UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-49899
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ATX COMMUNICATIONS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-4078506
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(State or other jurisdiction of incorporation (I.R.S. Employer
Identification No.)
or organization)
50 Monument Road, Bala Cynwyd, Pennsylvania 19004
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(Address of principal executive offices) (Zip Code)
(610) 668-3000
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(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 such filing
requirements for the past 90 days. Yes X No ______
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Indicate by check mark whether the registrant is an accelerated filer (As
defined in Rule 12b-2 of the Exchange Act). Yes___ No X
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The number of shares outstanding of the issuer's common stock as of June 30,
2003 was 29,967,430.
ATX Communications, Inc.
Index
PART I. FINANCIAL INFORMATION Page
------------------------------ ----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 2003 (Unaudited) and December 31, 2002 ................................... 2
Condensed Consolidated Statements of Operations -
Three and Six months ended June 30, 2003 and 2002 (Unaudited) ..................... 3
Condensed Consolidated Statement of Shareholders' Deficiency -
Six months ended June 30, 2003 (Unaudited) ........................................ 4
Condensed Consolidated Statements of Cash Flows -
Six months ended June 30, 2003 and 2002 (Unaudited) ............................... 5
Notes to Unaudited Condensed Consolidated Financial Statements ....................... 6
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition ...............................................22
Item 3. Quantitative and Qualitative Disclosures about Market Risk ...........................32
Item 4. Controls and Procedures...............................................................33
PART II. OTHER INFORMATION
------------------------------
Item 1. Legal Proceedings.....................................................................34
Item 2. Changes In Securities and Use of Proceeds.............................................41
Item 6. Exhibits and Reports on Form 8-K .....................................................42
SIGNATURES........................................................................................ 43
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1
ATX Communications, Inc.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
June 30, 2003 December 31, 2002
-----------------------------------------------
(Unaudited) (See Note)
Assets
Current assets:
Cash and cash equivalents $ 6,235,000 $ 9,959,000
Accounts receivable-trade, less allowance for doubtful
accounts of $9,122,000 (2003) and $8,755,000 (2002) 32,412,000 35,150,000
Due from NTL Incorporated 948,000 1,120,000
Other 4,752,000 4,845,000
-----------------------------------------------
Total current assets 44,347,000 51,074,000
Fixed assets, net 32,758,000 37,861,000
Goodwill 79,558,000 79,558,000
Other, net of accumulated amortization of
$2,423,000 (2003) and $1,871,000 (2002) 9,368,000 10,570,000
-----------------------------------------------
$ 166,031,000 $ 179,063,000
===============================================
Liabilities and shareholders' deficiency
Current liabilities:
Accounts payable $ 64,380,000 $ 65,799,000
Accrued expenses 54,840,000 53,060,000
Current portion of long-term debt, less unamortized discount 8,271,000 1,512,000
Current portion of capital lease obligations 8,866,000 9,534,000
Deferred revenue 19,208,000 21,928,000
-----------------------------------------------
Total current liabilities 155,565,000 151,833,000
Long-term debt, less unamortized discount 140,741,000 145,809,000
Notes payable to NTL Incorporated, less unamortized discount 18,617,000 17,632,000
Commitments and contingent liabilities
Shareholders' deficiency:
Preferred stock-- $.01 par value, authorized
10,000,000 shares; issued and outstanding none -- --
Common stock-- $.01 par value, authorized 250,000,000
shares; issued 30,000,000 shares; outstanding
29,967,000 shares (2003) and 29,667,000 shares (2002) 300,000 300,000
Additional paid-in capital 1,030,044,000 1,030,613,000
Deficit (1,179,163,000) (1,166,389,000)
-----------------------------------------------
(148,819,000) (135,476,000)
Treasury stock at cost, 33,000 shares (2003) and 333,000 shares (2002)
(73,000) (735,000)
-----------------------------------------------
(148,892,000) (136,211,000)
-----------------------------------------------
$ 166,031,000 $ 179,063,000
===============================================
Note: The balance sheet at December 31, 2002 has been derived from the audited balance sheet at that date.
See accompanying notes.
2
ATX Communications, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
-------------------------------------- ---------------------------------------
Revenues $ 71,934,000 $ 75,209,000 $ 142,893,000 $ 149,520,000
Costs and expenses
Operating 45,939,000 48,758,000 91,899,000 96,796,000
Selling, general and administrative 20,054,000 20,224,000 39,629,000 42,537,000
Corporate 1,826,000 1,616,000 3,923,000 3,314,000
Recapitalization costs -- 4,270,000 -- 5,452,000
Other charges 293,000 -- 293,000 --
Depreciation 6,034,000 9,140,000 9,799,000 18,021,000
Amortization -- 83,000 -- 167,000
-------------------------------------- ---------------------------------------
74,146,000 84,091,000 145,543,000 166,287,000
-------------------------------------- ---------------------------------------
Operating loss (2,212,000) (8,882,000) (2,650,000) (16,767,000)
Other expenses
Interest expense and other, net (5,613,000) (3,637,000) (10,124,000) (7,406,000)
-------------------------------------- ---------------------------------------
Net loss $ (7,825,000) $ (12,519,000) $(12,774,000) $(24,173,000)
====================================== =======================================
Basic and diluted net loss per share $ (0.26) $ (0.42) $ (0.43) $ (0.81)
====================================== =======================================
Weighted average number of shares 29,734,000 30,000,000 29,700,000 30,000,000
====================================== =======================================
See accompanying notes.
3
ATX Communications, Inc.
Condensed Consolidated Statement of Shareholders' Deficiency
(Unaudited)
Common Stock Additional Treasury Stock
--------------------------- ---------------------------
Shares Par Paid-In Capital Deficit Shares Amount
-----------------------------------------------------------------------------------------------
Balance, December 31, 2002 30,000,000 $ 300,000 $ 1,030,613,000 $ (1,166,389,000) $ 333,000 $ (735,000)
Issuance of Shares from Treasury -- -- (569,000) -- (300,000) 662,000
Net loss -- -- -- (12,774,000) -- --
-----------------------------------------------------------------------------------------------
Balance, June 30, 2003 30,000,000 $ 300,000 $ 1,030,044,000 $ (1,179,163,000) $ 33,000 $ (73,000)
===============================================================================================
See accompanying notes.
4
ATX Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
2003 2002
-------------------------------------------
Net cash provided by operating activities $ 1,380,000 $ 1,126,000
Investing activities
Purchase of fixed assets (4,728,000) (5,448,000)
-------------------------------------------
Net cash used in investing activities (4,728,000) (5,448,000)
Financing activities
Principal payments of capital lease obligations (376,000) (292,000)
-------------------------------------------
Net cash used in financing activities (376,000) (292,000)
-------------------------------------------
Decrease in cash and cash equivalents (3,724,000) (4,614,000)
Cash and cash equivalents at beginning of period 9,959,000 24,966,000
-------------------------------------------
Cash and cash equivalents at end of period $ 6,235,000 $ 20,352,000
===========================================
Supplemental disclosure of cash flow information
Cash paid for interest $ 1,672,000 $ 5,463,000
===========================================
Supplemental schedule of non-cash investing activities
Liabilities incurred to acquire fixed assets $ 32,000 $ 293,000
===========================================
See accompanying notes.
5
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information pursuant to the rules and regulations of the Securities
and Exchange Commission, known as the SEC. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three and six
months ended June 30, 2003 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2003. For further information,
refer to the consolidated financial statements and footnotes thereto included in
Item 8 of ATX Communications, Inc.'s annual report on Form 10-K for the year
ended December 31, 2002.
Certain amounts have been reclassified to conform to the 2003 presentation.
Note 2. ATX Recapitalization
In July 2002, ATX Communications, Inc., referred to herein as ATX or the
Company, completed a recapitalization, which began in December 2001. Pursuant to
the terms of the recapitalization, the Company eliminated approximately $600
million of debt and preferred stock and more than $100 million of other
liabilities and future obligations. The Company incurred additional costs, which
consist primarily of employee incentives, legal fees, accounting fees and
printing fees, in connection with the recapitalization of $4,270,000 and
$5,452,000, respectively, during the three and six months ended June 30, 2002.
Note 3. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Such estimates and assumptions impact, among others, the following: the amount
of uncollectible accounts receivable, the amount to be paid to terminate certain
agreements included in reorganization costs, the amount to be paid to settle
certain toll and interconnection liabilities, the amount to be paid as a result
of certain sales and use tax audits, potential liabilities arising from other
sales tax matters and estimates related to the value of long-lived assets,
goodwill and other intangible assets. Actual results could differ from those
estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated in consolidation.
6
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 3. Significant Accounting Policies (continued)
Contingent Liabilities
The Company's determination of the treatment of contingent liabilities is based
on a view of the expected outcome of the applicable contingency. The Company's
legal counsel is consulted on matters related to litigation. Experts both within
and outside the Company are consulted with respect to other matters that arise
in the ordinary course of business. Examples of matters that are based on
assumptions, judgments and estimates are the amount to be paid to terminate some
agreements included in reorganization costs, the amounts to be paid to settle
some toll and interconnection liabilities, the amount to be paid as a result of
some sales and use tax audits and potential liabilities arising from other sales
tax matters. A liability is accrued if the likelihood of an adverse outcome is
probable of occurrence and the amount is estimable.
Net Loss Per Share
The Company reports its basic and diluted net loss per share in accordance with
Financial Accounting Standards Board, referred to as FASB, Statement of
Financial Accounting Standards, referred to as SFAS, No. 128, "Earnings Per
Share."
Revenue Recognition and Certain Cost Classifications
Revenues are recognized at the time the service is rendered to the customer or
the performance of the service has been completed. Charges for services that are
billed in advance are deferred and recognized when earned.
Operating costs includes direct costs of sales and network costs. Direct costs
of sales include the costs directly incurred primarily with other
telecommunications carriers in order to render services to customers. Network
costs include the costs of fiber and access, points of presence, repairs and
maintenance, rent, utilities and property taxes of the telephone, Internet and
data network, as well as salaries and related expenses of network personnel.
7
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 3. Significant Accounting Policies (continued)
Stock-Based Compensation
The Company's employees participate in the ATX stock option plan. ATX applies
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", known herein as APB Opinion No. 25, and related interpretations.
When applying APB Opinion No. 25, compensation expense for compensatory plans is
measured based on "intrinsic value" (i.e., the excess of the market price of the
stock over the exercise price on the measurement date). Under the intrinsic
value method, compensation is determined on the measurement date; that is, the
first date on which both the number of shares the employee is entitled to
receive and the exercise price, if any, are known. Compensation expense, if any,
generally is recognized over the equity award's vesting period. Compensation
expense associated with awards that immediately are vested or attributable to
past services is recognized when granted.
The following table provides pro forma information regarding net loss as if the
Company had accounted for its employee stock options under the fair value method
pursuant to SFAS No. 123 "Accounting for Stock Based Compensation."
Three Months Ended June 30, Six Months Ended June 30,
-----------------------------------------------------------------------
2003 2002 2003 2002
-----------------------------------------------------------------------
Net loss-- as reported $ (7,825,000) $ (12,519,000) $ (12,774,000) $ (24,173,000)
Stock based compensation expenses
under SFAS No. 123 (907,000) (895,000) (1,807,000) (1,790,000)
-----------------------------------------------------------------------
Pro forma net loss (8,732,000) (13,414,000) (14,581,000) (25,963,000)
=======================================================================
Basic and diluted per share information:
Net loss-- as reported $ (0.26) $ (0.42) $ (0.43) $ (.81)
Stock based compensation expenses
under SFAS No. 123 (0.03) (0.03) (0.06) (.06)
-----------------------------------------------------------------------
Pro forma net loss per share $ (0.29) $ (0.45) $ (0.49) $ (.87)
=======================================================================
8
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 4. Revenues
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
-----------------------------------------------------------------------
Local exchange services $ 22,672,000 $ 20,787,000 $ 45,266,000 $ 43,005,000
Internet, data and web-related services 20,934,000 22,931,000 41,896,000 46,375,000
Toll-related telephony services 18,086,000 18,221,000 36,117,000 35,910,000
Other (a) 10,242,000 13,270,000 19,614,000 24,230,000
-----------------------------------------------------------------------
$ 71,934,000 $ 75,209,000 $ 142,893,000 $ 149,520,000
=======================================================================
(a) Other includes carrier access billing, reciprocal compensation, wireless,
paging and information services.
Note 5. Fixed Assets
Fixed assets consist of:
June 30, December 31,
2003 2002
-----------------------------------
Operating equipment................................................. $ 33,018,000 $ 30,204,000
Computer hardware and software...................................... 8,749,000 6,929,000
Other equipment..................................................... 5,903,000 5,634,000
Construction-in-progress............................................ 130,000 337,000
-----------------------------------
47,800,000 43,104,000
-----------------------------------
Accumulated depreciation............................................ (15,042,000) (5,243,000)
-----------------------------------
$ 32,758,000 $ 37,861,000
===================================
9
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 6. Accrued Expenses
Accrued expenses consist of:
June 30, December 31,
------------------------------------------
2003 2002
------------------------------------------
Toll and interconnect.................................................... $22,503,000 $23,016,000
Taxes, including income taxes............................................ 10,549,000 11,473,000
Payroll and related...................................................... 6,514,000 6,431,000
Accrued interest......................................................... 5,824,000 797,000
Other.................................................................... 5,141,000 5,616,000
Reorganization costs..................................................... 3,386,000 4,542,000
Professional fees........................................................ 923,000 1,185,000
------------------------------------------
$54,840,000 $ 53,060,000
==========================================
Note 7. Long-Term Debt
Long-term debt consists of:
June 30, December 31,
------------------------------------------
2003 2002
------------------------------------------
Senior secured credit facility, less unamortized discount of
$9,509,000 (2003) and $10,291,000 (2002)............................... $146,591,000 $ 145,809,000
6% Convertible Notes, less unamortized discount of $1,937,000
(2003) $2,846,000 (2002)................................................ 2,421,000 1,512,000
------------------------------------------
149,012,000 147,321,000
Less current portion.................................................. (8,271,000) (1,512,000)
------------------------------------------
$140,741,000 $ 145,809,000
==========================================
The Company's consolidated balance sheet includes CCL Historical, Inc.'s, 6%
Convertible Subordinated Notes. These notes are obligations of CCL Historical,
Inc., referred to herein as CCL, and do not represent obligations of the Company
or any of its other subsidiaries. The semi-annual interest payments that were
due under the outstanding notes since April 1, 2002 have not been made and CCL
is in default under these notes. As such, the notes and the accrued interest
thereon are currently due and payable in full.
10
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 7. Long-Term Debt (continued)
On March 31, 2003, the Company entered into an amendment to its senior secured
credit facility. Under this amendment, the lenders under the facility agreed to
defer interest payments on the outstanding loans during the period beginning
March 12, 2003, and ending on February 2, 2004, during which time the loans will
accrue interest at a rate of 5.5% per annum plus the base rate, which is the
higher of the prime rate or the federal funds effective rate plus 0.5% per
annum. As of June 30, 2003, this rate was 9.75%. In addition, the required
principal payments originally scheduled for 2003, which totaled $1,950,000, were
deferred to February 2, 2004. The lenders have also agreed to waive and/or amend
certain financial covenants set forth in the credit agreement until January 31,
2004, and added other financial covenants, in order to better reflect the
Company's current operations. The Company incurred deferred financing costs of
$557,000, which consist primarily of legal and consulting fees, in connection
with this amendment. These deferred financing costs will be amortized during the
effective term of this amendment. The current portion of long-term debt includes
principal payments due under the senior credit facility within one year.
All of the Company's subsidiaries have unconditionally guaranteed payment under
the senior secured credit facility.
Note 8. Related Party Transactions
Some of the directors of the Company were or are officers or directors of NTL
Incorporated, referred to herein as NTL. In April 2001, CCL and the Company as
co-obligors issued to NTL $15 million aggregate principal amount of 10.75%
Unsecured Convertible PIK Notes Due April 2011. At June 30, 2003 and December
31, 2002, the total amount of the notes outstanding, less the unamortized
discount of $308,000 and $327,000, respectively, was $18,617,000 and 17,632,000,
respectively. These notes are now held by NTL Europe, Inc.
Until 2002, NTL provided the Company with management, financial, legal and
technical services, access to office space and equipment and use of supplies.
Amounts charged to the Company by NTL consisted of salaries and direct costs
allocated to the Company where identifiable, and a percentage of the portion of
NTL's corporate overhead, which could not be specifically allocated to NTL.
Effective January 1, 2001, the percentage used to allocate estimated corporate
overhead was reduced. It is not practicable to determine the amounts of these
expenses that would have been incurred had the Company operated as an
unaffiliated entity. For the three and six months ended June 30, 2002, NTL
charged the Company $88,000 and $172,000, respectively, which is included in
corporate expenses.
11
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 8. Related Party Transactions (continued)
A subsidiary of the Company provides billing and software development services
to subsidiaries of NTL. During the third quarter of 2002, the Company began
recording the billings for these services as revenue. The Company recorded
revenues for these billings, totaling $708,000 and $1,440,000, for the three and
six months ended June 30, 2003. The Company historically recorded these billings
as a reduction of selling, general and administrative expenses. Selling, general
and administrative expenses were reduced by $254,000 and $566,000 for the three
and six months ended June 30, 2002 for these billings.
In 2001, the Company and NTL entered into a license agreement whereby NTL was
granted an exclusive, irrevocable, perpetual license to use certain billing
software developed by the Company for telephony rating, digital television
events rating, fraud management and other tasks. The Company recorded the $12.8
million received as deferred revenue to be recognized over a period of three
years, which was the estimated amount of time the Company expected to provide
services under this arrangement. The Company recognized $1,069,000 of this
revenue during each of the three-month periods ended June 30, 2003 and 2002 and
recognized $2,137,000 during each of the six-month periods ended June 30, 2003
and 2002.
The Company leases office space and a network facility from entities controlled
by an individual who owns 34% of the outstanding shares of the Company's common
stock. Rent expense for these leases was approximately $418,000 and $450,000 for
the three months ended June 30, 2003 and 2002 and approximately $836,000 and
$900,000 for the six months ended June 30, 2003 and 2002, respectively.
The Company engaged B/G Enterprises, LLC, a company affiliated with a director
of the Company, to provide travel related services. The cost of these services
totaled $81,000 during the six months ended June 30, 2003.
Note 9. Other Charges
During June 2003, the Company paid $200,000 in cash and issued 300,000 shares of
common stock, valued at $93,000, from its treasury in consideration for
settlement of certain legal matters. The Company has recorded these costs in
other charges for the three and six-month periods ended June 30, 2003.
Note 10. Reorganization Costs
The Company recorded no reorganization costs during the first six months of
2003. In 2001, the Company announced that it was taking actions to reorganize,
re-size and reduce operating costs and create greater operating efficiencies.
The major actions involved in the 2001 reorganization included: (1)
consolidation of functions such as network operations, customer service and
finance, (2) initiatives to increase gross margins and (3) agreements with
vendors to reduce or eliminate purchase commitments. Charges for these actions
included lease exit costs and agreement termination charges. All of these
actions were completed during 2002 and the remaining liability is expected to be
paid through 2005.
12
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 10. Reorganization Costs (continued)
The Company utilized $1,156,000 of accrued reorganization costs during the six
months ended June 30, 2003. As of June 30, 2003, the Company's remaining accrued
reorganization costs totaled $3,386,000 consisting primarily of accruals for
agreement terminations.
Note 11. Commitments and Contingent Liabilities
As of June 30, 2003, the Company had purchase commitments of approximately
$2,894,000 outstanding, all of which are due during 2003. Additionally, the
Company had standby letters of credit of approximately $2,704,000 outstanding as
of June 30, 2003, which are fully collateralized by certificates of deposit.
The Company is involved in various disputes, arising in the ordinary course of
its business, which may result in pending or threatened litigation. None of
these matters are expected to have a material adverse effect on the Company's
financial position, results of operations or cash flows. Some of these disputes,
regardless of their merit, could subject the Company to costly litigation and
the diversion of technical and/or management personnel. Additionally, in light
of the Company's ongoing litigation and other disputes with various local
exchange carriers, some of whom the Company depends upon for certain services,
from time to time, those carriers have and will likely continue to threaten
service disruptions or terminations. Certain service disruptions or
terminations, if actually implemented, could have a material adverse effect on
the Company's business, finances and/or results of operations.
Currently, the Company has the following outstanding matters, which if resolved
unfavorably, could have a material adverse effect on the Company:
o On August 12, 2002, Verizon Communications, Inc. and several of its
subsidiaries filed a complaint in the United States District Court for
the District of Delaware against the Company and several of its
indirect wholly-owned subsidiaries, referred to herein as the
defendants, seeking payment of approximately $37 million allegedly
owed to Verizon under various contracts and state and federal law.
Verizon also asked the Court to issue a declaratory ruling that it has
not violated the antitrust laws.
13
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
The defendants believe that they have meritorious defenses to the
complaint, and further, that the amounts owed are substantially less
than the amounts claimed by Verizon. For example, the defendants
believe the figure specified in the complaint includes payments that
have been made by the defendants to Verizon (including in excess of
$14 million paid soon after the filing of the complaint), credits that
Verizon has issued to the defendants since the filing of the
complaint, and additional disputes for which Verizon owes credits to
the defendants. The defendants have filed an answer to Verizon's
complaint denying Verizon's claims, in part, and have asserted various
counterclaims against Verizon, including claims seeking damages for
breach of contract and treble damages for violating the antitrust
laws. The defendants have also moved to dismiss Verizon's request for
a declaratory ruling on the antitrust claims, which Verizon has
opposed.
On November 18, 2002, Verizon filed a motion to dismiss defendants'
antitrust counterclaims, relying heavily on a decision by the United
States Court of Appeals for the 7th Circuit in Goldwasser vs.
Ameritech Corp., 222 F.3d 390 (7th Cir. 2000) dismissing antitrust
claims brought on behalf of a class of consumers who had purchased
services from Ameritech in Illinois. On January 9, 2003, the
defendants filed their opposition to Verizon's motion, noting not only
that the Goldwasser case is distinguishable from the defendants'
antitrust claims, but also that the appellate court's rationale in
Goldwasser had been effectively repudiated by the appellate courts of
the 2nd and 11th circuits, as well as by a federal trial court in the
antitrust claim raised by the Company against SBC/Ameritech in the
United States District Court for the Northern District of Ohio.
On March 20, 2003, the Court issued an order denying the parties'
respective motions without prejudice to renew, pending a decision by
the United States Supreme Court in Verizon Communications, Inc. vs.
Law Offices of Curtis V. Trinko, LLP, Supreme Court Docket No. 02-682
(cert. granted March 10, 2003). By order of the Court issued May 6,
2003, the parties have been directed to proceed with discovery on all
issues. The Company and its subsidiaries intend to pursue all
available remedies and counterclaims and defend themselves vigorously;
however, the Company and its subsidiaries cannot be certain how or
when these matters will be resolved or of the outcome of the
litigation.
14
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o On March 7, 2002, CoreComm Massachusetts, Inc., an indirect
wholly-owned subsidiary of the Company, initiated litigation against
Verizon New England d/b/a Verizon Massachusetts in the Suffolk
Superior Court, Massachusetts, alleging breach of contract and seeking
a temporary restraining order against Verizon Massachusetts. Verizon
has filed its answer to CoreComm Massachusetts' complaint and filed
counterclaims seeking payment of approximately $1.2 million allegedly
owed by CoreComm Massachusetts under the parties' interconnection
agreement and Verizon's tariffs. During the course of discovery,
Verizon conceded that it had over-billed CoreComm Massachusetts by
approximately $800,000. As a result, CoreComm Massachusetts amended
its complaint to include claims against Verizon for unfair and
deceptive acts or practices in violation of Massachusetts' fair trade
practice laws. Verizon subsequently amended its complaint to specify a
revised claim of $1.1 million. CoreComm Massachusetts ceased offering
local telephone services in Massachusetts in December 2002 and is
presently withdrawing from the market. CoreComm Massachusetts'
withdrawal from providing telephone services in Massachusetts has not
had any material adverse affect on the Company's consolidated
business.
o By letter dated April 4, 2003, the Company received a notice from
Verizon claiming that Verizon is owed approximately $8.4 million by
one of its subsidiaries, CoreComm New York, Inc., for services
allegedly purchased in the state of New York, including approximately
$5.1 million of charges that Verizon contends were mistakenly credited
to the accounts of CoreComm New York, Inc. in connection with the
acquisition out of bankruptcy of certain assets of USN Communications,
Inc. in May 1999. In response, CoreComm New York, Inc. challenged the
accuracy of Verizon's figures and provided formal written notification
that it was disputing Verizon's right to payment of the amounts
specified in Verizon's April 4 letter. Subsequently, by letter dated
June 24, 2003, Verizon made a demand for payment from CoreComm New
York of approximately $6 million of alleged charges, including
approximately $2.3 million of charges that have been disputed by
CoreComm New York and are the subject of pending litigation between
the parties in the federal case in Delaware, and threatening to
implement an embargo on CoreComm New York's accounts if the requested
payment was not received by July 25, 2003. In response, CoreComm New
York challenged Verizon's right to proceed as threatened and Verizon
implemented the embargo over CoreComm New York's objections. CoreComm
New York intends to pursue this matter in its pending litigation with
Verizon, but is not presently able to predict how or when this matter
will be resolved. The operations of CoreComm New York do not represent
a material component of the Company's revenue, profits or operations
and the Company does not anticipate that an embargo of CoreComm New
York's accounts will have a material adverse affect on its business,
finances or results of operations.
15
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o The Company and CoreComm Newco, Inc., an indirect, wholly-owned
subsidiary of the Company, are currently in litigation with SBC Corp.,
Ameritech Ohio and other SBC subsidiaries over various billing and
performance issues, including SBC/Ameritech's alleged violation of the
antitrust laws and the adequacy of SBC/Ameritech's performance under a
1998 contract between CoreComm Newco and Ameritech Ohio. This
litigation began in June 2001 when Ameritech threatened to stop
processing new orders following CoreComm Newco's exercise of its right
under the contract to withhold payments for Ameritech's performance
failures. On October 9, 2001, Ameritech filed an amended complaint in
the United States District Court, Northern District of Ohio seeking a
total of approximately $14.4 million in alleged outstanding charges.
On December 26, 2001, CoreComm Newco filed its answer to Ameritech's
amended complaint and simultaneously filed three counterclaims against
SBC Corp., Ameritech Ohio and certain of their respective subsidiaries
and affiliates, alleging breach of contract, antitrust violations, and
fraudulent or negligent misrepresentation claims. On July 25, 2002,
the Court issued a decision denying a motion to dismiss from Ameritech
and upholding CoreComm Newco's right to proceed with its antitrust,
breach of contract and misrepresentation claims against all
counter-defendants. On January 21, 2003, CoreComm Newco amended its
complaint to include the Company and other affiliates as additional
claimants and to add additional allegations supporting its claims, and
on February 17, 2003, SBC/Ameritech filed its answer to the amended
complaint. On May 22, 2003, the parties entered into a stay agreement
pursuant to which they agreed to jointly petition the Court to suspend
the litigation in all respects, including all claims and
counterclaims, until 15 calendar days after the United States Supreme
Court issues its opinion in the Trinko case, or until further order of
the Court. Pursuant to that agreement, the parties subsequently filed
a joint motion for stay of the litigation, which was granted by the
Court on June 19, 2003.
The Company believes that CoreComm Newco has meritorious defenses to
Ameritech's amended complaint that could reduce the amount currently
in dispute. For example, the figure specified in Ameritech's complaint
may not account for various amounts that have been properly disputed
by CoreComm Newco as a result of billing errors and other improper
charges, various refunds that Ameritech contends it has already
credited to CoreComm Newco's accounts since the filing of the
complaint, and payments that were made by CoreComm Newco in the
ordinary course after the time of Ameritech's submission. However, the
Company cannot be certain how or when the matter will be resolved. The
Company also believes that, to the extent Ameritech prevails with
respect to any of its claims, Ameritech's award may be offset in whole
or in part by amounts that the Company and CoreComm Newco are seeking
to obtain from SBC/Ameritech under their counterclaims. The Company
and CoreComm Newco intend to pursue all available remedies and to
defend themselves vigorously. However, it is impossible at this time
to predict the outcome of the litigation.
16
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o On April 16, 2003, SBC Ohio (formerly known as SBC Ameritech Ohio)
filed with the Public Utilities Commission of Ohio, known as the PUCO,
a third supplement to its application for review of an order entered
by a PUCO Hearing Examiner barring SBC Ohio from refusing to process
new service orders from CoreComm Newco pending the resolution of
various billing disputes at issue between the parties. Among other
things, the April 16 supplement contends that the Hearing Examiner's
entry provided CoreComm Newco with a competitive advantage by allowing
it to withhold payment on approximately $8.7 million of alleged
undisputed charges for local and collocation services in Ohio as of
March 31, 2003. On May 2, 2003, CoreComm Newco submitted a reply to
the April 16 supplement in which it disputed the accuracy of SBC
Ohio's claims and explained that the outstanding balance of
approximately $1.9 million is consistent with common practice
considering SBC Ohio's billing problems and the numerous payment
cycles at issue. On June 20, 2003 CoreComm Newco and the Company's
operating subsidiaries in the states of Illinois, Michigan, Indiana
and Wisconsin entered into a standstill agreement with SBC's operating
subsidiaries in those states pursuant to which the parties agreed to
refrain from taking certain actions against one another for a period
of at least nine months while working to reconcile their respective
accounts. Pursuant to that agreement, SBC Ohio asked the PUCO to place
into abeyence its appeal of the Hearing Examiner's Entry for the
duration of the nine month standstill. CoreComm Newco has already
identified and lodged millions of dollars worth of billing and
performance disputes and is continuing to identify charges that it
believes are not properly owed to SBC Ohio. Should the PUCO litigation
resume, CoreComm Newco intends to defend itself vigorously and to
pursue all available remedies and counterclaims. However, it is not
possible to predict the outcome of this matter at this time.
17
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
o By letters dated April 23, 2003 and April 25, 2003, SBC/Midwest
demanded payment from certain of the Company's subsidiaries of
approximately $9.5 million of alleged undisputed, past due charges for
wholesale services allegedly provided to its operating subsidiaries in
Illinois, Michigan, Indiana and Wisconsin, and threatened to pursue
further collection activities against those entities. The letters
regarding Michigan and Wisconsin requested that the recipients pay
into escrow an unspecified sum for Michigan and approximately $135,240
for Wisconsin in connection with charges that SBC Midwest contends the
Company's subsidiaries have disputed in those states. In response, the
Company's subsidiaries notified SBC Midwest that they are disputing
the accuracy of the figures set forth in its letters as well as its
right to request an escrow deposit to cover disputed charges, and that
they are prepared to engage in further discussions regarding the
various amounts at issue. As noted above, on June 20, 2003, the
Company's operating subsidiaries in Ohio, Illinois, Michigan, Indiana
and Wisconsin entered into a standstill agreement with SBC's operating
subsidiaries in those states pursuant to which the parties agreed to
refrain from taking certain actions against one another for a period
of nine months. The Company's subsidiaries intend to contest any
charges that they believe are not properly owed and to vigorously
pursue all claims and defend themselves against any collections
action. However, the Company is not currently able to predict how or
when these matters will be resolved or what amount, if any, will need
to be paid at the time of resolution.
o On December 3, 2001, General Electric Capital Corp., referred to as
GECC, filed a civil lawsuit in the Circuit Court of Cook County,
Illinois against CCL and MegsINet, Inc., an indirect subsidiary of the
Company, seeking approximately $8 million in allegedly past due
amounts and the return of equipment under a capital equipment lease
agreement between Ascend and MegsINet. Thereafter, on May 1, 2002, the
complaint was amended to add the Company as an additional defendant.
Although neither CCL nor the Company are parties to the agreement
between Ascend and MegsINet, the complaint contends that CCL and/or
the Company should be held responsible for MegsINet's obligations
under an "alter ego" theory of liability. CCL and the Company are
contesting this claim and do not believe that the obligations of
MegsINet are obligations of CCL or the Company.
18
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
Subsequent to the filing of its initial complaint, GECC filed a second
complaint in the Circuit Court of Cook County, Illinois against
MegsINet, CCL and the Company seeking a court order allowing it to
take repossession of its alleged equipment. On September 24, 2002, the
Court issued an order granting GECC's request for repossession of the
equipment. MegsINet has allowed GECC to take possession of the
equipment, which has not had any material impact on the Company's
business or operations. On April 23, 2003, GECC filed a motion for
summary judgment asking the Court to rule in its favor, without the
need for trial, that MegsINet, CCL and the Company breached their
alleged contractual obligations to make required lease payments to
GECC and awarding GECC damages in the amount of $9,100,053 plus
attorneys' fees and interest. MegsINet, CCL and the Company have filed
a consolidated opposition to that motion and oral argument on the
matter was heard by the Court on August 6, 2003. The defendants do not
believe that it would be appropriate for the Court to resolve this
litigation through summary judgment as requested by GECC and they
intend to defend themselves vigorously and to pursue all available
claims and defenses. However, it is impossible at this time to predict
the outcome of the litigation. MegsINet does not represent a material
component of the Company's revenue, profits or operations. All of the
assets of the Company and its subsidiaries, including those of
MegsINet, are subject to a first priority security interest in favor
of the senior lenders under the $156 million senior credit facility.
o On May 25, 2001, KMC Telecom, Inc. and some of its operating
subsidiaries filed an action in the Supreme Court of New York for New
York County against CCL, Cellular Communications of Puerto Rico, Inc.,
CoreComm New York, Inc. and MegsINet. KMC contends that it is owed
approximately $2 million, primarily in respect of alleged early
termination liabilities, under a services agreement and a co-location
agreement with MegsINet. The defendants have denied KMC's claims and
have asserted that the contracts at issue were signed without proper
authorization, that KMC failed to perform under the alleged contracts,
and that the termination penalties are not enforceable. On March 27,
2002, certain of the defendants initiated litigation against several
former principals of MegsINet seeking indemnification and contribution
against KMC's claims for breach of various representations and
warranties made under the merger agreement pursuant to which MegsINet
became a subsidiary of the Company. Defendants have also initiated
coverage under an insurance policy designed to protect against such
claims; the insurance carrier has initially declined coverage and it
may be necessary to pursue litigation to obtain coverage in the event
of a loss under the policy.
19
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o On September 24, 2002, GATX Technologies, Inc., known herein as GATX,
filed an action in the Thirteenth Judicial Circuit in Florida against
CoreComm-Voyager, Inc., an indirect wholly-owned subsidiary of the
Company, seeking recovery of amounts allegedly owed under an equipment
lease totaling approximately $150,000. On October 21, 2002,
CoreComm-Voyager moved to dismiss GATX's action for lack of
jurisdiction. The motion is now pending with the Court. On October 28,
2002, 3Com Corporation, known as 3Com, filed an action against the
Company in the Court of Common Pleas, Montgomery County, Pennsylvania
seeking payment of approximately $900,000 under an equipment lease.
The Company has filed preliminary objections to 3Com's complaint on
the basis that the Company is not a proper party to the dispute, and
the Court has not yet ruled on those objections. Should either action
proceed further, the defendants will defend themselves vigorously and
pursue all available claims. However, it is not possible at this time
to predict how or when either of these matters will be resolved.
o On March 1, 2002, Easton Telecom Services, LLC initiated litigation in
the Northern District of Ohio against CoreComm Internet Group, Inc.
seeking payment of approximately $4.9 million, primarily in respect of
alleged early termination penalties for telecommunications services
purportedly provided under alleged contracts. On August 23, 2002, the
Court issued an order dismissing approximately $4 million of Easton's
claims as invalid. Upon the conclusion of a jury trial that ended on
November 8, 2002, Easton obtained a judgment against CoreComm Internet
Group, Inc., Voyager Information Networks, Inc. and MegsINet in the
total amount of $1,085,000. On February 4, 2003, the defendants filed
an appeal in this matter with the United States Court of Appeals for
the Sixth Circuit, and the plaintiff has filed a cross-appeal.
Plaintiff is currently pursuing discovery in aid of execution on its
judgment against defendants. All of the assets of the Company and its
subsidiaries, including those of the defendants, are subject to a
first priority security interest in favor of the senior lenders under
the $156 million senior credit facility.
o On June 7, 2002, the Board of Revenue and Finance of the Commonwealth
of Pennsylvania issued an order granting in part and denying in part a
petition for review of a decision by a lower administrative authority
relating to the Company's alleged liability for sales and use tax for
the period September 1, 1997 through July 31, 2000. Pursuant to the
June 7 order, the Company has been assessed sales and use tax for the
period at issue in the amount of $631,429, which has been accrued in
the Company's consolidated financial statements. On July 8, 2002, the
Company filed a petition for review of the board's order in the
Commonwealth Court of Pennsylvania seeking a further reduction of the
assessment. The Company believes that it has meritorious defenses and
that the assessment should be reduced; however it is not possible at
this time to predict how this matter will be resolved.
20
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o On February 28, 2003, Focal Communications Corp. and certain of its
subsidiaries initiated adversarial proceedings in Focal's Chapter 11
case under the U.S. bankruptcy laws against the Company and certain of
its subsidiaries seeking payment of an aggregate of approximately
$859,514 in charges for interstate and intrastate switched access
services allegedly provided by Focal's subsidiaries in Illinois,
Pennsylvania, Delaware and New York. On April 7, 2003, Focal filed a
motion for summary adjudication for services allegedly provided to the
Company's subsidiaries operating in Illinois, and these subsidiaries
filed an opposition to that motion challenging the validity of Focal's
charges as well as its right to summary adjudication of the issues. On
August 8, 2003, the bankruptcy court issued a Report and
Recommendation finding that Focal's action is a "non-core" proceeding
and issuing an advisory opinion to the U.S. District Court for the
District of Delaware recommending that summary judgment be granted in
favor of Focal against the Company's operating subsidiaries in the
aggregate amount of $134,376. The Defendants believe that the
recommendation reached by the bankruptcy court is erroneous and the
defendants intend to file objections to the bankruptcy court's report
and recommendation with the District Court. In addition, the
defendants intend to seek a stay from the bankruptcy court of the
pending summary adjudication motions for services allegedly provided
to the Company's subsidiaries operating in Pennsylvania, Delaware and
New York. Although the Company and its subsidiaries continue to
believe that they have meritorious defenses and arguments on appeal,
it is not possible at this time to predict how or when these matters
will be resolved.
o On January 3, 2003, the Company and its indirect subsidiary, MegsINet,
Inc., filed a complaint against Broadwing in the U.S. District Court
for the Eastern District of Pennsylvania seeking the return of
approximately $700,000 in taxes billed by Broadwing in alleged
violation of two Master Service Agreements. The Court issued an order
referring the matter to arbitration pursuant to the terms of the
contract between MegsINet and Broadwing. A schedule for the
arbitration has not yet been established.
21
ITEM 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Results of Operations
Until December 2001, we were a direct, wholly-owned subsidiary of CCL
Historical, Inc. (formerly named CoreComm Limited, known herein as CCL). As a
result of the recapitalization transactions completed in December 2001 and on
July 1, 2002, CCL has been merged into one of our wholly-owned subsidiaries.
Prior to our recapitalization, CCL operated the same businesses that we
currently operate.
In 2001, we significantly revised our business plan to focus on our most
profitable businesses and geographic areas, and reduce our operational costs and
need for capital. In 2001 and 2002, we streamlined our strategy and operations
to focus on our two most successful and promising lines of business. The first
is integrated communications products and other high bandwidth/data/web-oriented
services for the business market. The second is bundled local telephony and
Internet products for the residential market, with a focus on using Internet
interfaces, as well as our call centers, to efficiently sell and install our
products and service our customers. As a result of these changes, we are now
focused primarily in the Mid-Atlantic and Mid-West regions of the U.S.
We have implemented cost savings through a variety of means, including facility
consolidation, efficiency improvements, vendor negotiations, network
optimization and headcount reduction. We have improved our operating efficiency
through improved pricing terms and the elimination of duplicative or unnecessary
network facilities. We have also reduced network costs and capital expenditures
by converting many of our local access lines to more profitable Unbundled
Network Element - Platform pricing from Total Service Resale pricing, which
provides higher margins. In addition, we were able to reduce the number of our
facilities without substantially affecting our service area by leasing enhanced
extended local loops from the incumbent local exchange carriers.
Three Months Ended June 30, 2003 and 2002
The decrease in revenues to $71,934,000 from $75,209,000 is primarily
attributable to a decrease in Internet access services and other revenue
partially offset by an increase in local exchange revenue.
Operating costs include direct cost of sales, network costs and salaries and
related expenses of network personnel. Operating costs decreased to $45,939,000
from $48,758,000 due to a decrease in costs as a result of optimization of our
network and facilities and reduced headcount.
Selling, general and administrative expenses decreased to $20,054,000 from
$20,224,000 due to a decrease in costs as a result of reduced headcount and a
reduction of our facilities.
Corporate expenses include the costs of our officers and headquarters staff, the
costs of operating the headquarters and costs incurred for strategic planning
and evaluation of business opportunities. Corporate expenses increased to
$1,826,000 from $1,616,000 due to increased costs incurred for strategic
planning and other corporate activities.
22
During the three months ended June 30, 2002, we incurred additional costs of
$4,270,000, in connection with our recapitalization, which consisted primarily
of employee incentives, legal fees, accounting fees and printing fees.
During the three months ended June 30, 2003, we incurred other charges of
$293,000, which consist of settlement costs related to legal matters.
Depreciation expense decreased to $6,034,000 from $9,140,000 primarily as a
result of the reduction in the carrying value of our fixed assets during the
fourth quarter of 2002 as determined by fair value analysis performed in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets."
Amortization expense has been eliminated due to the reduction in the carrying
value of our intangible assets as determined by a fair value analysis performed
on October 1, 2002 in accordance with SFAS No. 144.
Interest expense and other increased to $5,613,000 from $3,637,000 primarily due
to the net effect of an increase in the effective interest rate on our senior
secured credit facility and the amortization of debt discount associated with
CCL's 6% Convertible Subordinated Notes. The effective interest rate on our
senior secured credit facility during the three months ended June 30, 2003 and
2002 was 9.75% and 6.75%, respectively.
Six Months Ended June 30, 2003 and 2002
The decrease in revenues to $142,893,000 from $149,520,000 is primarily
attributable to a decrease in Internet access services and other revenue
partially offset by an increase in local exchange revenue.
Operating costs include direct cost of sales, network costs and salaries and
related expenses of network personnel. Operating costs decreased to $91,899,000
from $96,796,000 due to a decrease in costs as a result of optimization of our
network and facilities and reduced headcount.
Selling, general and administrative expenses decreased to $39,629,000 from
$42,537,000 due to a decrease in costs as a result of reduced headcount and a
reduction of our facilities.
Corporate expenses include the costs of our officers and headquarters staff, the
costs of operating the headquarters and costs incurred for strategic planning
and evaluation of business opportunities. Corporate expenses increased to
$3,923,000 from $3,314,000 due to increased costs incurred for strategic
planning and other corporate activities.
During the six months ended June 30, 2002, we incurred additional costs of
$5,452,000, in connection with our recapitalization, which consisted primarily
of employee incentives, legal fees, accounting fees and printing fees.
During the six months ended June 30, 2003, we incurred other charges of
$293,000, which consist of settlement costs related to legal matters.
23
Depreciation expense decreased to $9,799,000 from $18,021,000 primarily as a
result of the reduction in the carrying value of our fixed assets during the
fourth quarter of 2002 as determined by fair value analysis performed in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets."
Amortization expense has been eliminated due to the reduction in the carrying
value of our intangible assets as determined by a fair value analysis performed
on October 1, 2002 in accordance with SFAS No. 144.
Interest expense and other increased to $10,124,000 from $7,406,000, primarily
due to the net effect of an increase in the effective interest rate on our
senior secured credit facility and the amortization of debt discount associated
with CCL's 6% Convertible Subordinated Notes. The effective interest rate on our
senior secured credit facility during the six months ended June 30, 2003 and
2002 was 8.37% and 6.80%, respectively.
24
Liquidity and Capital Resources
Based on our current business plan, we anticipate that we will have sufficient
cash and cash equivalents on hand to fund our operations, capital expenditures
and debt service for the remainder of 2003. Our ability to raise additional
capital in the future will be dependent on a number of factors, such as our
results of operations, the amount of our indebtedness, and also general economic
and market conditions, which are beyond our control. If we are unable to obtain
additional financing or to obtain it on favorable terms, we may be required to
further reduce our operations, forgo business opportunities or take other
actions, each of which could adversely affect our business, results of
operations and financial condition. In addition, we are also involved in
litigation, which if resolved unfavorably to us, could have a material adverse
effect on our business, financial condition and results of operations, including
our ability to fund our operations.
As of June 30, 2003, we had long-term debt, which consisted of a $156.1 million
senior secured credit facility, approximately $18.9 million in principal amount
of 10.75% Unsecured Convertible PIK Notes due 2011 and approximately $8.9
million of capital leases. In addition, as of June 30, 2003, CCL had $4.4
million of 6% Convertible Subordinated Notes outstanding.
On March 31, 2003, we entered into an amendment to our senior secured credit
facility. Under this amendment, the lenders under the facility agreed to defer
interest payments on the outstanding loans during the period beginning March 12,
2003 and ending on February 2, 2004, during which time the loans are accruing
interest at prime plus 5.5% (9.75% at June 30, 2003). In addition, the required
principal payments originally scheduled for 2003, which totaled $1.95 million,
were deferred until February 2, 2004. The lenders have also agreed to waive
and/or amend certain financial covenants set forth in the credit agreement until
February 2, 2004, and also added other financial and operating covenants during
2003, in order to better reflect our current operations. As of June 30, 2003, we
are in compliance with all of the required ratios and covenants contained in our
agreement. We intend to utilize the increased liquidity afforded by the
amendment to invest in several areas of our core operations. In addition, during
this period, we intend to seek and consider strategic alternatives in order to
reduce our overall indebtedness, including amounts under the senior secured
credit facility. Such strategic alternatives may include, among other things,
debt or equity financings or refinancings, recapitalizations, restructurings,
mergers and acquisitions or other transactions. It is likely that any of such
transactions, if implemented, would result in material dilution to common
stockholders.
Although the amendment has been designed to provide us with significant relief
from cash obligations under the senior secured credit facility until February 2,
2004, there can be no assurance that the financial and other covenants under the
facility will continue to be met or that we will be successful in identifying or
implementing one or more strategic alternatives to reduce our indebtedness. In
addition, based on our current business plan, we do not expect that we will have
the cash available to fund the required deferred interest and principal payments
on or before February 2, 2004, the date on which such payments become due.
Accordingly, there can be no assurance that there will not be an event of
default under the credit facility at that time, or that we will be able to enter
into additional amendments to the senior secured credit facility by that time.
25
Taking the amendment into effect, debt service on the senior secured credit
facility includes approximately $1.7 million in cash interest expense paid in
2003, $23.0 million due in 2004 and $8.6 million due in 2005, on an annualized
basis, based on current interest rates, as well as quarterly amortization and
principal reductions which total $0 in 2003, $11.7 million in 2004, and $25.4
million in 2005. The 10.75% Unsecured Convertible PIK Notes due 2011 have no
cash interest payments, and are not due until 2011. As of June 30, 2003, our
current liabilities exceed our current assets by approximately $111 million.
Under our current business plan, capital expenditures remain significantly
reduced from their historical levels. Total actual capital expenditures for the
six months ended June 30, 2003, described as cash used to purchase fixed assets
in our cash flow statement, were approximately $4.7 million. According to our
current plans, capital expenditures are expected to be approximately $4.2
million during the remainder of 2003, $8.9 million in 2004, and $10.2 million in
2005. These future capital expenditures will depend on a number of factors
relating to our business, in particular the growth level, geographic location
and services provided to new customers added during these years. Capital
expenditures in future years will also depend on the availability of capital and
the amount of cash, if any, generated by operations, which may impact our
capital decisions relating to initiatives such as, for example, network
expansion and the implementation of upgrades to our information services
platforms.
For the first six months of 2003, cash provided by operating activities was
approximately $1.4 million. If we are unable to continue to generate cash from
operations and/or raise additional financing, it may affect our ability to meet
our cash requirements, which may have an adverse affect on us, and potentially
our viability as an ongoing business.
Our capital requirements in 2003 and thereafter will depend on the success of
the continued execution of our business plan, and the amount of capital required
to fund future capital expenditures and other working capital requirements that
exceed net cash provided by operating activities. We anticipate that we will not
generate sufficient cash flow from operations to repay at maturity the entire
principal amount of our outstanding indebtedness. In addition, based on our
current business plan, we do not expect that we will have the cash available to
fund the required deferred interest and principal payments on or before February
2, 2004, the date on which such payments become due. In addition, we anticipate
that we may be required to raise additional capital in the future in order to
fund the capital expenditures and other working capital requirements that exceed
net cash provided by operating activities.
26
Accordingly, we may be required to consider a number of measures, including: (1)
seeking modifications or waivers to certain provisions of the terms of our
indebtedness, (2) refinancing all or a portion of our indebtedness, (3) seeking
additional debt financing, which may be subject to obtaining necessary lender
consents, (4) seeking additional equity financing, (5) completing a
recapitalization or restructuring of our indebtedness or (6) a combination of
the foregoing. The consideration, timing and implementation of such measures
will depend upon the success of the execution of our business plan, the amount
of capital required to fund our operations in the future and the terms of any
financings or other transactions that we may consider.
In addition, we cannot assure you that:
(a) actual costs will not exceed the amounts estimated in our business
plan or that additional funding will not be required;
(b) we will prevail in our material litigation matters as described in
Note 11 to the condensed consolidated financial statements;
(c) we and our subsidiaries will be able to generate sufficient cash from
operations to meet capital requirements, debt service and other
obligations when required;
(d) we will be able to continue to be in compliance with all required
ratios and covenants contained in agreements governing our outstanding
indebtedness or that we will be able to modify the requirements or
terms of such indebtedness;
(e) we will be able to refinance our indebtedness as it comes due;
(f) we will be able to sell our assets or businesses (the net proceeds
from a sale may be required to be used to repay certain indebtedness);
(g) we will not be adversely affected by interest rate fluctuations; or
(h) we will be able to access the cash flow of our subsidiaries.
27
The following table shows our aggregate cash interest expense and principal
payments on our existing long-term debt, anticipated capital expenditures,
payments on capital leases and other debt, as well as the sources of funds that
we expect to use to meet these cash requirements through 2005.
Six Months For the Year Ended
Ended December 31, December 31,
------------------- ----------------------
2003 2004 2005 Source of Funds
----------------- --------- ------------ ---------------------------------------------
(in millions)
Cash interest expense on $ 0.5 $ 23.3 $ 8.9 For 2003: cash and cash equivalents on hand
existing long-term debt (1) and cash from operations; for 2004 and
2005: cash and cash equivalents on hand,
cash from operations and, if required,
refinancing or other sources of financing
(4)
Estimated capital 4.2 8.9 10.2 Cash and cash equivalents on hand and cash
expenditures (2) from operations
Principal payments on existing - Cash and cash equivalents on hand, cash
long-term debt (3) 11.7 25.4 from operations and, if required,
refinancing or other sources of financing.
(4)
Payments on Capital Leases 8.9 - - Approximately $8.0 million of these capital
leases are obligations of our subsidiary
MegsINet Internet, Inc. and are not our
obligations. The source of funds for the
remaining amounts: cash and cash
equivalents on hand and cash from
operations (5)
----------------- --------- ------------
$13.6 $ 43.9 $ 44.5
================= ========= ============
(1) During the remainder of 2003, the only long-term debt that requires cash
interest expense is CCL's $4.4 million 6% Convertible Subordinated Notes.
(2) Future capital expenditures will depend on a number of factors relating to
our business, in particular the growth level, geographic location and
services provided to new customers during these years.
(3) Principal payments indicated are principal reductions under our senior
secured credit facility. The 2003 amount excludes the outstanding $4.4
million 6% Convertible Subordinated Notes due 2006 of CCL. CCL is in
default on these notes.
(4) Refinancing sources may include, for example, a new bank facility used to
repay these amounts; other sources of financing may include capital raised
through new debt or equity financing or asset sales. There can be no
assurance that we will be able to refinance our indebtedness or raise the
required funds. Based on our current business plan, we do not expect that
we will have the cash available to fund the required deferred interest and
principal payments on or before February 2, 2004, the date on which such
payments become due.
(5) Approximately $8.0 million of the capital lease and other debt obligations
of MegsINet Internet, Inc. are the subject of current litigation, as
described in Part II, Item I of this Quarterly Report on Form 10-Q entitled
"Legal Proceedings."
28
Although we believe that our plans, intentions and expectations as reflected in
or suggested by these forward-looking statements are reasonable as of the date
of this quarterly report, we can give no assurance that our plans, intentions
and expectations will be achieved in a timely manner if at all.
In addition, we are a holding company with no significant assets other than cash
and securities and investments in, and advances to, our subsidiaries. We are,
therefore, likely to be dependent upon receipt of funds from our subsidiaries to
meet our own obligations. However, our subsidiaries' debt agreements prevent the
payment of dividends, loans or other distributions to us, except in limited
circumstances. However, the limited permitted circumstances of distributions
from our subsidiaries may be sufficient for our operations, because nearly all
of the uses of funds described above are cash requirements of our subsidiaries.
Contractual Obligations and Commercial Commitments
Our contractual obligations and commercial commitments are summarized below, and
are fully disclosed in the Notes to the Condensed Consolidated Financial
Statements.
The following table includes aggregate information about our contractual
obligations as of June 30, 2003 and the periods in which payments are due:
Payments Due by Period
-----------------------------------------------------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 Year Years Years Years
----------------------------------------------------------------------------------------------------------------------
(in thousands)
Long-Term Debt (1) $ 179,383 $ 10,208 $ 44,850 $ 85,800 $ 38,525
Capital Lease Obligations 8,866 8,866 - - -
Operating Lease Obligations 23,594 5,283 9,607 6,473 2,231
Unconditional Purchase Obligations - - - - -
Other Long-Term Obligations.... - - - - -
-----------------------------------------------------------------
Total Contractual Cash Obligations $ 211,843 $ 24,357 $ 54,457 $ 92,273 $ 40,756
=================================================================
(1) Long-term debt includes the senior secured credit facility of $156,100,000,
10.75% Unsecured Convertible PIK Notes due April 2011 of $18,925,000
including accrued PIK interest, and CCL's 6% Convertible Subordinated Notes
due 2006 of $4,358,000. The Convertible Subordinated Notes due 2006 of
$4,358,000 have been reflected as due in less than one year because CCL is
currently in default of this obligation.
29
The following table includes aggregate information about our commercial
commitments as of June 30, 2003 and the periods in which payments are due.
Commercial commitments are items that we could be obligated to pay in the
future. They are not required to be included in the consolidated balance sheet.
Amount of Commitment Expiration Per Period
------------------------------------------------------------------
Less than 1 1 - 3 4 - 5 Over 5
Other Commercial Commitments Total Year Years Years Years
-----------------------------------------------------------------------------------------------------------------------
(in thousands)
Guarantees $ - $ - $ - $ - $ -
Lines of Credit - - - - -
Standby Letters of Credit 2,704 2,704 - - -
Standby Repurchase Obligations - - - - -
Other Commercial Commitments 2,894 2,894 - - -
-----------------------------------------------------------------
Total Commercial Commitments $ 5,598 $ 5,598 $ - $ - $ -
=================================================================
Consolidated Statement of Cash Flows
For the six months ended June 30, 2003, cash provided by operating activities
increased to $1,380,000 from $1,126,000 for the six months ended June 30, 2002.
The change in cash provided by operating activities is primarily due to changes
in our operating assets and liabilities.
For the six months ended June 30, 2003, cash used to purchase fixed assets
decreased to $4,728,000 from $5,448,000 for the six months ended June 30, 2002,
which reflects decreased purchases of operating equipment.
30
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Certain statements contained herein constitute "forward-looking statements" as
that term is defined under the Private Securities Litigation Reform Act of 1995.
When used herein, the words, "believe," "anticipate," "plan," "will," "expects,"
"projects," "positioned," "strategy," "targeted" and similar expressions
identify such forward-looking statements. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors that may cause
the actual results, performance or achievements of the Company, or industry
results, to be materially different from those contemplated, projected,
forecasted, estimated or budgeted, whether expressed or implied, by such
forward-looking statements. Such factors include, without limitation, the
following: the ability of the Company to obtain trade credit and shipments and
terms with vendors and service providers for current orders; the Company's
ability to maintain contracts that are critical to its operations; the ability
to remain in compliance with all required ratios and covenants contained in
agreements governing its outstanding indebtedness; the Company's ability to
identify or implement one or more strategic alternatives to reduce the Company's
indebtedness; the ability of the Company to generate sufficient cash to fund its
interest and principal payments when such payments become due; potential adverse
developments with respect to the Company's liquidity or results of operations;
the ability to fund and execute its business plan; the ability of the Company to
continue as a going concern; potential adverse developments resulting from
litigation; the ability to attract, retain and compensate key executives and
associates; the ability of the Company to attract and retain customers; general
economic and business conditions, technological developments, the Company's
ability to continue to design networks, install facilities, obtain and maintain
any required governmental licenses or approvals and finance construction and
development, all in a timely manner at reasonable costs and on satisfactory
terms and conditions, as well as assumptions about customer acceptance, churn
rates, overall market penetration and competition from providers of alternative
services, the impact of restructuring and integration actions, the impact of new
business opportunities requiring significant up-front investment, interest rate
fluctuations and availability, terms and deployment of capital. The Company
assumes no obligation to update the forward-looking statements contained herein
to reflect actual results, changes in assumptions or changes in factors
affecting such statements.
We encourage you to review the risk factors relating to our business and our
industry set forth in Item 1 of our Annual Report on Form 10-K for the year
ended December 31, 2002.
31
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
The SEC's rule relating to market risk disclosure requires that we describe and
quantify our potential losses from market risk sensitive instruments
attributable to reasonably possible market changes. Market risk sensitive
instruments include all financial or commodity instruments and other financial
instruments, such as investments and debt, that are sensitive to future changes
in interest rates, currency exchange rates, commodity prices or other market
factors. We are not exposed to market risks from changes in foreign currency
exchange rates or commodity prices. We do not hold derivative financial
instruments nor do we hold securities for trading or speculative purposes. Under
our current policies, we do not use interest rate derivative instruments to
manage our exposure to interest rate changes.
The fair market value of long-term fixed interest rate debt is subject to
interest rate risk. Generally, the fair market value of fixed interest rate debt
will increase as interest rates fall and decrease as interest rates rise. The
carrying amount of the variable rate senior secured credit facility approximates
the fair value. The fair value of our other notes payable are estimated using
discounted cash flow analyses, based on our current incremental borrowing rates
for similar types of borrowing arrangements.
Interest Rate Sensitivity
As of June 30, 2003
Principal Amount by Expected Maturity
Average Interest Rate
July 1, 2003
to
December 31, For the Years Ending December 31,
-----------------------------------------------------------
Fair
2003 2004 2005 2006 2007 Thereafter Total Value
---------------------------------------------------------------------------------------------
Long-term debt,
including current
portion:
Fixed rate $ 4,358 $-- $-- $-- $-- $46,909(a) $51,267 $ - (c)
Average interest rate 6.00% 10.75%
Variable rate $ -- $11,700 $25,350 $50,700 $39,000 $29,350 $156,100 $ - (c)
Average interest rate
Base rate Libor + Libor + Libor + Libor + Libor +
+ 5.5%(b) 4.5% or 4.5% or 4.5% or 4.5% or 4.5% or
base rate base rate base rate Base rate base rate
+ 3.5%(b) + 3.5% + 3.5% + 3.5% + 3.5%
(a) Represents the value at maturity of 10.75% Unsecured Convertible PIK
Notes due April 2011.
(b) On March 31, 2003, we entered into an amendment to our senior secured
credit facility. Under this amendment, the lenders under the facility
agreed to defer interest payments on the outstanding loans during the
period beginning March 12, 2003 and ending on February 2, 2004, during
which time the loans will accrue interest at the base rate plus 5.5%.
(c) Amounts not determinable.
32
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures - Under the
supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a-14(c) and
15d-14(c) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act")) as of June 30, 2003 (the "Evaluation Date"). Based on
such evaluation, such officers have concluded that, as of the
Evaluation Date, the Company's disclosure controls and procedures are
effective in alerting them on a timely basis to material information
relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's reports filed or submitted
under the Exchange Act.
(b) Changes in Internal Controls - Since the Evaluation Date, there have
not been any significant changes in the Company's internal controls or
in other factors that could significantly affect such controls.
33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Through our various operating subsidiaries, we purchase goods and services from
a wide variety of vendors under contractual and other arrangements that
sometimes give rise to litigation in the ordinary course of business. Our
subsidiaries also provide goods and services to a wide range of customers under
arrangements that sometimes lead to disputes over payment, performance and other
obligations. Some of these disputes, regardless of their merit, could subject us
to costly litigation and the diversion of technical and/or management personnel.
Additionally, in light of our ongoing litigation and other disputes with various
local exchange carriers, some of whom we depend upon for certain services, from
time to time, those carriers have and will likely continue to threaten service
disruptions or terminations. Certain service disruptions or terminations, if
actually implemented, could have a material adverse effect on our business.
Additionally, liabilities from litigation that are not covered by insurance or
that exceed such coverage could have a material adverse effect on our business,
finances and/or results of operations.
Currently, we have the following outstanding matters, which if resolved
unfavorably to us, could have a material adverse effect on us:
o On August 12, 2002, Verizon Communications, Inc. and several of its
subsidiaries filed a complaint in the United States District Court for
the District of Delaware against us and several of our indirect
wholly-owned subsidiaries, referred to herein as the defendants,
seeking payment of approximately $37 million allegedly owed to Verizon
under various contracts and state and federal law. Verizon also asked
the Court to issue a declaratory ruling that it has not violated the
antitrust laws.
The defendants believe that they have meritorious defenses to the
complaint, and further, that the amounts owed are substantially less
than the amounts claimed by Verizon. For example, the defendants
believe the figure specified in the complaint includes payments that
have been made by the defendants to Verizon (including in excess of
$14 million paid soon after the filing of the complaint), credits that
Verizon has issued to the defendants since the filing of the
complaint, and additional disputes for which Verizon owes credits to
the defendants. The defendants have filed an answer to Verizon's
complaint denying Verizon's claims, in part, and have asserted various
counterclaims against Verizon, including claims seeking damages for
breach of contract and treble damages for violating the antitrust
laws. The defendants have also moved to dismiss Verizon's request for
a declaratory ruling on the antitrust claims, which Verizon has
opposed.
34
On November 18, 2002, Verizon filed a motion to dismiss defendants'
antitrust counterclaims, relying heavily on a decision by the United
States Court of Appeals for the 7th Circuit in Goldwasser vs.
Ameritech Corp., 222 F.3d 390 (7th Cir. 2000) dismissing antitrust
claims brought on behalf of a class of consumers who had purchased
services from Ameritech in Illinois. On January 9, 2003, the
defendants filed their opposition to Verizon's motion, noting not only
that the Goldwasser case is distinguishable from the defendants'
antitrust claims, but also that the appellate court's rationale in
Goldwasser had been effectively repudiated by the appellate courts of
the 2nd and 11th circuits, as well as by a federal trial court in the
antitrust claim raised by us against SBC/Ameritech in the United
States District Court for the Northern District of Ohio.
On March 20, 2003, the Court issued an order denying the parties'
respective motions without prejudice to renew, pending a decision by
the United States Supreme Court in Verizon Communications, Inc. vs.
Law Offices of Curtis V. Trinko, LLP, Supreme Court Docket No. 02-682
(cert. granted March 10, 2003). By order of the Court issued May 6,
2003, the parties have been directed to proceed with discovery on all
issues. We and our subsidiaries intend to pursue all available
remedies and counterclaims and defend ourselves vigorously; however,
we and our subsidiaries cannot be certain how or when these matters
will be resolved or of the outcome of the litigation.
o On March 7, 2002, CoreComm Massachusetts, Inc., an indirect
wholly-owned subsidiary of ours, initiated litigation against Verizon
New England d/b/a Verizon Massachusetts in the Suffolk Superior Court,
Massachusetts, alleging breach of contract and seeking a temporary
restraining order against Verizon Massachusetts. Verizon has filed its
answer to CoreComm Massachusetts' complaint and filed counterclaims
seeking payment of approximately $1.2 million allegedly owed by
CoreComm Massachusetts under the parties' interconnection agreement
and Verizon's tariffs. During the course of discovery, Verizon
conceded that it had over-billed CoreComm Massachusetts by
approximately $800,000. As a result, CoreComm Massachusetts amended
its complaint to include claims against Verizon for unfair and
deceptive acts or practices in violation of Massachusetts' fair trade
practice laws. Verizon subsequently amended its complaint to specify a
revised claim of $1.1 million. CoreComm Massachusetts ceased offering
local telephone services in Massachusetts in December 2002 and is
presently withdrawing from the market. CoreComm Massachusetts'
withdrawal from providing telephone services in Massachusetts has not
had any material adverse affect on our consolidated business.
35
o By letter dated April 4, 2003, we received a notice from Verizon
claiming that Verizon is owed approximately $8.4 million by one of our
subsidiaries, CoreComm New York, Inc., for services allegedly
purchased in the state of New York, including approximately $5.1
million of charges that Verizon contends were mistakenly credited to
the accounts of CoreComm New York, Inc. in connection with the
acquisition out of bankruptcy of certain assets of USN Communications,
Inc. in May 1999. In response, CoreComm New York, Inc. challenged the
accuracy of Verizon's figures and provided formal written notification
that it was disputing Verizon's right to payment of the amounts
specified in Verizon's April 4 letter. Subsequently, by letter dated
June 24, 2003, Verizon made a demand for payment from CoreComm New
York of approximately $6 million of alleged charges, including
approximately $2.3 million of charges that have been disputed by
CoreComm New York and are the subject of pending litigation between
the parties in the federal case in Delaware, and threatening to
implement an embargo on CoreComm New York's accounts if the requested
payment was not received by July 25, 2003. In response, CoreComm New
York challenged Verizon's right to proceed as threatened and Verizon
implemented the embargo over CoreComm New York's objections. CoreComm
New York intends to pursue this matter in its pending litigation with
Verizon, but is not presently able to predict how or when this matter
will be resolved. The operations of CoreComm New York do not represent
a material component of our revenue, profits or operations and we do
not anticipate that an embargo of CoreComm New York's accounts will
have a material adverse affect on our business, finances or results of
operations.
o We and CoreComm Newco, Inc., an indirect, wholly-owned subsidiary of
ours, are currently in litigation with SBC Corp., Ameritech Ohio and
other SBC subsidiaries over various billing and performance issues,
including SBC/Ameritech's alleged violation of the antitrust laws and
the adequacy of SBC/Ameritech's performance under a 1998 contract
between CoreComm Newco and Ameritech Ohio. This litigation began in
June 2001 when Ameritech threatened to stop processing new orders
following CoreComm Newco's exercise of its right under the contract to
withhold payments for Ameritech's performance failures. On October 9,
2001, Ameritech filed an amended complaint in the United States
District Court, Northern District of Ohio seeking a total of
approximately $14.4 million in alleged outstanding charges.
On December 26, 2001, CoreComm Newco filed its answer to Ameritech's
amended complaint and simultaneously filed three counterclaims against
SBC Corp., Ameritech Ohio and certain of their respective subsidiaries
and affiliates, alleging breach of contract, antitrust violations, and
fraudulent or negligent misrepresentation claims. On July 25, 2002,
the district Court issued a decision denying a motion to dismiss from
Ameritech and upholding CoreComm Newco's right to proceed with its
antitrust, breach of contract and misrepresentation claims against all
counter-defendants. On January 21, 2003, CoreComm Newco amended its
complaint to include the Company and other affiliates as additional
claimants and to add additional allegations supporting its claims, and
on February 17, 2003, SBC/Ameritech filed its answer to the amended
complaint. On May 22, 2003, the parties entered into a stay agreement
pursuant to which they agreed to jointly petition the Court to suspend
the litigation in all respects, including all claims and
counterclaims, until 15 calendar days after the United States Supreme
Court issues its opinion in the Trinko case, or until further order of
the Court. Pursuant to that agreement, the parties subsequently filed
a joint motion for stay of the litigation, which was granted by the
Court on June 19, 2003.
36
We believe that CoreComm Newco has meritorious defenses to Ameritech's
amended complaint that could reduce the amount currently in dispute.
For example, the figure specified in Ameritech's complaint may not
account for various amounts that have been properly disputed by
CoreComm Newco as a result of billing errors and other improper
charges, various refunds that Ameritech contends it has already
credited to CoreComm Newco's accounts since the filing of the
complaint, and payments that were made by CoreComm Newco in the
ordinary course after the time of Ameritech's submission. However, we
cannot be certain how or when the matter will be resolved. We also
believes that, to the extent Ameritech prevails with respect to any of
its claims, Ameritech's award may be offset in whole or in part by
amounts that CoreComm Newco and we are seeking to obtain from
SBC/Ameritech under their counterclaims. CoreComm Newco and we intend
to pursue all available remedies and to defend themselves vigorously.
However, it is impossible at this time to predict the outcome of the
litigation.
o On April 16, 2003, SBC Ohio (formerly known as SBC Ameritech Ohio)
filed with the Public Utilities Commission of Ohio, known as the PUCO,
a third supplement to its application for review of an order entered
by a PUCO Hearing Examiner barring SBC Ohio from refusing to process
new service orders from CoreComm Newco pending the resolution of
various billing disputes at issue between the parties. Among other
things, the April 16 supplement contends that the Hearing Examiner's
entry provided CoreComm Newco with a competitive advantage by allowing
it to withhold payment on approximately $8.7 million of alleged
undisputed charges for local and collocation services in Ohio as of
March 31, 2003. On May 2, 2003, CoreComm Newco submitted a reply to
the April 16 supplement in which it disputed the accuracy of SBC
Ohio's claims and explained that the outstanding balance of
approximately $1.9 million is consistent with common practice
considering SBC Ohio's billing problems and the numerous payment
cycles at issue. On June 20, 2003 CoreComm Newco and our operating
subsidiaries in the states of Illinois, Michigan, Indiana and
Wisconsin entered into a standstill agreement with SBC's operating
subsidiaries in those states pursuant to which the parties agreed to
refrain from taking certain actions against one another for a period
of at least nine months while working to reconcile their respective
accounts. Pursuant to that agreement, SBC Ohio asked the PUCO to place
into abeyence its appeal of the Hearing Examiner's Entry for the
duration of the nine month standstill. CoreComm Newco has already
identified and lodged millions of dollars worth of billing and
performance disputes and is continuing to identify charges that it
believes are not properly owed to SBC Ohio. Should the PUCO litigation
resume, CoreComm Newco intends to defend itself vigorously and to
pursue all available remedies and counterclaims. However, it is not
possible to predict the outcome of this matter at this time.
37
o By letters dated April 23, 2003 and April 25, 2003, SBC/Midwest
demanded payment from certain of the Company's subsidiaries
approximately $9.5 million of alleged undisputed, past due charges for
wholesale services allegedly provided to our operating subsidiaries in
Illinois, Michigan, Indiana and Wisconsin, and threatened to pursue
further collection activities against those entities. The letters
regarding Michigan and Wisconsin requested that the recipients pay
into escrow an unspecified sum for Michigan and approximately $135,240
for Wisconsin in connection with charges that SBC Midwest contends our
subsidiaries have disputed in those states. In response, our
subsidiaries notified SBC Midwest that they are disputing the accuracy
of the figures set forth in its letters as well as its right to
request an escrow deposit to cover disputed charges, and that they are
prepared to engage in further discussions regarding the various
amounts at issue. As noted above, on June 20, 2003, our operating
subsidiaries in Ohio, Illinois, Michigan, Indiana and Wisconsin
entered into a standstill agreement with SBC's operating subsidiaries
in those states pursuant to which the parties agreed to refrain from
taking certain actions against one another for a period of nine
months. Our subsidiaries intend to contest any charges that they
believe are not properly owed and to vigorously pursue all claims and
defend themselves against any collections action. However, we are not
currently able to predict how or when these matters will be resolved
or what amount, if any, will need to be paid at the time of
resolution.
o On December 3, 2001, General Electric Capital Corp., referred to as
GECC, filed a civil lawsuit in the Circuit Court of Cook County,
Illinois against CCL and MegsINet, Inc., an indirect subsidiary of
ours, seeking approximately $8 million in allegedly past due amounts
and the return of equipment under a capital equipment lease agreement
between Ascend and MegsINet. Thereafter, on May 1, 2002, the complaint
was amended to add us as an additional defendant. Although neither CCL
nor we are parties to the agreement between Ascend and MegsINet, the
complaint contends that CCL and/or we should be held responsible for
MegsINet's obligations under an "alter ego" theory of liability. CCL
and we are contesting this claim and do not believe that the
obligations of MegsINet are obligations of CCL or us.
38
Subsequent to the filing of its initial complaint, GECC filed a second
complaint in the Circuit Court of Cook County, Illinois against
MegsINet, CCL and us seeking a court order allowing it to take
repossession of its alleged equipment. On September 24, 2002, the
Court issued an order granting GECC's request for repossession of the
equipment. MegsINet has allowed GECC to take possession of the
equipment, which has not had any material impact on our business or
operations. On April 23, 2003, GECC filed a motion for summary
judgment asking the Court to rule in its favor, without the need for
trial, that MegsINet, CCL and ATX breached their alleged contractual
obligations to make required lease payments to GECC and awarding GECC
damages in the amount of $9,100,053 plus attorneys' fees and interest.
MegsINet, CCL and us have filed a consolidated opposition to that
motion and oral argument on the matter was heard by the Court on
August 6, 2003. The defendants do not believe that it would be
appropriate for the court to resolve this litigation through summary
judgment as requested by GECC and they intend to defend themselves
vigorously and to pursue all available claims and defenses. However,
it is impossible at this time to predict the outcome of the
litigation. MegsINet does not represent a material component of our
revenue, profits or operations. All of our assets and those of our
subsidiaries, including those of MegsINet, are subject to a first
priority security interest in favor the senior lenders under the $156
million Senior Credit Facility.
o On May 25, 2001, KMC Telecom, Inc. and some of our operating
subsidiaries filed an action in the Supreme Court of New York for New
York County against CCL, Cellular Communications of Puerto Rico, Inc.,
CoreComm New York, Inc. and MegsINet. KMC contends that it is owed
approximately $2 million, primarily in respect of alleged early
termination liabilities, under a services agreement and a co-location
agreement with MegsINet. The defendants have denied KMC's claims and
have asserted that the contracts at issue were signed without proper
authorization, that KMC failed to perform under the alleged contracts,
and that the termination penalties are not enforceable. On March 27,
2002, certain of the defendants initiated litigation against several
former principals of MegsINet seeking indemnification and contribution
against KMC's claims for breach of various representations and
warranties made under the merger agreement pursuant to which MegsINet
became a subsidiary of ours. Defendants have also initiated coverage
under an insurance policy designed to protect against such claims; the
insurance carrier has initially declined coverage and it may be
necessary to pursue litigation to obtain coverage in the event of a
loss under the policy.
39
o On September 24, 2002, GATX Technologies, Inc., known herein as GATX,
filed an action in the Thirteenth Judicial Circuit in Florida against
CoreComm-Voyager, Inc., an indirect wholly-owned subsidiary of ours,
seeking recovery of amounts allegedly owed under an equipment lease
totaling approximately $150,000. On October 21, 2002, CoreComm-Voyager
moved to dismiss GATX's action for lack of jurisdiction. The motion is
now pending with the Court. On October 28, 2002, 3Com Corporation,
known as 3Com, filed an action against the Company in the Court of
Common Pleas, Montgomery County, Pennsylvania seeking payment of
approximately $900,000 under an equipment lease. We have filed
preliminary objections to 3Com's complaint on the basis that we are
not a proper party to the dispute, and the Court has not yet ruled on
those objections. Should either action proceed further, the defendants
will defend themselves vigorously and pursue all available claims.
However, it is not possible at this time to predict how or when either
of these matters will be resolved.
o On March 1, 2002, Easton Telecom Services, LLC initiated litigation in
the Northern District of Ohio against CoreComm Internet Group, Inc.
seeking payment of approximately $4.9 million, primarily in respect of
alleged early termination penalties for telecommunications services
purportedly provided under alleged contracts. On August 23, 2002, the
Court issued an order dismissing approximately $4 million of Easton's
claims as invalid. Upon the conclusion of a jury trial that ended on
November 8, 2002, Easton obtained a judgment against CoreComm Internet
Group, Inc., Voyager Information Networks, Inc. and MegsINet in the
total amount of $1,085,000. On February 4, 2003, the defendants filed
an appeal in this matter with the United States Court of Appeals for
the Sixth Circuit, and the plaintiff has filed a cross-appeal.
Plaintiff is currently pursuing discovery in aid of execution on its
judgment against defendants. All of our assets and those of our
subsidiaries, including those of the defendants, are subject to a
first priority security interest in favor of the senior lenders under
the $156 million senior credit facility.
40
o On June 7, 2002, the Board of Revenue and Finance of the Commonwealth
of Pennsylvania issued an order granting in part and denying in part a
petition for review of a decision by a lower administrative authority
relating to our alleged liability for sales and use tax for the period
September 1, 1997 through July 31, 2000. Pursuant to the June 7 order,
we have been assessed sales and use tax for the period at issue in the
amount of $631,429, which has been accrued in our consolidated
financial statements. On July 8, 2002, we filed a petition for review
of the board's order in the Commonwealth Court of Pennsylvania seeking
a further reduction of the assessment. We believe that we have
meritorious defenses and that the assessment should be reduced;
however it is not possible at this time to predict how this matter
will be resolved
o On February 28, 2003, Focal Communications Corp. and certain of its
subsidiaries initiated adversarial proceedings in Focal's Chapter 11
case under the U.S. bankruptcy laws against us and certain of our
subsidiaries seeking payment of an aggregate of approximately $859,514
in charges for interstate and intrastate switched access services
allegedly provided by Focal's subsidiaries in Illinois, Pennsylvania,
Delaware and New York. On April 7, 2003, Focal filed a motion for
summary adjudication for services allegedly provided to our
subsidiaries operating in Illinois, and these subsidiaries filed an
opposition to that motion challenging the validity of Focal's charges
as well as its right to summary adjudication of the issues. On August
8, 2003, the bankruptcy court issued a Report and Recommendation
finding that Focal's action is a "non-core" proceeding and issuing an
advisory opinion to the U.S. District Court for the District of
Delaware recommending that summary judgment be granted in favor of
Focal against our operating subsidiaries in the aggregate amount of
$134,376. The Defendants believe that the recommendation reached by
the bankruptcy court is erroneous and the defendants intend to file
objections to the bankruptcy court's report and recommendation with
the District Court. In addition, the defendants intend to seek a stay
from the bankruptcy court of the pending summary adjudication motions
for services allegedly provided to our subsidiaries operating in
Pennsylvania, Delaware and New York. Although we and our subsidiaries
continue to believe that we have meritorious defenses and arguments on
appeal, it is not possible at this time to predict how or when these
matters will be resolved.
o On January 3, 2003, we and our indirect subsidiary, MegsINet, Inc.,
filed a complaint against Broadwing in the U.S. District Court for the
Eastern District of Pennsylvania seeking the return of approximately
$700,000 in taxes billed by Broadwing in alleged violation of two
Master Service Agreements. The Court issued an order referring the
matter to arbitration pursuant to the terms of the contract between
MegsINet and Broadwing. A schedule for the arbitration has not yet
been established.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 9, 2003, we issued 300,000 shares of common stock in consideration for
settlement of certain litigation issues. This distribution was made in
accordance with the exemption from registration provided under Section 4(2) of
the Securities Act of 1933.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
31.1 Certification dated August 12, 2003 pursuant to Exchange Act Rule
13a-14(a) or 15d-14(a) of principal executive officer as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2003, by
Thomas J. Gravina, President - Chief Executive Officer.
31.2 Certification dated August 12, 2003 pursuant to Exchange Act Rule
13a-14(a) or 15d-14(a) of principal financial officer as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2003, by
Michael A. Peterson, Executive Vice President - Chief Operating
Officer and Chief Financial Officer.
32.1 Certification dated August 12, 2003 pursuant to 18 U.S.C. Section
1350 of CEO and CFO pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by
Thomas J. Gravina, President - Chief Executive Officer, and
Michael A. Peterson, Executive Vice President - Chief Operating
Officer and Chief Financial Officer
(b) Reports on Form 8-K.
During the quarter ended June 30, 2003, ATX Communications filed
the following reports on Form 8-K:
(i) Report dated April 10, 2003, reporting under Item 7,
Exhibits, ATX Communications, Inc. announced its operating
results for the year ended December 31, 2002
(ii) Report dated May 15, 2003, reporting under Item 9,
Regulation FD disclosure, that ATX Communications, Inc.
announced its consolidated operating results for the quarter
ended March 31, 2003.
No financial statements were filed with these reports.
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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.
ATX COMMUNICATIONS, INC.
Date: August 12, 2003 By: /s/ Michael A. Peterson
-----------------------------------
Michael A. Peterson
Executive Vice President -
Chief Operating Officer and
Chief Financial Officer
Date: August 12, 2003 By: /s/ Neil Peritz
-----------------------------
Neil Peritz
Senior Vice President - Controller
and Treasurer (Principal Accounting
Officer)
43