares outstanding at
September 30, 2002 and 2001, respectively, that were not included in the
calculation of diluted loss per share because the effect would be antidilutive.
NOTE 11. RESTRUCTURING COSTS
During the three-month period ended September 30, 2002, the Company
identified opportunities to optimize the use of capital and company assets and
committed to a plan of workforce reductions, closing operations in its Ann Arbor
and Lansing, Michigan market and reducing reliance on certain collocation sites.
On September 5, 2002, the Company announced it had reduced its
workforce by 102 operational and administrative positions. All positions were
terminated by September 30, 2002 and termination benefits for these positions
are included in the restructuring costs. In addition, approximately 100
positions were eliminated through normal attrition.
On October 9, 2002, the Company notified its customers in the
communities of Ann Arbor and Lansing, Michigan that the Company would be closing
that market. The Company has stopped selling services to new clients in this
market and has notified existing customers of the decision and the approximate
time remaining until services are terminated, which is currently estimated as
December 1, 2002. The Company will redeploy certain equipment from this market
to other markets to optimize its network assets. Revenue and operating results
of the Ann Arbor and Lansing, Michigan market are not significant to the
Company's consolidated results of operations.
In connection with the above activities, the Company recorded
restructuring costs of $5.3 million in the three-month period ended September
30, 2002, comprised of employee termination benefits of $0.6 million,
contractual lease obligations of $3.4 million and network facility costs of $1.3
million. At September 30, 2002, approximately $0.1 million of the restructuring
costs had been paid and it is anticipated that the remaining charges will be
liquidated within the next calendar year, except for contractual lease
obligations that extend beyond one year and are included in other long-term
liabilities.
18
NOTE 12. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES AND
CASH FLOW INFORMATION
During the nine months ended September 30, 2002, the Company executed
capital leases for the indefeasible rights to use fiber, with a related party,
for $9.3 million. The leases were for fiber deployed in Pittsburgh,
Pennsylvania, Indianapolis, Indiana, Springfield, Massachusetts, Hartford,
Connecticut and Providence, Rhode Island.
Supplemental disclosures of cash flow information for the nine months
ended:
September 30, September 30,
2002 2001
Interest paid.................. $24,713 $40,675
======= =======
NOTE 13. COMMITMENTS AND CONTINGENCIES
On January 26, 2002, the Company and its wholly owned subsidiary US
Xchange Inc. (referred to collectively for purposes of this paragraph as the
Company), filed suit against AT&T Corp ("AT&T"). This action is now pending in
the United States District Court for the Western District of New York
(02-CV-6090L). The Company's complaint seeks damages from AT&T for breach of
contract, based upon AT&T's failure to pay, either on time or in full, the
Company's invoices for access services provided to AT&T. An answer was filed by
AT&T. The Company has filed a reply. On April 26, 2002, the Company filed a
motion for partial summary judgment based upon AT&T's failure to pay the
Company's invoices on account, and for a declaration that AT&T materially
breached its agreements for failure to pay. AT&T cross-moved for partial summary
judgment, seeking dismissal of several of the Company's causes of action.
On September 24, 2002, following oral argument, the Court rendered a decision
dismissing some of the Company's causes of action, but preserving for trial the
Company's claim for breach of contract and declaratory judgement, based upon
AT&T's failure to pay, either on time or in full, the Company's invoices for
access services provided to AT&T. The parties are now engaged in the discovery
process.
19
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
From time to time, the Company makes oral and written statements that may
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Act") or by the Securities and
Exchange Commission ("SEC") in its rules, regulations, and releases. The words
or phrases "believes", "expects", "estimates", "anticipates", "will", "will be",
"could", "may" and "plans" and the negative or other similar words or
expressions identify forward-looking statements made by or on behalf of the
Company. The Company desires to take advantage of the "safe harbor" provisions
in the Act for forward-looking statements made from time to time, including, but
not limited to, the forward-looking information contained in the Management's
Discussion and Analysis of Financial Condition and Results of Operations and
other statements made in this Form 10-Q and in other filings with the SEC.
The Company cautions readers that any such forward-looking statements made by or
on behalf of the Company are based on management's current expectations and
beliefs but are not guarantees of future performance. Actual results could
differ materially from those expressed or implied in the forward-looking
statements. Factors that could impact the Company include, but are not limited
to:
o Compliance with covenants for borrowing under our bank credit facility;
o The availability of additional financing;
o Successful marketing of our services to current and new customers;
o The existence of strategic alliances, relationships and suitable
acquisitions;
o Technological, regulatory or other developments in the Company's
business;
o Shifts in market demand and other changes in the competitive
telecommunications sector;
These and other applicable risks are summarized under the caption "Risk
Factors" and elsewhere in the Company's Annual Report on Form 10-K, filed on
April 1, 2002. You should consider all of our subsequent written and oral
forward-looking statements only in light of such cautionary statements. You
should not place undue reliance on these forward-looking statements and you
should understand that they represent management's view only as of the dates we
make them.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are an integrated communications provider offering facilities-based
voice and data telecommunications services and web services primarily to small
and medium-sized businesses in 30 second and third tier markets in 12 states in
the northeastern and midwestern United States. Our offerings include local
exchange and long distance service, high-speed data and Internet services, and
web hosting and design services. Our principal competitors are incumbent local
exchange carriers, such as the regional Bell operating companies, as well as
other integrated communications providers.
20
We seek to become the leading integrated communications provider in
each of our markets by offering a single source for competitively priced, high
quality, customized telecommunications and web-based services. A key element of
our strategy has been to be one of the first integrated communications providers
to provide comprehensive network coverage in each of the markets we serve. We
are achieving this market coverage by installing both voice and data equipment
in multiple established telephone company central offices. As of September 30,
2002, we have connected 92% of our clients directly to our own switches, which
allows us to more efficiently route traffic, ensure a high quality of service
and control costs.
We, and many financial analysts, evaluate the growth of our business by
focusing on various operational data in addition to financial data. Lines in
service represent the lines sold that are now being used by our clients
subscribing to our services. Although the number of lines we service for each
client may vary, our primary focus is on the small- to medium-sized business
customer. On average, our clients have 5 lines. We plan to continue to focus on
small- to medium-sized business clients.
The table below provides selected key operational data as of:
September 30, 2002 September 30, 2001
Markets served 30 28
Number of switches-voice 26 25
Number of switches-data 63 63
Total central office collocations 530 461
Estimated addressable market
(Business lines) 5.7 million 4.9 million
Lines in service-total 492,879 295,319
Lines in service-voice 475,930 285,709
Lines in service-data 16,949 9,610
Total employees 1,615 1,751
Direct sales employees 436 562
Included in management's discussion and analysis of financial condition
and results of operations are adjusted EBITDA amounts. Adjusted EBITDA
represents earnings before interest, income taxes, depreciation and
amortization, and non-cash charges. Adjusted EBITDA is used by management and
certain investors as an indicator of a company's historical ability to service
its debt. Management believes that an increase in adjusted EBITDA is an
indicator of improved ability to service existing debt, to sustain potential
future increases in debt and to satisfy capital requirements. However, adjusted
EBITDA is not intended to represent cash flows for the period, nor has it been
presented as an alternative to either operating income, as determined by
generally accepted accounting principles, nor as an indicator of operating
performance or cash flows from operating, investing and financing activities, as
determined by generally accepted accounting principles, and is thus susceptible
to varying calculations. Adjusted EBITDA as presented may not be comparable to
other similarly titled measures of other companies. We turned adjusted EBITDA
positive in August 2002. We expect to continue to generate positive adjusted
EBITDA during the fourth quarter of 2002 and into 2003.
21
Adjusted EBITDA was the following for the period ended:
(in thousands)
Three Months Ended Nine Months Ended
September 30, June 30, September 30 September 30, September 30,
2002 2002 2001 2002 2001
---- ---- ---- ---- ----
Loss from operations $(39,353) $(324,114) $(47,947) $(396,672) $(152,720)
Non-cash adjustments:
Depreciation &
amortization 18,427 16,533 22,544 51,135 64,675
Deferred compensation 762 2,037 2,350 4,909 7,193
Management ownership
allocation charge 200 5,348 6,040 10,915 19,146
Specific bad debt
Reserves 2,816 11,800 -- 15,416 --
Other non-cash charge -- 571 -- 571 --
Restructuring costs 5,283 -- -- 5,283 --
Loss on dispositions
of assets 36 533 -- 814 801
Impairment loss on
long-lived assets 11,273 283,251 -- 294,524 --
-------- -------- --------- --------- ---------
Adjusted EBITDA $ (556) $ (4,041) $(17,013) $ (13,105) $ (60,905)
=========== ========== =========== =========== =========
During the nine months ended September 30, 2002, we increased bad debt
reserves for accounts receivable related to telecommunication carriers
negatively affected by current economic conditions, including Global Crossing,
WorldCom, and other distressed carriers. Global Crossing filed for bankruptcy on
January 28, 2002 while WorldCom filed for bankruptcy on July 21, 2002. We have
commenced legal action against AT&T for delays in payment of access revenues
owed to us. We have also increased the bad debt reserves for retail accounts
which continue to be negatively affected by current economic conditions.
During the three months ended June 30, 2002, we noted a significant
adverse change in the business climate of the company and telecommunications
industry in general. These circumstances required us to perform an interim
goodwill impairment test. As a result, we recorded an impairment charge of
$283.0 million. The amount of the impairment charge was determined utilizing a
combination of market-based methods to estimate the fair value of the assets in
accordance with SFAS No. 142. In addition, we recorded a $0.3 million charge to
write-down the value of acquired customer relationships related to the our web
hosting and design services in accordance with the provisions of SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets".
During the three months ended September 30, 2002, we identified
opportunities to optimize the use of capital and company assets and committed to
a plan of workforce reductions, closing operations in the Ann Arbor and Lansing,
Michigan market and reducing reliance on certain collocation sites through
network optimization initiatives. We reduced our workforce by 102 operational
and administrative positions. In addition, approximately 100 positions were
eliminated through normal attrition. On October 9, 2002, we notified customers
in the communities of Ann Arbor and Lansing, Michigan that we would be closing
that market.
22
In connection with the above activities, we recorded restructuring
costs of $5.3 million in the three-month period ended September 30, 2002,
comprised of employee termination benefits, contractual lease obligations and
network facility costs
In conjunction with the above described restructuring plan, we
evaluated the related long-lived assets for impairment. We recorded an
impairment charge of approximately $7.3 million for the value of unrecoverable
leasehold improvements and other general equipment that will be abandoned, which
is reported in impairment loss on long-lived assets on the Consolidated
Statement of Operations. The restructuring plan and related asset impairment
required us to evaluate for impairment our equipment held for use. It was
determined that a portion of this equipment would not be used. We recorded an
impairment charge of $4.0 million related to this equipment that will be
abandoned, which is reported in impairment loss on long-lived assets on the
Consolidated Statement of Operations.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AS COMPARED
TO SEPTEMBER 30, 2001
REVENUE
We generated $74.4 million in revenue during the three months ended
September 30, 2002. This represents a 52.6% increase compared to revenue for the
three months ended September 30, 2001, and a 1.7% increase compared to the three
months ended June 30, 2002. The increase from the same quarter a year ago is
primarily attributable to an increase in volume due to the increase in the
number of lines in service. At September 30, 2002, we had a total installed base
of 492,879 lines, as compared with 295,319 lines at September 30, 2001. The
increase in revenues was partially offset by decreases in local and long
distance usage, per-minute rates, and Federal Communications Commission (FCC)
mandated reductions for access rates. Revenue was generated principally from
local calling services, long distance services, digital subscriber lines (DSL)
and other data services, as well as e-services, including web design and hosting
services. Revenue growth for local and long distance services is principally
generated from capturing market share from other service providers. We have
benefited and continue to benefit from the declining number of competitors in
our market footprint. Revenue growth for the remainder of 2002 will also depend
on our ability to obtain and retain a significant number of customers and
selling additional value added services to our existing customers.
We expect revenue from access charges that are based on other
established telephone companies' long distance calls made by and to our clients,
and revenue from reciprocal compensation that entitles us to bill the
established telephone companies for calls in the same local calling area, placed
by their clients to our clients, to increase during the remainder of 2002 as we
increase our client base, but on a declining per unit basis. Beyond 2002, access
is expected to continue to decline on a per unit basis as the Federal
Communications Commission's benchmark for established interstate access rates
declines. Reciprocal compensation is also expected to decline beyond 2002.
The market for high-speed data communications services and Internet
access is intensely competitive. We offer data services in all of our markets.
We generate revenue from the sale of these services to end user clients in the
small and medium-sized business market segments. We price our services
competitively in relation to those of the established telephone companies and
offer combined service discounts designed to give clients incentives to buy a
portfolio of services.
23
Our churn for the three months ended September 30, 2002, of our
facilities-based business clients, increased slightly to an average of 1.6% per
month. Our churn levels continue to compare favorably to the significant churn
of clients within the telecommunications industry. We seek to minimize churn by
providing superior client care, by offering a competitively priced portfolio of
local, long distance and Internet services, by signing a significant number of
clients to multi-year service agreements, and by focusing on offering our own
facilities-based services.
NETWORK COSTS
Network costs for the three months ended September 30, 2002 were $40.3
million representing a 30.0% increase compared to network costs for the three
months ended September 30, 2001, and a 0.3% decrease compared to network costs
for the three months ended June 30, 2002. Network costs as a percentage of total
revenues were 54.1% at September 30, 2002, down from 63.5% at September 30, 2001
and 55.2% at June 30, 2002. We believe that network costs as a percentage of
revenue should continue to decline for the fourth quarter of 2002.
The increase in network costs from the same period a year ago is
consistent with the deployment of our networks and the increase in number of
lines in service. We have increased our markets from 28 to 30, added 69
collocation sites and grown lines in service approximately 66.9% to 492,879 from
295,319. The increase in network costs from the three months ended June 30, 2002
is related to the increase in total number of lines in service, offset by the
elimination of redundancies resulting from duplicate collocations acquired from
FairPoint Communications Solutions Corp. ("FairPoint").
Our network costs include:
o Leases of high-capacity digital lines that interconnect our network
with established telephone company networks;
o Leases of local loop lines which connect our clients to our network;
o Leased space in established telephone company central offices for
collocating our transmission equipment;
o Completion of local calls originated by our clients, completion of
originating (1+ calling) and terminating (inbound 800 calling) long
distance calls by our clients; and
o Leases of our inter-city network.
We lease fiber capacity in certain markets when economically justified
by traffic volume growth in order to reduce the overall cost of local transport
and reduce our reliance on the established telephone company. Fiber deployment
provides the bandwidth necessary to support substantial incremental growth and
allows us to improve gross margins and enhance the quality and reliability of
our network which strengthens our competitive advantage in the markets.
24
During the three months ended September 30, 2002, we took possession of
fiber networks in Indianapolis, Indiana and Hartford, Connecticut from Fibertech
Networks, bringing to 18 the number of markets where we have intra-city fiber
connecting our collocations. We plan to activate fiber in an additional 3
markets across our footprint. Our operational fiber network now consists of
2,030 operational route miles of intra- and inter-city fiber miles. Once
complete, our fiber network will consist of approximately 3,400 fiber miles.
GROSS PROFIT
During the three months ended September 30, 2002 and 2001, we achieved
gross profit (revenue less direct network costs) of $34.1 million, or 45.9% of
revenue, and $17.8 million, or 36.5% of revenue, respectively. This represents a
91.9% increase over the same three months in 2001. Gross profit increased 4.2%
from the three months ended June 30, 2002, from $32.8 million, or 44.8% of
revenue. We expect that our gross profit as a percentage of revenue will improve
as our revenue increases and we realize cost efficiencies in our network costs.
SELLING, GENERAL AND ADMINISTRATIE EXPENSES
Selling, general and administrative expenses for the three months ended
September 30, 2002 were $38.5 million compared to selling, general and
administrative expenses of $43.2 million and $56.6 million during the three
months ended September 30, 2001 and June 30, 2002, respectively. Excluding the
non-cash deferred compensation and management ownership allocation charges, the
selling, general and administrative expenses increased from $34.8 million during
the three months ended September 30, 2001 to $37.5 million during the three
months ended September 30, 2002. For the three months ended June 30, 2002,
selling, general and administrative expenses excluding non-cash deferred
compensation and management allocation was $49.2 million.
Excluding non-cash deferred compensation and management ownership
allocation charges, the increase in selling, general and administrative expenses
from the same period a year ago resulted primarily from the growth of our
operations and ongoing back office infrastructure enhancements and an increase
in our bad debt reserves, offset by cost containment and business streamlining
initiatives commenced in the three months ended September 30, 2002 and general
workforce reductions as more fully explained under Restructuring Costs later in
our discussion and analysis. The decrease in selling, general and administrative
expenses over the three months ended June 30, 2002 was $11.7 million or 23.7%
and was primarily due to the increase in bad debt reserves in the three months
ended June 30, 2002. We increased our bad debt reserves by $2.8 million in the
three months ended September 30, 2002 versus $11.8 million in the three months
ended June 30, 2002 for accounts that continued to be negatively impacted by
current economic conditions. Excluding these charges, selling, general and
administrative expenses decreased $2.7 million or approximately 7.2% for the
reasons noted previously.
The number of employees decreased to 1,615 as of September 30, 2002
from 1,751 as of September 30, 2001, and from 1,801 as of June 30, 2002. As of
September 30, 2002, the number of direct sales employees was 436. This
represents a decrease of 126 employees from 562 as of September 30, 2001 and a
decrease of 105 employees from 541 as of June 30, 2002. A significant part of
this change occurred in September 2002 when we eliminated 102 positions and is
more fully explained under Restructuring Costs later in our discussion and
analysis.
Our selling, general and administrative expenses include:
o Costs associated with sales and marketing, client care, billing,
corporate administration,personnel and network maintenance;
o Network maintenance costs;
o Administrative overhead and office lease expense; and
o Bad debt expense.
We expect selling, general and administrative expenses to decline
through the remainder of 2002 as our economies of scale improve and cost
containment and network optimization initiatives commenced by the company during
the three months ended September 30, 2002 are realized.
25
MANAGEMENT OWNERSHIP ALLOCATION CHARGE AND DEFERRED COMPENSATION
Upon consummation of our initial public offering, we were required by
generally accepted accounting principles to record a $119.9 million increase in
the assets of Choice One Communications L.L.C. allocated to management as an
increase in additional paid-in capital, with a corresponding increase in
deferred compensation. During the three months ended September 30, 2002 and
2001, we amortized $0.2 million and $6.0 million, respectively, of the deferred
charge. Amortization expense declined from the same quarter a year ago due to
the expiration of the period over which we may repurchase the securities of
certain members of management. The deferred compensation related to securities
of management is now fully amortized.
We also recognized $0.8 million and $2.4 million of non-cash deferred
compensation amortization during the three months ended September 30, 2002 and
2001, respectively. Amortization expense is expected to further decrease in the
three months ended December 31, 2002 as the amount related to the issuance of
restricted shares to the employees of the former US Xchange is now fully
amortized. Deferred compensation was recorded in connection with membership
units of Choice One Communications L.L.C. sold to certain management employees,
grants to employees under our 1998 Employee Stock Option Plan, and the issuance
of restricted shares to the employees of the former US Xchange in August 2000.
RESTRUCTURING COSTS
During the three months ended September 30, 2002, we identified
opportunities to optimize the use of capital and company assets and committed to
plan of workforce reductions, closing operations in our Ann Arbor and Lansing,
Michigan market and reducing reliance on certain collocation sites.
On September 5, 2002, we announced that we had reduced our workforce by
102 operational and administrative positions. In addition, approximately 100
positions were eliminated through normal attrition.
On October 9, 2002, we notified our customers in the communities of Ann
Arbor and Lansing, Michigan that we would be closing that market. We have
stopped selling services to new clients in this market and have notified
existing customers of the decision and the approximate time remaining until
services are terminated, which is currently estimated as December 1, 2002. We
will redeploy certain equipment from the market to other markets to optimize our
network assets and to minimize future capital expenditures. Revenue and
operating results of the Ann Arbor and Lansing, Michigan market are not
significant to our consolidated results of operations. Closure of the market
will have an immaterial impact on revenue and have a positive effect on EBITDA
in 2003 as the closing of the market is not expected to be completed until
December 2002.
In connection with the above activities, we recorded restructuring
costs of $5.3 million in the three-month period ended September 30, 2002,
comprised of employee termination benefits of $0.6 million, contractual lease
obligations of $3.4 million and network facility costs of $1.3 million. At
September 30, 2002, approximately $0.1 million of the restructuring costs had
been paid and it is anticipated that the remaining charges will be liquidated
within the next calendar year, except for contractual lease obligations that
extend beyond one year.
26
IMPAIRMENT LOSS ON LONG-LIVED ASSETS
In conjunction with the above described restructuring plan, we
evaluated the related long-lived assets for impairment. We recorded an
impairment charge of approximately $7.3 million for the value of unrecoverable
leasehold improvements and other general equipment that will be abandoned, which
is reported in impairment loss on long-lived assets on the Consolidated
Statement of Operations. The restructuring plan and related asset impairment
required us to evaluate for impairment our equipment held for use. It was
determined that a portion of this equipment would not be used. We recorded an
impairment charge of $4.0 million related to this equipment that will be
abandoned, which is reported in impairment loss on long-lived assets on the
Consolidated Statement of Operations.
DEPRECIATION AND AMMORTIZATION
Depreciation and amortization for the three months ended September 30,
2002 was $18.4 million. This represents an 18.3% decrease and an 11.5% increase
compared to the three months ended September 30, 2001 and June 30, 2002,
respectively. The decrease from the same quarter a year ago results from the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" which requires
us to discontinue the systematic amortization of goodwill and intangible assets
with indefinite lives. Amortization from goodwill was $8.3 million during the
three months ended September 30, 2001. This decrease was somewhat offset by the
increase in depreciation expense related to the deployment of our networks and
initiation of service in our markets in 2001 and early 2002. The increase in
depreciation from the three months ended June 30, 2002 was also related to
network deployments as well as other asset acquisitions being placed in service
during the three-month periods ended March 31, 2002 and June 30, 2002. Our
depreciation and amortization expense includes depreciation of switch related
equipment, non-recurring charges and equipment collocated in established
telephone company central offices, network infrastructure equipment, information
systems, furniture and fixtures, indefeasible rights to use fiber and
amortization of customer relationships.
INTEREST AND INCOME
Interest expense for the three months ended September 30, 2002 and 2001
was approximately $15.5 million and $13.8 million, respectively. Interest
expense for the three months ended June 30, 2002 was $15.0 million. Interest
expense includes interest payments on borrowings under our senior credit
facility and subordinated notes, amortization of deferred financing costs
related to such facilities, amortization of the discount on the subordinated
notes and commitment fees on the unused senior credit facility. Interest expense
on the subordinated notes is payable in-kind (PIK) through November 2006.
Interest expense increased from the same quarter a year ago due to an
increase in the amount of borrowings, offset by favorable declines in LIBOR
rates that impacted our borrowing rates. We expect interest expense to increase
over the next quarter due to the borrowings under the Term C loan that closed on
September 13, 2002. Cash interest expense was $10.1 million for the three months
ended September 30, 2002 as compared to $7.0 million for the three months ended
September 30, 2001 and $7.7 million for the three months ended June 30, 2002.
The increase in cash interest expense is a result of our amended credit
agreement that requires interest be paid monthly on the Term A, Term B and
revolver loans. Cash interest expense for the fourth quarter of 2002 is expected
to be $7.6 million.
Interest income for the three months ended September 30, 2002 and 2001
was approximately $0.1 and $0.8 million, respectively. Interest income for the
three months ended June 30, 2002 was $76,000. Interest income results from the
investment of cash and cash equivalents, mainly from the cash proceeds generated
from the borrowings under our senior credit and subordinated debt facilities. We
expect interest income to increase slightly in the fourth quarter of 2002 as a
result of higher cash balances and stable market interest rates.
27
INCOME TAXES
We have not generated any taxable income to date and do not expect to
generate taxable income in the next few years. Use of our net operating loss
carryforwards, which begin to expire in 2021, may be subject to limitations
under Section 382 of the Internal Revenue Code of 1986, as amended. We have
recorded a full valuation allowance on the deferred tax asset, consisting
primarily of net operating loss carryforwards, due to the uncertainty of its
realizability.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AS COMPARED
TO SEPTEMBER 30, 2001
REVENUE
We generated $218.2 million in revenue during the nine months ended
September 30, 2002. This represents an increase of $92.8 million, or 74.0%, as
compared to revenues of $125.4 million for the nine months ended September 30,
2001. The increase from the same period a year ago is primarily attributable to
an increase in volume due to an increase in the number of lines in service. At
September 30, 2002, we had a total installed base of 492,879 lines, as compared
with 295,319 lines at September 30, 2001.
Revenue was generated principally from local calling services, long
distance services, DSL and other data services, as well as e-services, including
web design and hosting services. Revenue growth for local and long distance
services is principally generated from capturing market share from other service
providers. We have benefited and continue to benefit from the declining number
of competitors in our market footprint. Revenue growth for the remainder of 2002
will also depend on our ability to obtain and retain a significant number of
customers, and selling additional value added services to our existing
customers.
We expect revenue from access charges that are based on other incumbent
telephone companies' long distance calls made by and to our clients, and revenue
from reciprocal compensation that entitles us to bill the established telephone
companies for calls in the same local calling area, placed by their clients to
our clients, to increase during the remainder of 2002 as we increase our client
base, but on a declining per unit basis. Beyond 2002, access is expected to
continue to decline on a per unit basis as the Federal Communications
Commission's benchmark for established interstate access rates declines.
Reciprocal compensation is also expected to decline beyond 2002.
The market for high-speed data communications services and Internet
access is intensely competitive. We offer data services in all of our markets.
We generate revenue from the sale of these services to end user clients in the
small and medium-sized business market segments. We price our services
competitively in relation to those of the established telephone companies and
offer combined service discounts designed to give clients incentives to buy a
portfolio of services.
Our churn for the nine months ended September 30, 2002, of our
facilities-based business clients, has remained relatively stable at
approximately 1.4% per month. Our churn levels continue to compare favorably to
the significant churn of clients within the telecommunications industry. We seek
to minimize churn by providing superior client care, by offering a competitively
priced portfolio of local, long distance and Internet services, by signing a
significant number of clients to multi-year service agreements, and by focusing
on offering our own facilities-based services.
28
NETWORK COSTS
Network costs for the nine months ended September 30, 2002 were $122.9
million representing a 42.5% increase compared to network costs for the nine
months ended September 30, 2001. Network costs as a percentage of total revenues
decreased from 69.0% at September 30, 2001 to 56.3% at September 30, 2002. We
believe that network costs as a percentage of revenue should continue to decline
in the last quarter of 2002 and first quarter of 2003.
The increase in network costs from the same period a year ago is
consistent with the deployment of our networks and the increase in number of
lines in service. We have increased our markets from 28 to 30, added 69
collocation sites and grown lines in service approximately 66.9% to 492,879 from
295,319.
Our network costs include:
o Leases of high-capacity digital lines that interconnect our network
with established telephone company networks;
o Leases of local loop lines which connect our clients to our network;
o Leased space in established telephone company central offices for
collocating our transmission equipment;
o Completion of local calls originated by our clients, completion of
originating (1+ calling) and terminating (inbound 800 calling) long
distance calls by our clients; and
o Leases of our inter-city network.
We lease fiber capacity in certain markets when economically justified
by traffic volume growth in order to reduce the overall cost of local transport
and reduce our reliance on the established telephone company. Fiber deployment
provides the bandwidth necessary to support substantial incremental growth and
allows us to improve gross margins and enhance the quality and reliability of
our network which strengthens our competitive advantage in the markets.
We have currently taken possession of fiber networks, using intra-city
fiber to connect our collocations, in 18 markets. We plan to activate fiber in
an additional 3 markets across our footprint. Our operational fiber network now
consists of 2,030 operational route miles of intra- and inter-city fiber miles.
Once complete, our fiber network will consist of approximately 3,400 fiber
miles.
29
GROSS PROFIT
During the nine months ended September 30, 2002 and 2001, we achieved
gross profit (revenue less direct network costs) of $95.3 million, or 43.7% of
revenue, and $38.8 million, or 31.0% of revenue, respectively. This represents
an increase of $56.5 million, or approximately 145.4%, over the same nine months
in 2001. We expect that our gross profit as a percentage of revenue will improve
as our revenue increases and we realize cost efficiencies in our network costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the nine months ended
September 30, 2002 were $140.2 million compared to selling, general and
administrative expenses of $126.1 million during the nine months ended September
30, 2001, respectively. Excluding the non-cash deferred compensation and
management ownership allocation charges, the selling, general and administrative
expenses increased from $99.7 million during the nine months ended September 30,
2001 to $124.4 million during the nine months ended September 30, 2002. This
represents an increase of $24.7 million or approximately 24.7%.
Excluding non-cash deferred compensation and management ownership
allocation charges, the increase in selling, general and administrative expenses
from the same period a year ago resulted primarily from the growth of our
operations, ongoing back office infrastructure enhancements and related changes
in the number of employees. During this period, salary, commissions and benefits
increased approximately $6.5 million, directly related to headcount increases
prior to our reduction of 102 positions in September 2002. The acquisition of
assets from Fairpoint Communications Solutions Corp. ("Fairpoint") also resulted
in incremental expenses of $3.3 million in 2002. These increases were offset by
decreases in other expense items including outsourcing costs of $1.3 million as
we brought access billing functions in-house.
We also increased the bad debt reserves during the nine months ended
September 30, 2002 for accounts receivable negatively affected by current
economic conditions, by $14.9 million. This includes accounts related to
telecommunications carriers including Global Crossing, Worldcom, and other
distressed carriers. It also includes accounts related to retail customers that
continue to be negatively affected by current economic conditions. Global
Crossing filed for bankruptcy on January 28, 2002 and WorldCom filed for
bankruptcy on July 21, 2002. Accounts receivable related to the periods before
those dates may be uncollectible due to the bankruptcy protection. We have fully
reserved this amount. We have also commenced legal action against AT&T for
delays in the payment of access revenues owed us.
Our selling, general and administrative expenses include:
o Costs associated with sales and marketing, client care, billing,
corporate administration,personnel and network maintenance;
o Network maintenance costs;
o Administrative overhead and office lease ; and
o Bad debt expense.
We expect selling, general and administrative expenses to decline
through the remainder of 2002 as our economies of scale improve and cost
containment and network optimization initiatives commenced by the company during
the three months ended September 30, 2002 are realized.
30
MANAGEMENT OWNERSHIP ALLOCATION CHARGE AND DEFERRED COMPENSATION
Upon consummation of our initial public offering, we were required by
generally accepted accounting principles to record a $119.9 million increase in
the assets of Choice One Communications L.L.C. allocated to management as an
increase in additional paid-in capital, with a corresponding increase in
deferred compensation. During the nine months ended September 30, 2002 and 2001,
we amortized $10.9 million and $19.1 million, respectively, of the deferred
charge. Amortization expense declined from the same nine months a year ago due
to the expiration of the period over which we may repurchase the securities of
certain members of management. The deferred compensation related to securities
of management is now fully amortized.
We also recognized $4.9 million and $7.2 million of non-cash deferred
compensation amortization during the nine months ended September 30, 2002 and
2001, respectively. Deferred compensation was recorded in connection with
membership units of Choice One Communications L.L.C. sold to certain management
employees, grants to employees under our 1998 Employee Stock Option Plan, and
the issuance of restricted shares to the employees of the former US Xchange in
August 2000.
RESTRUCTURING COSTS
During the three months ended September 30, 2002, we identified
opportunities to optimize the use of capital and company assets and committed to
plan of workforce reductions, closing operations in our Ann Arbor and Lansing,
Michigan market and reducing reliance on certain collocation sites.
On September 5, 2002, we announced that we had reduced our workforce by
102 operational and administrative positions. In addition, approximately 100
positions were eliminated through normal attrition.
On October 9, 2002, we notified our customers in the communities of Ann
Arbor and Lansing, Michigan that we would be closing that market. We have
stopped selling services to new clients in this market and have notified
existing customers of the decision and the approximate time remaining until
services are terminated, which is currently estimated as December 1, 2002. We
will redeploy certain equipment to other markets to optimize our network assets
and to minimize future capital expenditures. Revenue and operating results of
the Ann Arbor and Lansing, Michigan market are not significant to our
consolidated results of operations. Closure of the market will have an
immaterial impact on revenue and have a positive effect on EBITDA in 2003 as the
closing of the market is not expected to be completed until December 2002.
In connection with the above activities, we recorded restructuring
costs of $5.3 million in the three-month period ended September 30, 2002,
comprised of employee termination benefits of $0.6 million, contractual lease
obligations of $3.4 million and network facility costs of $1.3 million. At
September 30, 2002, approximately $0.1 million of the restructuring costs had
been paid and it is anticipated that the remaining costs will be liquidated
within the next calendar year, except for contractual lease obligations that
extend beyond one year.
IMPAIRMENT LOSS ON LONG-LIVED ASSETS
In conjunction with the above described restructuring plan, we
evaluated the related long-lived assets for impairment. We recorded an
impairment charge of approximately $7.3 million for the value of unrecoverable
leasehold improvements and other general equipment that will be abandoned, which
is reported in impairment loss on long-lived assets on the Consolidated
Statement of Operations. The restructuring plan and related asset impairment
required us to evaluate for impairment our equipment held for use. It was
determined that a portion of this equipment would not be used. We recorded an
impairment charge of $4.0 million related to this equipment that will be
abandoned, which is reported in impairment loss on long-lived assets on the
Consolidated Statement of Operations.
During the three-month period ended June 30, 2002, we noted a
significant adverse change in the business climate of the company and
telecommunications industry in general. These circumstances required us to
perform an interim goodwill impairment test. As a result, we recorded an
impairment charge of $283.0 million. The amount of the impairment charge was
determined utilizing a combination of market-based methods to estimate the fair
value in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets." In
addition, we recorded a $0.3 million charge to write-down the value of acquired
customer relationships related to the our web hosting and design services in
accordance with the provisions of SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets".
31
DEPRECIATION AND AMMORTIZATION
Depreciation and amortization for the nine months ended September 30,
2002 was $51.1 million. This represents a decrease of $15.2 million, or 23.5%,
compared to the nine months ended September 30, 2001. The decrease from the same
period a year ago results from the adoption of SFAS No. 142 "Goodwill and Other
Intangible Assets" which requires us to discontinue the systematic amortization
of goodwill and intangible assets with indefinite lives. Amortization from
goodwill was $24.7 million during the nine months ended September 30, 2001. This
decrease was partially offset by the increase in depreciation expense related to
the deployment of our networks and initiation of service in our markets as well
as other asset acquisitions being placed in service in 2001 and the first three
quarters of 2002. Our depreciation and amortization expense includes
depreciation of switch related equipment, non-recurring charges and equipment
collocated in established telephone company central offices, network
infrastructure equipment, information systems, furniture and fixtures,
indefeasible rights to use fiber and amortization of customer relationships.
INTEREST EXPENSE AND INCOME
Interest expense for the nine months ended September 30, 2002 and 2001
was approximately $44.6 million and $42.4 million, respectively. Interest
expense includes interest payments on borrowings under our senior credit
facility and subordinated notes, amortization of deferred financing costs
related to such facilities, amortization of the discount on the subordinated
notes and commitment fees on the unused senior credit facility. Interest expense
on the subordinated notes is PIK through November 2006.
Interest expense increased from the same nine months a year ago due to
increases in the amount of borrowings, offset by favorable declines in LIBOR
rates that impacted our borrowing rates We expect interest expense to increase
over the next quarter due to the borrowings under the Term C loan that closed on
September 13, 2002. Cash interest expense was $24.7 million for the nine months
ended September 30, 2002 as compared to $40.7 million for the nine months ended
September 30, 2001. Cash interest expense decreased from the same period a year
ago as a result of the rollover of the subordinated notes in November 2001 for
which interest became payable in-kind.
Interest income for the nine months ended September 30, 2002 and 2001
was approximately $0.2 and $4.6 million, respectively. Interest income results
from the investment of cash and cash equivalents, mainly from the cash proceeds
generated from the borrowings under our senior credit and subordinated debt
facilities. Cash and cash equivalents, restricted cash and investments on which
interest income is earned were significantly lower during the nine months ended
September 30, 2002 as compared to the same period a year ago. We expect interest
income to increase slightly in the fourth quarter of 2002 as a result of higher
cash balances and stable market interest rates.
INCOME TAXES
We have not generated any taxable income to date and do not expect to
generate taxable income in the next few years. Use of our net operating loss
carryforwards, which begin to expire in 2021, may be subject to limitations
under Section 382 of the Internal Revenue Code of 1986, as amended. We have
recorded a full valuation allowance on the deferred tax asset, consisting
primarily of net operating loss carryforwards, due to the uncertainty of its
realizability.
32
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, we had $42.3 million in cash and cash
equivalents available. We also have available funding of $4.375 million under
our Term D loan facility, beginning on December 31, 2002 in five equal quarterly
installments This funding may be drawn in five equal quarterly installments. At
September 30, 2002, we are in compliance with all covenants under our Credit
Agreement.
On September 13, 2002, we completed new debt financing of $48.875
million, a waiver of the default of the revenue covenant at June 30, 2002 from
our lending institutions, and an amendment to our existing senior credit
facility. Morgan Stanley Capital Partners and the lenders of our subordinated
notes provided us with a $44.5 million Senior Secured Term Loan Facility (the
Term C loan). Additionally, certain of our existing senior lenders have made
available a separate term loan facility of $4.375 million (the Term D loan) to
be drawn in five equal quarterly installments commencing on December 31, 2002
and maturing on February 1, 2009. We intend to use the net proceeds from these
loans for general corporate purposes.
The following is a summary of the principal terms of the new
facilities:
o Provides a Term C loan facility of $44.5 million. Such loan is
secured on an equivalent basis with the same collateral that secures
the existing senior credit facility. Interest on this term loan
accrues at LIBOR plus 5.75% or at a base rate, as defined in the
Credit Agreement, plus 4.75%, at our option. Interest on the Term C
loan that would otherwise be payable from September 13, 2002 through
March 31, 2004 will accrue monthly and be added to the principal
amount of the loan (the "Term C Loan Deferred Interest"). Thereafter,
interest accruing on the Term C loan is payable in cash at the end of
each month. All Term C Loan Deferred Interest and principal amount of
the Term C loan is due at maturity on March 31, 2009. The Term C loan
was drawn down in full at closing of the Credit Agreement.
o Provides a Term D loan facility in an aggregate principal
amount of $4.375 million and is available to us in five equal
quarterly installments commencing on December 31, 2002. Interest on
the Term D loans will accrue at the same rate applicable to the
outstanding revolving loans and Term A loans under the Credit
Agreement. The applicable interest rate is determined by a grid and is
tied to our leverage ratio as calculated pursuant to the terms of the
Credit Agreement. Initially, the applicable interest rate will be
LIBOR plus 4.00% or the base rate, as defined in the Credit Agreement,
plus 3.00%, at our option. Interest accruing on the Term D loans is
payable in cash at the end of each month. The outstanding principal
under Term D loan shall be repaid quarterly commencing on June 30,
2004 through September 30, 2008 at the rate of 0.25 % of the aggregate
principal amount, then at the rate of 47.5% on December 30, 2008. Any
remaining unpaid principal and accrued interest is due in full at the
maturity date of January 31, 2009.
33
In addition to establishing the Term C loan and Term D loan facilities
as described above, the prior terms of our credit agreement were amended to
provide for, among other things, the following:
o Deferring principal payments originally due on December 31, 2003 and
March 31, 2004 on the outstanding Term A and Term B loans until
maturity at July 31, 2008 and January 31, 2009, respectively.
o Amending a financial covenant to require us to have cash and available
committed financing of not less than $10,000,000 at any time prior to
July 1, 2004.
o Amending a financial covenant to limit us to maximum annual capital
expenditures of $35 million, $39 million, $43 million, $52 million, $59
million, $66 million and $74 million during each fiscal year ending
December 31, 2002 through December 31, 2008, respectively.
o Beginning with the quarter ended September 30, 2004, requiring us to
comply with amended financial covenants pertaining to our leverage
ratio, fixed charges coverage ratio and interest coverage ratio until
the final maturity of the outstanding loans.
o Eliminating minimum revenue and maximum EBITDA losses/minimum EBITDA
financial covenants for all periods.
o Permitting certain business and operating practices as defined in the
Credit Agreement.
On September 13, 2002, we also entered into a Third Amendment to the
Bridge Agreement with Morgan Stanley Senior Funding, Inc., as administrative
agent, Wachovia Investors, Inc. and CIBC Inc. (the "Bridge Agreement
Amendment"). The Bridge Agreement Amendment, among other things:
o Permits us to incur the additional debt under the Credit Agreement
comprised of the Term C and Term D loan facilities.
o Extends by one year to November 9, 2006 the period during which we may
pay interest in-kind, rather than in cash, on the subordinated notes
issued under the Bridge Agreement.
o Limits the maximum annual capital expenditures that the Company and its
subsidiaries may make to the same amounts permitted under the amended
Credit Agreement.
Our cash utilization for the three months ended September 30, 2002,
excluding proceeds received from the closing of the Term C loan, was $18.6
million as compared to $17.8 million for the three months ended June 30, and
$32.8 million for the three months ended March 31, 2002. The increase from the
second quarter was primarily due to a planned increase in capital expenditures
of $2.1 million, offset by changes in other assets and liabilities of $1.6
million.
We have experienced net losses applicable to common stockholders of
$66.0 million, $70.6 million and $349.8 million during the three-month periods
ended September 30, 2002, September 30, 2001 and June 20, 2002. We turned
positive adjusted EBITDA in August 2002. Our viability is dependent upon our
ability to continue to execute under our business strategy and to begin to
generate positive cash flows from operations during 2003, and to remain in
compliance with our covenants under our credit facilities. The execution of our
business strategy requires obtaining and retaining a significant number of
customers, and generating significant and sustained growth in our operating cash
flows to be able to meet our debt service obligations and fund working capital
and capital expenditures.
34
Our cash and cash equivalents will decline during the remainder of 2002
in accordance with our plan. However, we believe that our cash flow from
operations and the proceeds of our new debt financing will be sufficient to
enable us to execute our business strategy until such time as we have positive
cash flow from operations to fund working capital, capital expenditures and debt
service requirements. We can make no assurances, however, that our estimates
with respect to the occurrence and timing of positive cash flows will be
accurate. Accordingly, it may be necessary for us to seek additional sources of
capital, which may include capital lease financing, private equity, and other
sources of funding, for the successful execution of our business strategy. Our
estimates of funding may be inaccurate due to a variety of factors including
delay in timely collection of amounts owed to us, regulatory changes, changes in
technology, changing conditions within the industry and general economy,
increased competition in price and service, changes in number of customers and
penetration of new services, and changes in cost of our networks in each of our
markets. Our collections from interexchange carriers and established telephone
companies have been slower than those from end-users. Currently, we have
commenced a legal action against AT&T for delays in access payments owed to us.
Due to the uncertainty of all of these factors, actual funding available from
operations and other sources may vary from expected amounts, possibly to a
material degree, and such variations could affect our funding needs and could
result in a default under our credit facilities.
We cannot make any assurances that we would be successful in obtaining
additional funding, if needed or advisable, on favorable terms or at all. In
addition, financing in the form of equity could result in dilution to the common
stockholders. In light of current adverse conditions in the general economy and
specifically the telecommunications industry, it likely will be difficult to
obtain public/private financing, bank financing, capital lease or vendor
financing to continue funding our business. Failure to raise sufficient funds,
as and when needed or advisable, may require us to modify, delay or abandon some
or all of our future expenditures with respect to our business strategy, engage
in asset sales or pursue other alternatives designed to enhance our liquidity or
obtain relief from our obligations.
Our failure to comply with the covenants and restrictions contained in
our senior credit facility and subordinated note agreements could lead to
default under those agreements. If such default were to occur, our lenders could
declare all amounts owed to them immediately due and payable. If that event
should occur, we can make no assurances that we would be able to make payments
on our indebtedness, meet our working capital or capital expenditure
requirements, or that we would be able to obtain additional financing, any of
which would have a material adverse effect on our business, financial condition
and results of operations.
35
LISTING ON THE NASDAQ NATIONAL MARKET
Our common stock is currently traded on the Nasdaq National Market. For
continued listing on the National Market, Nasdaq requires, among other things,
that listed securities maintain a minimum bid price, minimum stockholders'
equity and minimum market value of publicly held shares. By letter dated June
28, 2002, Nasdaq advised us that we were not in compliance with the National
Market's continued listing standards because our stock price had closed below
$1.00 per share for 30 consecutive trading days. The letter gave us 90 days, or
until September 26, 2002, to regain compliance or our stock would be de-listed
from the Nasdaq National Market. By letter dated August 21, 2002, Nasdaq advised
us that we did not meet the Nasdaq National Market's minimum stockholders'
equity requirement. By letter dated September 30, 2002, Nasdaq informed us that
we had not regained compliance with the minimum stock price nor the minimum
stockholders' equity requirement and that our stock would be de-listed from the
Nasdaq National Market.
On October 4, 2002, we requested a hearing before the Nasdaq Listings
Qualifications Panel. By letter dated October 7, 2002, Nasdaq notified us that a
hearing is scheduled for November 14, 2002. Our stock continues to trade on the
Nasdaq National Market, pending the outcome of the hearing. There is no
guarantee that we will prevail at the November 14 hearing. If we do not prevail
at the hearing, the stock may be traded on the Nasdaq SmallCap Market or the OTC
Bulletin Board. Among other consequences, a move from the Nasdaq National Market
may cause reduced liquidity in the trading market for our common stock and
difficulty in obtaining future financing.
FINANCING FACILITIES
As of September 30, 2002, we have borrowed $394.5 million under our
senior credit facility. At such date, there was $125.0 million outstanding under
the Term A loan, $125.0 million outstanding under the Term B loan, $44.5 million
outstanding under the Term C loan, and $100.0 million outstanding under the
revolving portion. The senior credit facility, which is secured by liens on
substantially all of our and our subsidiaries' assets and a pledge of our
subsidiaries' common stock, contains covenants and events of default that are
customary for credit of this nature. We were in compliance with the covenants
under our senior credit facility for the three months ended September 30, 2002.
As of September 30, 2002, we had principal borrowings of $190.0
million, excluding the discount of $2.9 million and interest payable in kind of
$9.9 million in subordinated notes, which is subordinated to the senior credit
facility. The interest expense on the subordinated notes is PIK at a fixed rate
of 13.0%, accreting to principal semi-annually, until November 2006. Thereafter,
until maturity on November 9, 2010, interest will be payable in cash quarterly.
During the three months ended June 30, 2002, $11.7 million in PIK interest
accreted to principal. The subordinated notes contain covenants related to
capital expenditures and events of default that are similar to those within our
senior credit facility.
36
CASH FLOWS
We have incurred significant operating and net losses since our
inception. We generated positive adjusted EBITDA during August and September
2002. While we expect to continue to generate positive adjusted EBITDA, we
expect to continue to have operating losses as we penetrate our markets. As of
September 30, 2002, we had an accumulated deficit of $944.2 million. Net cash
used for operating activities was approximately $50.0 million and $101.2 million
for the nine months ended September 30, 2002 and 2001, respectively. The net
cash used for operating activities during the nine months ended September 30,
2002 and 2001 was primarily due to operating losses incurred while we grew our
client base.
Net cash provided by financing activities was $96.9 million and $25.5
million for the nine months ended September 30, 2002 and 2001, respectively. Net
cash provided by financing activities for the nine months ended September 30,
2002 was related to borrowings under the senior credit facility, including
financing under the Term C loan. Net cash provided by financing activities for
the nine months ended September 30, 2001 was also related to borrowings under
the senior credit facility. Funds received were used for general corporate
purposes.
Net cash used in investing activities was $19.0 million and $40.0
million for the nine months ended September 30, 2002 and 2001, respectively. Net
cash used in investing activities for the nine months ended September 30, 2002
related to capital expenditures offset slightly by the proceeds from the sale of
non-essential corporate assets. Net cash used in investing activities for the
nine months ended September 30, 2001 related to capital expenditures, the
maturity of short term investments and the release of restricted cash for the
quarterly interest payments on the subordinated debt.
CAPITAL REQUIREMENTS
Capital expenditures were $20.0 million and $66.0 million for the nine
months ended September 30, 2002 and 2001, respectively. We expect that our
capital expenditures will decrease slightly for the fourth quarter of 2002 and
will remain well below the level of 2001. The actual amount and timing of our
future capital requirements may differ materially from our estimates as a result
of the demand for our services and regulatory, technological and competitive
developments, including new opportunities in the industry.
SIGNIFICANT ACCOUNTING POLICIES
Our significant accounting policies, judgments and estimates include
those relating to revenue recognition, the allowance for doubtful accounts and
acquired intangibles.
General. The preparation of the consolidated financial statements requires
management to make estimates and judgments that affect the reported elements of
assets, liabilities, revenue and expenses and disclosure of contingent assets
and liabilities. On an on-going basis, management evaluates the estimates,
including those related to bad debts and income taxes. Management bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for judgments about carrying values of assets and liabilities. Actual
results could differ from these estimates.
37
Revenue recognition. Revenue from monthly recurring charges, enhanced features
and usage is recognized in the period in which service is provided. Deferred
revenue represents advance billings for services not yet provided. Such revenue
is deferred and recognized in the period in which service is provided.
Activation charges and the related direct costs are initially deferred and
recognized as revenue and expense over the average life of a customer. The
portion of activation costs that exceeds activation revenue is recognized in the
current period as expense. We recognize revenue from switched access and
reciprocal compensation based on management's best estimate of its
collectibility being reasonably assured. Certain judgments in measuring revenue
may affect our results. Revenue results may be difficult to predict, and any
shortfall in revenue or delay in recognizing revenue could cause our operating
results to vary significantly and could result in future operating losses.
Allowance for doubtful accounts. We maintain an allowance for doubtful accounts
for estimated losses resulting from the inability of our customers and
interexchange carriers to make the required payments. If the financial condition
of our customers and the interexchange carriers were to further deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required resulting in additional expense to us and affecting
our results of operations.
Acquired intangibles. Our business acquisitions have resulted in intangible
assets which affect the amount of future period amortization expense and
possible impairment expense that we may incur. The determination of the value,
and any subsequent impairment, of such intangible assets requires management to
make estimates and assumptions that affect our consolidated financial
statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets". We adopted this standard on January 1, 2002. Under SFAS No.
142, goodwill and acquired intangible assets with indefinite lives will no
longer be amortized but will be subject to at least an annual assessment for
impairment through the application of a fair value-based test. We completed the
required impairment evaluation of goodwill in conjunction with the adoption of
SFAS No. 142 during the three-month period ended March 31, 2002. Based on an
analysis that considered the future cash flows of the company and market
capitalization information, the evaluation noted no impairment of goodwill at
that time. During the three months ended June 30, 2002, we noted a significant
adverse change in the business climate of the company and telecommunications
industry in general. These circumstances required us to perform an interim
goodwill impairment test. As a result, we recorded an impairment charge of
$283.0 million. The amount of the impairment charge was determined utilizing a
combination of market-based methods to estimate the fair value in accordance
with SFAS No. 142. In addition, we recorded a $0.3 million charge to write-down
the value of acquired customer relationships related to the our web hosting and
design services in accordance with the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets".
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This standard addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The standard is effective for
fiscal years beginning after June 15, 2002. We expect to adopt this standard
effective January 1, 2003. We do not expect the adoption of SFAS No. 143 to have
a material impact on the company's financial statements or results of
operations.
38
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This standard amends Emerging
Issue Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity". This
statement requires that a liability for costs associated with an exit or
disposal activity be recognized when the liability is incurred, rather than when
an entity commits to an exit plan. The standard also established the use of fair
value for the measurement of exit liabilities. The standard is effective for
exit or disposal activities initiated after December 31, 2002, with early
application encouraged. We expect to adopt this standard effective January 1,
2003. We do not expect the adoption of SFAS No. 146 to have a material impact on
the company's financial statements or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 2002, the carrying value of our debt obligations,
excluding capital lease obligations, was $585.2 million and the fair value of
those obligations was $629.1 million. A hypothetical decrease of approximately
100 basis points from prevailing interest rates at September 30, 2002, would
have resulted in an increase in fair value of long-term debt by approximately
$20.2 million.
Also, a hypothetical increase of approximately 100 basis points from
prevailing interest rates at September 30, 2002, would have resulted in an
approximate increase in cash required for interest on variable rate debt during
the next two fiscal years of $2.1 million per year, declining to $1.9, $1.6 and
$1.0 million in the third, fourth and fifth years, respectively.
As a result of our operating and financing activities, we are exposed
to changes in interest rates that may adversely affect our results of operations
and financial position. In seeking to minimize the risks and/or costs associated
with such activities, we may enter into derivative contracts. However, we do not
use derivative financial instruments for speculative purposes. Interest rate
swaps were employed as a requirement under the Company's Second Amended and
Restated Credit Agreement. The Third Amended and Restated Credit Agreement does
not have such a requirement. This agreement does prohibit the Company from
entering into any new interest rate swap, collar, cap, floor or forward rate
agreements without the prior written consent of the lenders. Interest rate swap
agreements are used to reduce our exposure to risks associated with interest
rate fluctuations. By their nature, these instruments would involve risk,
including the risk of nonperformance by counterparties, and our maximum
potential loss may exceed the amount recognized in our balance sheet. We attempt
to control our exposure to counterparty credit risk through monitoring
procedures and by entering into multiple contracts.
At September 30, 2002, we had interest rate swap agreements for a
notional amount of $187.5 million. Based on the fair value of the interest rate
swaps at September 30, 2002, it would have cost us $20.1 million to terminate
the agreements. A hypothetical decrease of 100 basis points in the swap rate
would have increased the cost to terminate these agreements by approximately
$4.6 million.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
Based on their evaluation within 90 days prior to the date of the
filing of this Quarterly Report on Form 10-Q, the principal executive officer
and principal financial officer of Choice One Communications Inc., with the
participation and assistance of the Company's management, concluded that the
Company's disclosure controls and procedures as defined in Rules 13a-14(c) and
15d-14(c) promulgated under the Securities Exchange Act of 1934, were effective
in design and operation. There have been no significant changes in the Company's
system of internal controls or in other factors that could significantly affect
internal controls subsequent to the date of their evaluation.
39
PART II OTHER INFORMATION
Item 1. Legal Proceedings
On January 26, 2002, the Company and its wholly owned
subsidiary US Xchange Inc. (referred to collectively for
purposes of this paragraph as the Company), filed suit against
AT&T Corp ("AT&T"). This action is now pending in the United
States District Court for the Western District of New York
(02-CV-6090L). The Company's complaint seeks damages from AT&T
for breach of contract, based upon AT&T's failure to pay,
either on time or in full, the Company's invoices for access
services provided to AT&T. An answer was filed by AT&T. The
Company has filed a reply. On April 26, 2002, the Company
filed a motion for partial summary judgment based upon AT&T's
failure to pay the Company's invoices on account, and for a
declaration that AT&T materially breached its agreements for
failure to pay. AT&T cross-moved for partial summary judgment,
seeking dismissal of several of the Company's causes of
action. On September 24, 2002, following oral argument, a
decision dismissing some of the Company's causes of action,
but preserving for trial the Company's claim for breach of
contract and declaratory judgement, based upon AT&T's failure
to pay, either on time or in full, the Company's invoices for
access services provided to AT&T. The parties are now engaged
in the discovery process.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
In September 2002, the Company entered into a Third
Amended and Restated Credit Agreement. In consideration for
additional loans to the Company of $48.875 million, amendments
to financial covenants and other provisions of the Company's
credit agreement and amendments to the Company's bridge
financing agreement, the Company issued warrants with an
exercise price of $0.01 per share to the Company's lenders
under its credit agreement to purchase up to 10,596,137 shares
of common stock and to the Company's lenders under its bridge
financing agreement to purchase, on a contingent basis upon
the occurrence of certain events as described in Note 8 to the
Company's Consolidated Financial Statements, up to an
additional 4,851,872 shares of common stock. The Company
obtained the written consent of holders of a majority of its
common stock authorizing the issuance of such warrants. An
Information Statement describing the details of this
transaction was provided to the Company's stockholders in
October 2002.
40
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports for Form 8-K
A. Exhibits
See Exhibit Index
B. Reports on Form 8-K
On July 11, 2002, the Company filed a report on Form
8-K to report on the Audit Committee's decision to dismiss
Arthur Andersen LLP ("Andersen") as the Company's independent
auditor and to engage PricewaterhouseCoopers LLP ("PWC") to
serve in that capacity effective July 8, 2002.
On September 23, 2002, the Company filed a report on
Form 8-K to announce the Company's achievement of positive
EBITDA in August 2002.
On September 27, 2002, the Company filed a report on
Form 8-K to announce the Company had completed the closing of
a new debt financing arrangement in the amount of $48.875
million.
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHOICE ONE COMMUNICATIONS INC.
Registrant
DATE: November 14, 2002 By: /s/ Steve M. Dubnik
---------------------------------------------
Steve M. Dubnik, Chairman and Chief
Executive Officer
By: /s/ Ajay Sabherwal
--------------------------------------------
Ajay Sabherwal, Executive Vice President,
Finance and Chief Financial Officer
(Principal Financial Officer)
42
I, Steve M. Dubnik, the Chairman and Chief Executive Officer, Choice One
Communications Inc. (the "registrant"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Choice One
Communications Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Steve M. Dubnik
Steve M. Dubnik
Chairman and Chief Executive Officer
November 14, 2002
43
I, Ajay Sabherwal, Executive Vice President, Finance and Chief Financial
Officer, Choice One Communications Inc. (the "registrant"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Choice One
Communications Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Ajay Sabherwal
Ajay Sabherwal
Executive Vice President, Finance and Chief Financial Officer
November 14, 2002
44
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION LOCATION
------ ----------- --------
3.1 Amended and Restated Certificate of Incorporated by
Incorporation reference from
Exhibit 3.1 to
Choice One
Communication
Inc.s
Registration
Statement on Form
S-1 declared
effective on
February 16, 2000
located under
Securities and
Exchange
Commission File
No. 333-91321
(February 2000
Registration
Statement)
3.2 Amended and Restated Bylaws Incorporated by
reference from
Exhibit 3.2 to the
February 2000
Registration
Statement
3.3 Certificate of Designations for Series Incorporated by
A Senior Cumulative Preferred Stock reference from
Exhibit 3.1 to the
August 10, 2000
8-K filing located
under the
Securities and
Exchange
Commission File
No. 29279
3.4 Certificate of Amendment of Certificate Incorporated by
of Designations for Series A Senior reference from
Cumulative Preferred Stock of Choice Exhibit 10.25 to
One Communications Inc. the Companys 10-K
filed on April 1,
2002
45
3.5 Certificate of Amendment of Certificate Incorporated by
of Incorporation with Certificate of reference from
Designations, Preferences and Rights of Exhibit 3.4 to the
Series A Senior Cumulative Preferred Company's 10-Q
Stock dated March 30, 2002 filed on May 15,
2002.
3.6 Certificate of Amendment of Certificate Incorporated by
of Designations for Series A Senior reference from
Cumulative Preferred Stock Exhibit 4.6 to the
Company's 8-K
filed on September
27, 2002.
4.1 Registration Rights Agreement dated as Incorporated by
of July 8, 1998, among Choice One reference from
Communications Inc., the Investor Exhibit 10.10 to
Holders and the Management Holders the February 2000
Registration
Statement
4.2 Amendment No. 1 dated as of February Incorporated by
18, 1999 to Registration Rights reference from
Agreement dated as of July 8, 1998, Exhibit 10.11 to
among Choice One Communications Inc., the February 2000
the Investor Holders and the Management Registration
Holders Statement
4.3 Amendment No. 2 dated as of June 30, Incorporated by
1999 to Registration Rights Agreement reference from
dated as of July 8, 1998, among Choice Exhibit 10.12 to
One Communications Inc., the Investor the February 2000
Holders and the Management Holders Registration
Statement
4.4 Amendment No. 3 dated as of June 30, Incorporated by
1999 to Registration Rights Agreement reference from
dated as of July 8, 1998, among Choice Exhibit 10.13 to
One Communications Inc., the Investor the February 2000
Holders and the Management Holders Registration
Statement
4.5 Amendment No. 4 dated as of August 1, Incorporated by
2000 to Registration Rights Agreement reference from
dated as of July 8, 1998, among Choice Exhibit 10.1 to
One Communications Inc., the Investor the Company's 8-K
Holders and the Management Holders filed on August
10, 2000
46
4.6 Amendment No. 5 dated as of November 9, Incorporated by
2001 to Registration Rights Agreement reference from
dated as of July 8, 1998, among Choice Exhibit 10.22 to
One Communications Inc., the Investor the Company's 10-K
Holders and the Management Holders filed on April 1,
2002
4.7 Amendment No. 6 dated as of May 22, Incorporated by
2002 to Registration Rights Agreement reference from
dated as of July 8, 2002 among Choice Exhibit 10.23 to
One Communications Inc., the Investor the Company's 10-Q
Holders and the Management Holders. filed on August
14, 2002
4.8 Amendment No. 7 dated as of September Incorporated by
13, 2002 to Registration Rights reference from
Agreement dated as of July 18, 1998, Exhibit 4.2 to the
among Choice One Communications Inc., Company's 8-K
the Investors Holders and the filed on September
Management Holders 27, 2002
4.9 Debt Registration Rights Agreement Incorporated by
dated as of November 9, 2001 among reference from
Choice One Communications Inc., Morgan Exhibit 10.23 to
Stanley Senior Funding, Inc., First the Company's 10-K
Union Investors and CIBC Inc. filed on April 1,
2002
4.10 Equity Registration Rights Agreement Incorporated by
dated as of November 9, 2001 among reference from
Choice One Communications Inc., Morgan Exhibit 10.24 to
Stanley Senior Funding, Inc., First the Company's 10-K
Union Investors and CIBC Inc. filed on April 1,
2002
4.11 Amendment No. 1 dated as of September Incorporated by
13, 2002 to Equity Registration Rights reference from
Agreement dated as of November 9, 2001, Exhibit 4.1 to the
among Choice One Communications Inc., Company's 8-K
Morgan Stanley Senior Funding, Inc., filed on September
Wachovia Investors, Inc. (f/k/a First 27, 2002
Union Investors, Inc.), and CIBC Inc.
4.12 Investor Rights Agreement dated as of Incorporated by
December 19, 2001 between FairPoint reference from
Communications Solutions Corp. and Exhibit 10.25 to
Choice One Communications Inc. the Company's 10-K
filed on April 1,
2002
47
4.13 Agreement dated as of March 31, 2002 Incorporated by
between Choice One Communications Inc. reference from
and the Holders set forth on the Exhibit 10.41 to
signature pages thereto (Morgan Stanley the Company's 10-Q
Dean Witter Capital Partners IV, L.P., filed on May 15,
MSDW IV 892 Investors, L.P., Morgan 2002.
Stanley Dean Witter Capital Investors
IV, L.P.)
4.14 Warrant to Purchase Shares of Common Incorporated by
Stock of Choice One Communications Inc. reference from
Exhibit 10.4, 10.5
and 10.6 to the
Company's 8-K
filed on August
10, 2000
4.15 Warrant to Purchase Shares of Common Incorporated by
Stock of Choice One Communications Inc. reference from
Exhibit 10.42,
10.43 and 10.44 to
the Company's 10-K
filed on April 1,
2002
4.16 Form of Warrant for the Purchase of Incorporated by
Shares of Common Stock of Choice One reference from
Communications Inc. Exhibit 10.44 to
the Company's 10-Q
filed on May 15,
2002.
4.17 Form of Warrant for the Purchase of Incorporated by
Shares of Common Stock of Choice One reference from
Communications Inc. (warrant to Exhibit 10.45 to
purchase a number of shares in the Company's 10-Q
accordance with the definition of filed on May 15,
warrant share amount) 2002.
4.18 Form of Warrant for the Purchase of Incorporated by
Shares Of Common Stock Of Choice One reference from
Communications Inc. (warrant to Exhibit 4.3 to the
purchase a number of shares in Company's 8-K
accordance with the definition of filed on September
Warrant Share Amount) dated September 27, 2002
13, 2002
4.19 Form of Warrant for the Purchase of Incorporated by
Shares Of Common Stock Of Choice One reference from
Communications Inc. dated September 13, Exhibit 4.4 to the
2002 Company's 8-K
filed on September
27, 2002
48
4.20 Form of Warrant for the Purchase of Incorporated by
Shares Of Common Stock Of Choice One reference from
Communications Inc. (warrant to Exhibit 4.5 to the
purchase a number of shares in Company's 8-K
accordance with the definition of filed on September
Warrant Share Amount) dated September 27, 2002
13, 2002
4.21 Securities Purchase Agreement dated as Incorporated by
of August 1, 2000 among Morgan Stanley reference from
Dean Witter Capital Partners IV, L.P., Exhibit 10.7 to
Morgan Stanley Dean Witter Capital the Company's 8-K
Partners IV 892 Investors, L.P., Morgan filed on August
Stanley Dean Witter Capital Investors 10, 2000
IV, L.P., and Choice One Communications
Inc. relating to the purchase and sale
of securities of Choice One
Communications Inc.
4.22 Warrant Issuance Agreement dated as of Incorporated by
September 13, 2002 among Choice One reference from
Communications Inc., the Issuer, Exhibit 10.8 to
Wachovia Investors, Inc., Morgan the Company's 8-K
Stanley Emerging Markets Inc., CIBC filed on September
Inc., Morgan Stanley Dean Witter 27, 2002
Capital Partners IV, L.P., MSDW IV 892
Investors, L.P., Morgan Stanley Dean
Witter Capital Investors IV, L.P., the
Holders and Morgan Stanley & Co.
Incorporated
10.1 1998 Management Stock Incentive Plan of Incorporated by
Choice One Communications Inc. (May reference from
2000 Restatement) Exhibit 4.1 to the
September 29, 2000
S-8 located under
Securities and
Exchange
Commission File
No. 333-47002
10.2 Amendment No. 1 to the 1998 Management Incorporated by
Stock Incentive Plan of Choice One reference from
Communications Inc. (May 2000 Exhibit 4.4 to the
Restatement) December 21, 2001
S-8 located under
Securities and
Exchange
Commission File
No. 333-75712
10.3 1999 Directors' Stock Incentive Plan of Incorporated by
Choice One Communications Inc. reference from
Exhibit 4.1 to the
September 29, 2000
S-8 located under
Securities and
Exchange
Commission File
No. 333-47008
49
10.4 Transaction Agreement, dated as of July Incorporated by
8, 1998, among Choice One reference from
Communications Inc., Choice One Exhibit 10.3 to
Communications L.L.C. and holders of the February 2000
Investor Equity and Management Equity Registration
Statement
10.5 Amendment No. 1 dated as of December Incorporated by
18, 1998 to Transaction Agreement, reference from
dated as of July 8, 1998, among Choice Exhibit 10.4 to
One Communications Inc., Choice One the February 2000
Communications L.L.C. and holders of Registration
Investor Equity and Management Equity Statement
10.6 Amendment No. 2 dated as of February Incorporated by
18, 1999 to Transaction Agreement, reference from
dated as of July 8, 1998, among Choice Exhibit 10.5 to
One Communications Inc., Choice One the February 2000
Communications L.L.C. and holders of Registration
Investor Equity and Management Equity Statement
10.7 Amendment No. 3 dated as of May, 14 Incorporated by
1999 to Transaction Agreement, dated as reference from
of July 8, 1998, among Choice One Exhibit 10.6 to
Communications Inc., Choice One the February 2000
Communications L.L.C. and holders of Registration
Investor Equity and Management Equity Statement
10.8 Amendment No. 4 dated as of June 30, Incorporated by
1999 to Transaction Agreement, dated as reference from
of July 8, 1998, among Choice One Exhibit 10.7 to
Communications Inc., Choice One the February 2000
Communications L.L.C. and holders of Registration
Investor Equity and Management Equity Statement
10.9 Amendment No. 5 dated as of June 30, Incorporated by
1999 to Transaction Agreement, dated as reference from
of July 8, 1998, among Choice One Exhibit 10.8 to
Communications Inc., Choice One the February 2000
Communications L.L.C. and holders of Registration
Investor Equity and Management Equity Statement
50
10.10 Amendment No. 6 dated as of November Incorporated by
18, 1999 to Transaction Agreement, reference from
dated as of July 8, 1998, among Choice Exhibit 10.9 to
One Communications Inc., Choice One the February 2000
Communications L.L.C. and holders of Registration
Investor Equity and Management Equity Statement
10.11 Amendment No. 7 dated as of August 1, Incorporated by
2000 to Transaction Agreement, dated as reference from
of July 8, 1998, among Choice One Exhibit 10.2 to
Communications Inc., Choice One the Compan's 8-K
Communications L.L.C and holders of filed on August
Investor Equity and Management Equity 10, 2000
10.12 Amendment No. 8 dated as of December Incorporated by
20, 2000 to Transaction Agreement, reference from
dated as of July 8, 1998, among Choice Exhibit 10.11 to
One Communications Inc., Choice One the Company's 10-K
Communications L.L.C and holders of filed on March 6,
Investor Equity and Management Equity 2001
10.13 Amendment No. 9 dated as of March 13, Incorporated by
2001 to Transaction Agreement, dated as reference from
of July 8, 1998, among Choice One Exhibit 10.12 to
Communications Inc., Choice One the Company's 10-Q
Communications L.L.C. and holders of filed on August
Investor Equity and Management Equity 14, 2001
10.14 Amendment No. 10 dated as of June 21, Incorporated by
2001 to Transaction Agreement, dated as reference from
of July 8, 1998, among Choice One Exhibit 10.12 to
Communications Inc., Choice One the Company's 10-Q
Communications L.L.C. and holders of filed on August
Investor Equity and Management Equity 14, 2001
10.15 Amendment No. 10 dated as of November Incorporated by
9, 2001 to Transaction Agreement, dated reference from
as of July 8, 1998, among Choice One Exhibit 10.15 to
Communications Inc., Choice One the Company's 10-K
Communications L.L.C. and holders of filed on April 1,
Investor Equity and Management Equity 2002
(this Amendment No. 10 is a distinct
and separate amendment from the
Amendment No. 10 dated June 21, 2001
referenced in Exhibit 10.14 above)
10.16 Amendment No. 11 dated as of December Incorporated by
19, 2001 to Transaction Agreement, reference from
dated as of July 8, 1998, among Choice Exhibit 10.16 to
One Communications Inc., Choice One the Company's 10-K
Communications L.L.C. and holders of filed on April 1,
Investor Equity and Management Equity 2002
51
10.17 Amendment No. 13 dated as of September Incorporated by
12, 2002 to the Transaction Agreement, reference from
dated as of July 18, 1998, among Choice Exhibit 10.9 to
One Communications Inc. Choice One the Company's 8-K
Communications L.L.C. and holders of filed on September
Investor Equity and Management Equity 27, 2002
(as defined therein)
10.18 Form of Executive Purchase Agreement Incorporated by
dated July 8, 1998 among the Choice One reference from
Communication Inc., Choice One Exhibit 10.14 to
Communications L.L.C. and Certain the February 2000
Executives of the Registrant Registration
Statement
10.19 Executive Purchase Agreement dated as Incorporated by
of July 8, 1998 among the Choice One reference from
Communication Inc., Choice One Exhibit 10.15 to
Communications L.L.C. and Steve M. the February 2000
Dubnik Registration
Statement
10.20 Executive Purchase Agreement dated as Incorporated by
of July 8, 1998 among the Choice One reference from
Communication Inc., Choice One Exhibit 10.16 to
Communications L.L.C. and Mae Squire-Dow the February 2000
Registration
Statement
10.21 Executive Purchase Agreement dated as Incorporated by
of July 8, 1998 among the Choice One reference from
Communication Inc., Choice One Exhibit 10.17 to
Communications L.L.C. and Philip Yawman the February 2000
Registration
Statement
10.22 Executive Purchase Agreement dated as Incorporated by
of July 8, 1998 among the Choice One reference from
Communication Inc., Choice One Exhibit 10.18 to
Communications L.L.C. and Kevin Dickens the February 2000
Registration
Statement
10.23 Executive Purchase Agreement dated as Incorporated by
of July 8, 1998 among the Choice One reference from
Communication Inc., Choice One Exhibit 10.19 to
Communications L.L.C. and Ajay Sabherwal the February 2000
Registration
Statement
52
10.24 Third Amended and Restated Credit Incorporated by
Agreement dated as of September 13, reference from
2002 among Choice One Communications Exhibit 10.1 to
Inc., as Guarantor, its Subsidiaries as the Company's 8-K
Borrowers, Wachovia Investor, Inc. filed on September
(f/k/a First Union Investors, Inc.), as 27, 2002
Administrative Agent and Collateral
Agent, General Electric Capital
Corporation, as Syndication Agent,
Morgan Stanley Senior Funding, Inc., as
Documentation Agent, and the Lenders
thereto (the 'Amended Credit Agreement')
10.25 Third Amended and Restated Pledge Incorporated by
Agreement dated as of September 13, reference from
2002 made by Choice One Communications Exhibit 10.2 to
Inc. and its Subsidiaries listed on the the Company's 8-K
signature pages thereto in favor of filed on September
Wachovia Investor, Inc. (f/k/a First 27, 2002
Union Investors, Inc.), as
Administrative Agent, for the ratable
benefit of such Administrative Agent
and the Lenders under the Amended
Credit Agreement
10.26 Third Amended and Restated Security Incorporated by
Agreement dated as of September 13, reference from
2002 made by Choice One Communications Exhibit 4.2 to the
Inc. and its Subsidiaries listed on the Company's 8-K
signature pages thereto in favor of filed on September
Wachovia Investor, Inc. (f/k/a First 27, 2002
Union Investors, Inc.), as
Administrative Agent, for the ratable
benefit of such Administrative Agent
and the Lenders under the Amended
Credit Agreement.
10.27 Subordinated Guarantee dated as of Incorporated by
September 13, 2002 made by the reference from
subsidiaries of Choice One Exhibit 10.7 to
Communications Inc. listed on the the Company's 8-K
signature pages thereto in favor of filed on September
Morgan Stanley Senior Funding, Inc., as 27, 2002
Bridge Collateral Agent, for the
ratable benefit of itself and the
financial institutions as are, or may
from time to time become, parties to
the Bridge Agreement Amendment
10.28 Bridge Financing Agreement dated as of Incorporated by
August 1, 2000 among Choice One reference from
Communications Inc., the Lenders party Exhibit 10.3 to
hereto, and Morgan Stanley Senior the Company's 8-K
Funding, Inc., as Administrative Agent filed on August
10, 2000
53
10.29 Third Amendment to the Bridge Financing Incorporated by
Agreement dated as of September 13, reference from
2002, with respect to the Bridge Exhibit 10.4 to
Financing Agreement dated as of August the Company's 8-K
1, 2000, among the Choice One filed on September
Communications Inc., as Borrower, 27, 2002
Morgan Stanley Senior Funding, Inc., as
Administrative Agent and the Lenders
thereto (the 'Bridge Agreement
Amendment')
10.30 Bridge Pledge Agreement dated as of Incorporated by
September 13, 2002 made by Choice One reference from
Communications Inc. and its Exhibit 10.5 to
Subsidiaries listed on the signature the Company's 8-K
pages thereto in favor of Morgan filed on September
Stanley Senior Funding, Inc., as Bridge 27, 2002
Collateral Agent, for the ratable
benefit of itself and the financial
institutions as are, or may from time
to time become, parties to the Bridge
Agreement Amendment
10.31 Form of Rollover Note for the Bridge Incorporated by
Financing Agreement dated as of August reference from
1, 2000 among Choice One Communications Exhibit 10.46 to
Inc., the Lenders party hereto, and the Company's 10-K
Morgan Stanley Senior Funding, Inc., as filed on April 1,
Administrative Agent 2002
10.32 Bridge Security Agreement dated as of Incorporated by
September 13, 2002 made by Choice One reference from
Communications Inc. and its Exhibit 10.6 to
Subsidiaries listed on the signature the Company's 8-K
pages thereto in favor of Morgan filed on September
Stanley Senior Funding, Inc., as Bridge 27, 2002
Collateral Agent, for the ratable
benefit of itself and the financial
institutions as are, or may from time
to time become, parties to the Bridge
Agreement Amendment.
10.33 Lease between the Registrant and Incorporated by
Bendersen-Rochester Associates, LLC reference from
dated October 14, 1998, as amended Exhibit 10.21 to
the February 2000
Registration
Statement
10.34 Unit Purchase Agreement dated as of Incorporated by
October 21, 1999 among the Registrant, reference from
Atlantic Connections L.L.C., ACL Exhibit 10.22 to
Telecommunications, LTD., Paul Cissel, the February 2000
Antonio Lopez, Jr. and North Atlantic Registration
Venture Fund II, L.P Statement
54
10.35 General Agreement between the Incorporated by
Registrant and Lucent Technologies reference from
effective as of July 17, 1998, as Exhibit 10.23 to
amended the February 2000
Registration
Statement
10.36 Service Bureau Agreement between the Incorporated by
Registrant and Saville Systems Inc. reference from
effective September 30, 1998 Exhibit 10.24 to
the February 2000
Registration
Statement
10.37 Agreement and Plan of Merger by and Incorporated by
among Choice One Communications Inc., reference from
Barter Acquisition Corporation, US Exhibit 99.2 to
Xchange, Inc. and the Stockholder of US the Companys
Xchange, Inc. dated as of May 14, 2000 8-K/A filed on May
16, 2000
10.38 Fiber Optic Agreement and Grant of IRU Incorporated by
dated August 1, 2000 by and between reference from
Choice One Communications Inc. and RVP Exhibit 10.9 to
Fiber Company, L.L.C. the Companys 8-K
filed on August
10, 2000
10.39 Form of Executive Employment Agreement Incorporated by
between former executives of US reference from
Xchange, Inc. and Choice One Exhibit 10.10 to
Communications Inc. the Companys 8-K
filed on August
10, 2000
10.40 Master Facilities Agreement between Incorporated by
Fiber Technologies Operating Company, reference from
LLC and Choice One Communications Inc. Exhibit 10.1 to
dated as of May 31, 2000 * the Company's 10-Q
for the quarter
ended June 30, 2000
10.41 Addendum Number One 5ESS Switch and Incorporated by
Transmission Systems Purchase Agreement reference from
between Choice One Communications Inc. Exhibit 10.1 to
and Lucent Technologies Inc. dated as the Company's 10-Q
of January 1, 2000 ** for the quarter
ended March 31,
2000
55
10.42 Choice One Communications Inc. 401(K) Incorporated by
Plan reference from
Exhibit 4.3 to the
October 23, 2000
S-8 located under
Securities and
Exchange
Commission File
No. 333-48430
10.43 Amendment No.1 and No. 2 to the Choice Incorporated by
One Communications Inc. 401(K) Plan reference from
Exhibit 4.4 to the
December 21, 2001
S-8 located under
Securities and
Exchange
Commission File
No. 333-75710
10.44 Network Transition Agreement dated as Incorporated by
of November 7, 2001 between FairPoint reference from
Communications Solutions Corp., Choice Exhibit 10.53 to
One Communications Inc. and selected the Company's 10-K
subsidiaries of Choice One filed on April 1,
Communications Inc. 2002
*Portions of this agreement have been omitted and filed separately with
the Commission pursuant to an application for confidential treatment under Rule
24b-2, which was granted by the Commission until May 31, 2003.
**Portions of this agreement have been omitted and filed separately
with the Commission pursuant to an application for confidential treatment under
Rule 24b-2, which was granted by the Commission until December 31, 2002.