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 September 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 (I.R.S. Employer Identification No.)
incorporation 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 ___
Indicate by check mark whether the registrant is an accelerated filer (As
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
The number of shares outstanding of the issuer's common stock as of September
30, 2003 was 29,958,870.
ATX Communications, Inc.
Index
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
September 30, 2003 (Unaudited) and December 31, 2002 .............................2
Condensed Consolidated Statements of Operations -
Three and Nine months ended September 30, 2003 and 2002 (Unaudited) ..............3
Condensed Consolidated Statement of Shareholders' Deficiency -
Nine months ended September 30, 2003 (Unaudited) .................................4
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 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 .............................................25
Item 3. Quantitative and Qualitative Disclosures about Market Risk .........................36
Item 4. Controls and Procedures.............................................................37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................................38
Item 6. Exhibits and Reports on Form 8-K ...................................................47
SIGNATURES ....................................................................................48
1
ATX COMMUNICATIONS, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
September 30, 2003 December 31, 2002
----------------------- -----------------------
(Unaudited) (See Note)
Assets
Current assets:
Cash and cash equivalents $ 3,396,000 $ 9,959,000
Accounts receivable-trade, less allowance for doubtful
accounts of $10,704,000 (2003) and $8,755,000 (2002) 30,451,000 35,150,000
Due from NTL Incorporated 457,000 1,120,000
Other 5,494,000 4,845,000
----------------------- -----------------------
Total current assets 39,798,000 51,074,000
Fixed assets, net 30,904,000 37,861,000
Goodwill 79,558,000 79,558,000
Other, net of accumulated amortization of
$2,766,000 (2003) and $1,871,000 (2002) 8,463,000 10,570,000
----------------------- -----------------------
$ 158,723,000 $ 179,063,000
======================= =======================
Liabilities and shareholders' deficiency
Current liabilities:
Accounts payable $ 57,319,000 $ 65,799,000
Accrued expenses 67,433,000 53,060,000
Current portion of long-term debt, less unamortized discount 149,775,000 1,512,000
Current portion of capital lease obligations 8,866,000 9,534,000
Deferred revenue 16,802,000 21,928,000
----------------------- -----------------------
Total current liabilities 300,195,000 151,833,000
Long-term debt, less unamortized discount -- 145,809,000
Notes payable to NTL Europe, Inc., less unamortized discount 19,124,000 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
29,959,000 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 (1,190,864,000) (1,166,389,000)
----------------------- -----------------------
(160,520,000) (135,476,000)
Treasury stock at cost, 41,000 shares (2003) and 333,000 shares (2002) (76,000) (735,000)
----------------------- -----------------------
(160,596,000) (136,211,000)
----------------------- -----------------------
$ 158,723,000 $ 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.
ATX COMMUNICATIONS, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
2003 2002 2003 2002
--------------------- ------------------ ------------------- -------------------
Revenues $ 68,632,000 $ 73,422,000 $ 211,525,000 $ 222,942,000
Costs and expenses
Operating 46,546,000 47,927,000 138,445,000 144,723,000
Selling, general and administrative 22,355,000 18,512,000 61,984,000 61,049,000
Corporate 1,528,000 1,930,000 5,451,000 5,244,000
Recapitalization costs -- 373,000 -- 5,825,000
Other costs 127,000 -- 420,000 --
Depreciation 3,941,000 8,895,000 13,740,000 26,916,000
Amortization -- 84,000 -- 251,000
--------------------- ------------------ ------------------- -------------------
74,497,000 77,721,000 220,040,000 244,008,000
--------------------- ------------------ ------------------- -------------------
Operating loss (5,865,000) (4,299,000) (8,515,000) (21,066,000)
Other income (expense)
Interest income and other, net (78,000) 115,000 (180,000) 349,000
Interest expense (5,758,000) (4,503,000) (15,780,000) (12,143,000)
--------------------- ------------------ ------------------- -------------------
Loss before income taxes (11,701,000) (8,687,000) (24,475,000) (32,860,000)
Income tax benefit -- 92,000 -- 92,000
--------------------- ------------------ ------------------- -------------------
Net loss $(11,701,000) $ (8,595,000) $ (24,475,000) $(32,768,000)
===================== ================== =================== ===================
Basic and diluted net loss per share $ (0.39) $ (0.29) $ (0.82) $ (1.10)
===================== ================== =================== ===================
Weighted average number of shares 29,963,000 29,667,000 29,789,000 29,889,000
===================== ================== =================== ===================
See accompanying notes.
3
ATX COMMUNICATIONS, INC.
Condensed Consolidated Statement of Shareholders' Deficiency
(Unaudited)
Common Stock Treasury Stock
-------------------------- Additional ---------------------------
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)
Common shares returned to Treasury -- -- -- -- 8,000 (3,000)
Issuance of shares from Treasury -- -- (569,000) -- (300,000) 662,000
Net loss -- -- -- (24,475,000) -- --
----------- -------------- ------------------- ------------------- --------------- -----------
Balance, September 30, 2003 30,000,000 $ 300,000 $ 1,030,044,000 $ (1,190,864,000) 41,000 $ (76,000)
=========== ============== =================== =================== =============== ===========
See accompanying notes.
4
ATX COMMUNICATIONS, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30,
2003 2002
----------------------- ----------------------
Net cash (used in) provided by operating activities $ (404,000) $ 1,157,000
Investing activities
Purchase of fixed assets (6,783,000) (9,283,000)
Other - 470,000
----------------------- ----------------------
Net cash used in investing activities (6,783,000) (8,813,000)
Financing activities
Principal payments of capital lease obligations (376,000) (328,000)
Receipt of proceeds for notes receivable 1,000,000 -
----------------------- ----------------------
Net cash provided by (used in) financing activities 624,000 (328,000)
----------------------- ----------------------
Decrease in cash and cash equivalents (6,563,000) (7,984,000)
Cash and cash equivalents at beginning of period 9,959,000 24,966,000
----------------------- ----------------------
Cash and cash equivalents at end of period $ 3,396,000 $ 16,982,000
======================= ======================
Supplemental disclosure of cash flow information
Cash paid for interest $ 1,672,000 $ 8,127,000
======================= ======================
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 nine
months ended September 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 in
connection with the recapitalization, which consisted primarily of employee
incentives, legal fees, accounting fees and printing fees, of $373,000 and
$5,825,000, respectively, during the three and nine months ended September 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, and potential liabilities arising from
litigation. 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, and potential liabilities arising from litigation. 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.
Pro forma information regarding net loss and net loss per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 2003 and 2002: risk-free interest rate of 4.00% and 4.81%,
respectively, dividend yield of 0%, volatility factor of the expected market
price of the Company's common stock of 1.234 and 1.743, respectively, and a
weighted-average expected life of the options of 10 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options
8
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 3. Significant Accounting Policies (continued)
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." The effects
of applying SFAS No. 123 on pro forma disclosures of net loss for the three and
nine months ended September 30, 2003 and 2002 are not likely to be
representative of the pro forma effects on net loss in future years.
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------- -----------------------------------
2003 2002 2003 2002
----------------- ----------------- ---------------- ------------------
Net loss-- as reported $ (11,701,000) $ (8,595,000) $ (24,475,000) $ (32,768,000)
Stock based compensation expenses
under SFAS No. 123 (914,000) (895,000) (2,721,000) (2,687,000)
----------------- ----------------- ---------------- ------------------
Pro forma net loss $ (12,615,000) (9,490,000) $ (27,196,000) (35,455,000)
================= ================= ================ ==================
Basic and diluted per share information:
Net loss-- as reported $ (0.39) $ (0.29) $ (0.82) $ (1.10)
Stock based compensation expenses
under SFAS No. 123 (0.03) (0.03) (0.09) (.09)
----------------- ----------------- ---------------- ------------------
Pro forma net loss per share $ (0.42) $ (0.32) $ (0.91) $ (1.19)
================= ================= ================ ==================
Note 4. Revenues
Three Months Ended September 30, Nine Months Ended September 30,
2003 2002 2003 2002
------------------ ------------------ ---------------- ------------------
Local exchange services $ 22,454,000 $ 24,585,000 $ 67,720,000 $ 71,695,000
Internet, data and web-related services 20,658,000 21,980,000 62,554,000 68,355,000
Toll-related telephony services 17,976,000 16,688,000 54,093,000 52,598,000
Other (a) 7,544,000 10,169,000 27,158,000 30,294,000
------------------ ------------------ ---------------- ------------------
$ 68,632,000 $ 73,422,000 $ 211,525,000 $ 222,942,000
================== ================== ================ ==================
(a) Other includes carrier access billing, reciprocal compensation, wireless,
paging and information services.
Note 5. Fixed Assets
Fixed assets consist of:
September 30, December 31,
-------------------- ---------------------
2003 2002
-------------------- ---------------------
Operating equipment $ 34,821,000 $ 30,204,000
Computer hardware and software 9,394,000 6,929,000
Other equipment 5,647,000 5,634,000
Construction-in-progress 25,000 337,000
-------------------- ---------------------
49,887,000 43,104,000
Accumulated depreciation (18,983,000) (5,243,000)
-------------------- ---------------------
$ 30,904,000 $ 37,861,000
==================== =====================
9
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 6. Accrued Expenses
Accrued expenses consist of:
September 30, December 31,
-------------------- ---------------------
2003 2002
-------------------- ---------------------
Toll and interconnect $27,430,000 $23,016,000
Taxes, including income taxes 11,835,000 11,473,000
Accrued interest 10,446,000 1,416,000
Payroll and related 7,695,000 6,431,000
Other 5,641,000 4,997,000
Reorganization costs 3,364,000 4,542,000
Professional fees 1,022,000 1,185,000
-------------------- ---------------------
$67,433,000 $53,060,000
==================== =====================
Note 7. Long-Term Debt
Long-term debt consists of:
September 30, December 31,
---------------------- --------------------
2003 2002
---------------------- --------------------
Senior secured credit facility, less unamortized discount of
$9,094,000 (2003) and $10,291,000 (2002) $147,006,000 $145,809,000
6% Convertible Notes, less unamortized discount of
$1,589,000 (2003) and $2,846,000 (2002) 2,769,000 1,512,000
---------------------- --------------------
149,775,000 147,321,000
Less current portion (149,775,000) (1,512,000)
---------------------- --------------------
$ -- $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 September 30, 2003, this rate was 9.5%. The Company has recorded
accrued interest of $9,435,000 as of September 30, 2003. 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.
Based on the Company's current business plan, the Company will not have the cash
available to fund the required deferred interest and principal payments on or
before February 2, 2004. In addition, the Company may not have sufficient
liquidity to fund operations through the end of the year. The Company's
continued ability to fund operations could be adversely effected by various
circumstances, including, acceleration of critical operating payables, adverse
litigation results, service disruptions, lower than expected collections and
other circumstances outside of the Company's immediate and direct control. The
Company is in the process of seeking and considering strategic alternatives in
order to reduce its 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. There are no
assurances that the Company will obtain the financing that it is seeking. In the
event that the Company cannot obtain financing, reduce its indebtedness, and
satisfactorily resolve its outstanding litigation, the Company may need to file
for protection under the federal bankruptcy laws. If the Company engages in a
Chapter 11 bankruptcy proceeding, any proposed plan of reorganization would also
be subject to confirmation by the bankruptcy court after it has been voted on by
certain creditors whose interests would be impaired by the plan, including the
lenders under our senior secured credit facility, and satisfaction or waiver of
certain conditions. It is also possible that any new investor in the Company may
insist on the Company seeking bankruptcy protection as a precondition to or as
part of any such financing transaction.
We were not in compliance with certain of the covenants contained in our credit
agreement for the three-month period ending September 30, 2003. On November 14,
2003, the lenders agreed to waive compliance with these covenants for the third
quarter of 2003. There can be no assurances that the Company will be able to
maintain compliance with its covenants during the fourth quarter of 2003 or
obtain a waiver of those covenants in order to avoid an event of default under
the senior credit facility. Nor can there be any assurance that the Company will
be able to implement a strategic alternative as discussed above. Therefore, the
Company has classified the outstanding amounts under its senior secured credit
facility, less unamortized discount, as a current liability as of September 30,
2003.
All of the Company's subsidiaries have unconditionally guaranteed payment under
the senior secured credit facility.
11
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 8. Related Party Transactions
On May 8, 2002, NTL Incorporated (then known as NTL Communications Corp., "New
NTL"), NTL Europe, Inc. (then known as NTL Incorporated, "Old NTL") and certain
of New NTL's and Old NTL's subsidiaries, filed a pre-arranged joint
reorganization plan (the "Plan") under Chapter 11 of the U.S. Bankruptcy Code.
The Plan became effective on January 10, 2003, at which time both companies
emerged from Chapter 11 reorganization. Pursuant to the Plan, the entity
formerly known as NTL Incorporated and its subsidiaries and affiliates were
split into two separate groups, and New NTL and Old NTL each emerged as
independent public companies. New NTL became the holding company for the former
NTL group's principal UK and Ireland assets. Prior to consummation of the Plan,
New NTL was a wholly-owned subsidiary of the entity then known as NTL
Incorporated, which, pursuant to the Plan, was renamed "NTL Europe, Inc." and
which became the holding company for the former NTL group's continental European
and certain other assets. Some of the Company's directors were also directors of
Old NTL prior to its reorganization, and one director was a director of New NTL
following its reorganization.
In April 2001, CCL and the Company as co-obligors issued to Old NTL $15 million
aggregate principal amount of 10.75% Unsecured Convertible PIK Notes Due April
2011. At September 30, 2003 and December 31, 2002, the total amount of the notes
outstanding, less the unamortized discount of $298,000 and $327,000,
respectively, was $19,124,000 and $17,632,000, respectively.
Through 2002, New 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 New NTL consisted of salaries and direct costs
allocated to the Company where identifiable, and a percentage of the portion of
New NTL's corporate overhead, which could not be specifically allocated to New
NTL. 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 nine months ended September 30, 2002, New NTL charged the Company
$5,000 and $177,000, respectively, which is included in corporate expenses.
A subsidiary of the Company provides billing and software development services
to subsidiaries of New NTL. For the three months ended September 30, 2003 and
2002, the Company recognized revenues for these services, totaling $694,000 and
$707,000, respectively. For the nine months ended September 30, 2003, the
Company recognized revenues of $2,136,000 for these services. Prior to the third
quarter of 2002, the Company recorded the billings for these services as a
reduction of selling, general and administrative expenses. Selling, general and
administrative expenses were reduced by $1,508,000 during 2002.
12
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 8. Related Party Transactions (continued)
In 2001, the Company and Old NTL entered into a license agreement whereby Old
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 $1,068,000 of
this revenue during each of the three-month periods ended September 30, 2003 and
2002 and recognized $3,205,000 during each of the nine-month periods ended
September 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 $451,000 for
the three months ended September 30, 2003 and 2002 and approximately $1,254,000
and $1,352,000 for the nine months ended September 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 nine months ended September 30, 2003.
The Company inadvertently paid certain invoices that included approximately
$15,000 of personal expenses of one of its senior officers prior to the time
that such invoices were reimbursed to the Company by the senior officer. These
amounts have been reimbursed to the Company in full and the Company has
implemented additional controls and procedures to prevent this from recurring.
Note 9. Other Costs
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 recognized a $293,000
charge in other costs for the consideration given in this settlement.
During August 2003, the Company collected $1,000,000 in cash, received 8,560
shares of its common stock and 319,699 shares of CCL's common stock as payment
for notes receivable due from former shareholders of the Company. The shares of
common stock received were valued at $5,000 in the aggregate. The Company
recognized a $1,005,000 gain for the amounts received on these notes, which has
been recorded as a reduction of other costs.
During September 2003, a wholly-owned subsidiary of the Company settled an
outstanding legal matter regarding alleged early termination liabilities, under
a services agreement and a co-location agreement. The Company recognized a
$452,000 gain for this settlement, which was the difference between the
liability accrued and the amount paid. The gain has been recorded as a reduction
of other costs.
During September 2003, the Company entered into an agreement to terminate a
facility lease obligation with a remaining term of seven years. The agreement
required the Company to permit the landlord to retain the $500,000 security
deposit for the lease in October 2003 and to pay $1,250,000 over three years
beginning mid-November 2003. The Company recorded a charge of $1,584,000 in
other costs related to this agreement, which is equal to the present value of
the payments to be made under the agreement.
13
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 10. Reorganization Costs
The Company did not record any reorganization costs during the first nine 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.
The Company paid $1,178,000 of accrued reorganization costs during the nine
months ended September 30, 2003. As of September 30, 2003, the Company's
remaining accrued reorganization costs totaled $3,364,000, which consisted
primarily of reserves for agreement terminations.
Note 11. Commitments and Contingent Liabilities
As of September 30, 2003, the Company had purchase commitments of approximately
$3,289,000 outstanding, all of which are due during 2003 and 2004. Additionally,
the Company had standby letters of credit of approximately $2,204,000
outstanding as of September 30, 2003, which are fully collateralized by
certificates of deposit classified as part of other long-term assets.
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 and other telecommunications carriers, some of whom the Company depends
upon for certain services, those carriers have and will likely continue to
threaten service disruptions or terminations from time to time. 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.
14
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 fails to recognize 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. On November 14,
2003, Verizon filed a motion with the Court seeking permission for Verizon
to file an amendment to its complaint. A draft of the amendment that
accompanied Verizon's request indicates that Verizon intends to assert that
defendants now owe Verizon $40 million in alleged unpaid charges. The draft
also indicates that Verizon desires to amend its complaint to specify new
claims arising out of certain alleged misconduct arising out of purported
sales, billing, revenue and other practices as more fully described in the
amendment. The defendants have notified Verizon that they will not consent
to the filing of the amendment and defendants are currently preparing to
file an opposition to Verizon's motion asking the Court to reject Verizon's
effort to supplement its claims. 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.
15
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.
16
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o By letters dated October 31, 2003, the Company's operating subsidiaries in
Virginia, Maryland, and the District of Columbia received notices from
Verizon asserting that those entities are in default of their respective
payment obligations under an August 28, 2002 Settlement Agreement,
demanding that those subsidiaries pay Verizon the aggregate sum of $764,000
in order to cure the alleged payment defaults, and threatening to proceed
with the remedies set forth under applicable contracts in the absence of
payment within ten days after receipt of the notices. In response, the
Company's subsidiaries notified Verizon that they are disputing the
accuracy of Verizon claims and challenging its right to payment of the
amounts specified in its letters. Among other things, the subsidiaries
notified Verizon that it claims are inconsistent with the claims made in a
sworn affidavit from Verizon asserting that Verizon is unable to accurately
compute the amounts allegedly owed by the Company, that the demand letters
fail to account for hundreds of thousands of dollars of outstanding billing
disputes, and that Verizon has refused the Company's request for additional
information to substantiate Verizon's claims. The subsidiaries intend to
contest any charges that they believe are not properly owed and to
vigorously defend themselves and pursue all appropriate claims and
remedies. However, the Company is not able to predict how or when these
matters will be resolved.
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.
17
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
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.
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.
18
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
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.
19
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. On November 13, 2003, the Court
issued a ruling on GECC's motion for summary judgment in which it: a)
denied GECC's request for summary judgment against all defendants on its
contracts claims, b) granted GECC's request for summary judgment against
all defendants on its claims of conversion but declined to rule on the
issue of liability under those claims, c) denied the Company's motion
objecting to the court's jurisdiction over that entity, and d) granted
defendant's request for discovery against GECC on the issue of alleged
damages. As a result of the Court's ruling, the defendants anticipate that
the litigation will proceed with additional discovery on GECC's contracts
claims and alleged damages for conversion, which defendants intend to
pursue vigorously. However, it is impossible at this time to predict how or
when this matter will be resolved. 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 contended that it was owed approximately $2
million, primarily in respect of alleged early termination liabilities,
under a services agreement and a co-location agreement with MegsINet. 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 had also initiated coverage
under an insurance policy designed to protect against such claims. On
September 9, 2003, this matter was fully settled by agreement of the
parties, predominantly out of proceeds from insurance.
20
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o On October 10, 2003, APCC Services, Inc. and several of its clients,
referred to as APCC, filed a formal complaint with the Federal
Communications Commission ("FCC") against the Company and several of its
affiliated companies claiming they are responsible for payphone surcharge
compensation for the period between November 1996 to the present, in the
amount of $1,533,949, as calculated pursuant to the 5th Report and Order
issued by the FCC, currently on appeal in the D.C. Circuit Court of
Appeals. On October 23, 2003, the FCC directed APCC to correct deficiencies
in its allegations and to refile its complaint on or before November 7,
2003. In response to the complaint, the defendants expect to vigorously
defend against the asserted claims and pursue all available remedies.
However, it is not possible at this time to predict the outcome of the
litigation.
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.
21
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
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 had previously been pursuing discovery in
aid of execution on its judgment but has not been active in this area for
some time. On November 10, 2003, plaintiff filed a motion asking the Court
to appoint a receiver for the purpose of marshalling defendants' assets and
liquidating them to satisfy plaintiff's judgment. The defendants believe
that the motion is procedurally defective and substantively without merit
and defendants are in the process of preparing to file an opposition to
plaintiff's motion seeking its denial. Although defendants believe that
Easton's motion will be denied, it is not possible at this time to predict
with any certainty how or when this matter will be resolved. 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.
22
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 have filed objections to the bankruptcy court's report and
recommendation with the District Court. In addition, on August 21, 2003, at
the defendants' request, the bankruptcy court granted a stay of the pending
summary adjudication motions for services allegedly provided to the
Company's subsidiaries operating in Pennsylvania, Delaware and New York
pending resolution of the Illinois matter by the District Court. Focal
subsequently filed a motion asking the bankruptcy court to lift the stay
and asserting that its claims now stand at approximately $2 million. Upon
the Company's opposition, the bankruptcy court denied Focal's motion but
authorized it to take additional discovery in support of its claims.
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.
23
ATX Communications, Inc.
Notes to the Condensed Consolidated Financial Statements (continued)
(Unaudited)
Note 11. Commitments and Contingent Liabilities (continued)
o On September 9, 2003, Electronic Data Systems Corp., referred to as EDS,
filed a civil action in the Common Pleas Court Montgomery County,
Pennsylvania alleging breach of contract arising out of alleged billing
services provided to CoreComm-ATX, Inc. in the amount of $555,526. On
October 22, 2003, CoreComm-ATX answered the complaint and asserted
counterclaims against EDS for breach of contract, fraudulent
misrepresentation and negligent misrepresentation. CoreComm-ATX expects to
vigorously defend itself against the asserted claims, while simultaneously
pursing its counterclaims against EDS. However, it is not possible at this
time to predict the outcome of the litigation.
o On October 8, 2003, a complaint was filed by the Wisconsin Attorney
General's Office in the Circuit Court, Dane County against CoreComm
Wisconsin, Inc. In the Complaint, the Attorney General alleges that
CoreComm Wisconsin failed to properly disclose to certain of its Internet
customers policies relating to subscription cancellation and renewal,
resulting in the improper billing of customers, in violation of provisions
of the Wisconsin Administrative Code. The Attorney General's office is
seeking injunctive relief as well as penalties and customer refunds.
CoreComm Wisconsin is currently reviewing these allegations and believes it
has meritorious defenses to the Attorney General's complaint. CoreComm
Wisconsin expects to vigorously defend itself against the asserted claims,
however, at this time it is impossible to predict the outcome of this
matter.
o A subsidiary of the Company, ATX Licensing, Inc. ("ALI"), is presently in
discussions with regulatory authorities concerning a request to enter into
an extended payment plan in connection with an outstanding obligation of
approximately $4.8 million. ALI is not presently able to agree to all of
the terms of the proposed plan in light of certain restrictions set forth
in the Company's credit facility with its senior secured lenders. The
Company has made a request to its lenders that ALI be permitted to
participate in the plan under the terms proposed by the regulatory
authorities and is currently waiting for a final response to that request.
ALI has been advised by the regulatory authorities that if it is not
accepted to participate in an extended payment plan, then the entire amount
of the obligation will become due and payable within thirty days from the
date that ALI receives notice that it is not able to participate in the
plan. If ALI is not able to participate in an extension plan with the
approval of its lenders, and in the absence of additional funding to
satisfy the obligation, the Company does not believe that ALI will be able
to pay the obligation within the period of time specified by the regulatory
authorities. A failure to pay the obligation could result in the imposition
of regulatory penalties, including substantial fines, the revocation or
imposition of conditions on regulatory authorizations, and/or other
penalties.
24
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.
Three Months Ended September 30, 2003 and 2002
The decrease in revenues to $68,632,000 from $73,422,000 is attributable to a
decrease in other revenue, local exchange services and Internet access services
revenue partially offset by an increase in toll-related telephony services
revenue.
Operating costs include direct cost of sales, network costs and salaries and
related expenses of network personnel. Operating costs decreased to $46,546,000
from $47,927,000 due to a decrease in our revenues.
Selling, general and administrative expenses increased to $22,355,000 from
$18,512,000 due to increased payroll costs and professional fees and an increase
in our allowance for doubtful accounts relating to charges to a company that
filed for protection under bankruptcy.
25
Corporate expenses include the costs of some of our officers and corporate
staff, the costs of operating the corporate office and costs incurred for
strategic planning and evaluation of business opportunities. Corporate expenses
decreased to $1,528,000 from $1,930,000 due to decreases in payroll partially
offset by increased costs incurred for strategic planning and other corporate
activities.
During the three months ended September 30, 2002, we incurred additional costs
of $373,000 in connection with our recapitalization, which consisted primarily
of employee incentives, legal fees, accounting fees and printing fees.
During the three months ended September 30, 2003, we incurred other costs of
$127,000, which consisted of charges related to the termination of a facility
lease obligation of $1,584,000 net of gains totaling $1,457,000 related to the
collection of notes receivable and the settlement of certain legal matters.
Depreciation expense decreased to $3,941,000 from $8,895,000 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, other than amortization associated with deferred financing
costs included in interest expense, has been eliminated in 2003 due to the
reduction in the carrying value of our intangible assets to zero as determined
by a fair value analysis performed on October 1, 2002 in accordance with SFAS
No. 144.
Interest expense and other increased to $5,758,000 from $4,503,000 primarily due
to the effect of an increase in the effective interest rate on our senior
secured credit facility. The effective interest rate on our senior secured
credit facility during the three months ended September 30, 2003 and 2002 was
9.50% and 6.75%, respectively.
The income tax benefit of $92,000 during 2002 is from state and local income tax
refunds.
Nine Months Ended September 30, 2003 and 2002
The decrease in revenues to $211,525,000 from $222,942,000 is attributable to a
decrease in other revenue, local exchange services and Internet access services
revenue partially offset by an increase in toll-related telephony services
revenue.
Operating costs include direct cost of sales, network costs and salaries and
related expenses of network personnel. Operating costs decreased to $138,445,000
from $144,723,000 due to a decrease in our revenue.
Selling, general and administrative expenses increased to $61,984,000 from
$61,049,000 due increases in professional fees and an increase in our allowance
for doubtful accounts relating to charges to a company that filed for protection
under bankruptcy.
26
Corporate expenses include the costs of some of our officers and corporate
staff, the costs of operating the corporate office and costs incurred for
strategic planning and evaluation of business opportunities. Corporate expenses
increased to $5,451,000 from $5,244,000 due to increased costs incurred for
strategic planning and other corporate activities partially offset by decreases
in payroll.
We incurred additional costs, which consisted primarily of employee incentives,
legal fees, accounting fees and printing fees, in connection with our
recapitalization of $5,825,000 during the nine months ended September 30, 2002.
During the nine months ended September 30, 2003, we incurred other costs of
$420,000, which consisted of charges related to the termination of a facility
lease obligation and the settlement of certain legal matters totaling
$1,877,000, net of gains totaling $1,457,000, related to the collection of notes
receivable and the settlement of other legal matters.
Depreciation expense decreased to $13,740,000 from $26,916,000 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, other than amortization associated with deferred financing
costs included in interest expense, has been eliminated in 2003 due to the
reduction in the carrying value of our intangible assets to zero as determined
by a fair value analysis performed on October 1, 2002 in accordance with SFAS
No. 144.
Interest expense and other increased to $15,780,000 from $12,143,000 primarily
due to the 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 nine months ended September 30, 2003
and 2002 was 8.74% and 6.79%, respectively.
The income tax benefit of $92,000 during 2002 is from state and local income tax
refunds.
27
Liquidity and Capital Resources
On March 31, 2003, we entered into an amendment to our senior secured credit
facility, under which the lenders agreed to defer interest and principal
payments on the outstanding loans until February 2, 2004. Based on our current
business plan, we will not 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. As of September 30, 2003, the aggregate of these
required payments is $11,385,000. Further, we may not have sufficient liquidity
to fund operations through the end of this year, and our actual ability to fund
operations could be adversely affected by various circumstances, including;
acceleration of critical operating payables, adverse litigation results, service
disruptions, lower than expected collections and other cirumstances outside of
our immediate and direct control. As previously announced, we are in the process
of seeking and considering 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. Our ability to raise additional capital 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. There are no assurances that we will obtain the financing that we
are seeking. In the event we cannot obtain financing, reduce our indebtedness,
and satisfactorily resolve our outstanding litigation, we may need to file for
protection under the federal bankruptcy laws. If we engage in a Chapter 11
bankruptcy proceeding, any proposed plan of reorganization would also be subject
to confirmation by the bankruptcy court after it has been voted on by certain
creditors whose interests would be impaired by the plan, including the lenders
under our senior secured credit facility, and satisfaction or waiver of certain
conditions. It is also possible that any new investor in the Company may insist
on the Company seeking bankruptcy protection as a precondition to or as part of
any such financing transaction.
As of September 30, 2003, we had long-term debt, which consisted of a $156.1
million senior secured credit facility, approximately $19.4 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 September 30, 2003, CCL had $4.4
million of 6% Convertible Subordinated Notes outstanding.
28
Under the March 31, 2003 amendment, the lenders under the senior secured credit
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% (9.50% at September 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. 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 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 will not 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.
We are in the process of seeking and considering 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, other transactions or bankruptcy. It is likely that
any of such transactions, if implemented, would result in material dilution to
our stockholders or possibly the elimination of any recovery to common
stockholders.
We were not in compliance with certain of the covenants contained in our credit
agreement for the three-month period ending September 30, 2003. On November 14,
2003, the lenders agreed to waive compliance with these covenants for the third
quarter of 2003. There can be no assurances that we will be able to maintain
compliance with our covenants for the fourth quarter of 2003 or obtain a waiver
of those covenants in order to avoid an event of default under our senior
secured credit facility. Nor can there be any assurance that we will be able to
implement a strategic alternative as discussed above. Therefore, we have
classified all outstanding amounts due under our senior secured credit facility,
less unamortized discount, as a current liability as of September 30, 2003.
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, $24.2 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 September 30, 2003,
our current liabilities exceed our current assets by approximately $260 million.
29
Total actual capital expenditures for the nine months ended September 30, 2003,
described as cash used to purchase fixed assets in our cash flow statement, were
approximately $6.8 million. According to our business plans, capital
expenditures are expected to be approximately $2.1 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 nine months of 2003, cash used in operating activities was
approximately $0.4 million. If we continue to be unable 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 cash requirements in the remainder of 2003 and thereafter will depend on the
success of the continued execution of our business plan, and the amount of cash
required to fund future capital expenditures and other working capital
requirements that exceed net cash provided by operating activities. 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 will not 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.
30
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, (6) filing for protection
under the federal bankruptcy laws or (7) 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.
We cannot assure you that:
(a) actual costs will not exceed the amounts estimated in our
business plan;
(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 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.
31
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.
Three Months For the Year Ended
Ended December 31,
December 31,
----------------------------------------
2003 2004 2005 Source of Funds
---------------------------------------- ---------------------------------------------
(in millions)
Cash interest expense on $ 0.5 $ 24.5 $ 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 refinancing or
other sources of financing (4)
Estimated capital 2.1 8.9 10.2 Cash and cash equivalents on hand and cash
expenditures (2) from operations
Principal payments on existing - 25.4 Cash and cash equivalents on hand, cash
long-term debt (3) 11.7 from operations and 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)
----------------- --------- ------------
$11.5 $ 45.1 $ 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.
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 on these
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.
(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 will not have the
cash available to fund the required deferred interest and principal
payments under our senior secured credit facility on or before February 2,
2004, the date on which such payments become due.
(5) Approximately $8.0 million of the capital lease 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."
32
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 more fully disclosed in the Notes to the Condensed Consolidated Financial
Statements.
The following table includes aggregate information about our contractual
obligations as of September 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) $ 179,880 $ 12,158 $ 42,900 $ 85,800 $ 39,022
Capital Lease Obligations 8,866 8,866 - - -
Operating Lease Obligations 25,210 5,863 8,845 8,271 2,231
Unconditional Purchase Obligations - - - - -
Other Long-Term Obligations (2) 9,435 9,435 - - -
------------- ------------ ----------- ------------ -------------
Total Contractual Cash Obligations $ 223,391 $ 36,322 $ 51,745 $ 94,071 $ 41,253
============= ============ =========== ============ =============
(1) Long-term debt includes the senior secured credit facility of
$156,100,000, 10.75% Unsecured Convertible PIK Notes due April 2011 of
$19,422,000 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.
(2) Other long-term obligations consists of the interest accrued under the
senior secured credit facility.
33
The following table includes aggregate information about our commercial
commitments as of September 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 2,204 2,204 - - -
Standby Repurchase Obligations - - - - -
Other Commercial Commitments 3,289 3,289 - - -
-------------- ------------- ------------ ----------- ------------
Total Commercial Commitments $ 5,493 $ 5,493 $ - $ - $ -
============== ============= ============ =========== ============
Consolidated Statement of Cash Flows
For the nine months ended September 30, 2003, cash used in operating activities
was $404,000 in comparison to cash provided by operating activities of
$1,157,000 for the nine months ended September 30, 2002. The change in cash
(used in) provided by operating activities is primarily due to changes in our
operating assets and liabilities due to the timing of receipts and
disbursements.
For the nine months ended September 30, 2003, cash used to purchase fixed assets
decreased to $6,783,000 from $9,283,000 for the nine months ended September 30,
2002, which reflects decreased purchases of operating equipment.
During August 2003, the Company collected $1,000,000 in cash as partial
consideration for notes receivable due from former shareholders of the Company.
34
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
avoid bankruptcy; 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;
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.
35
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. We are
currently pursuing strategic alternatives such as refinancings in order to
reduce our overall indebtedness, including amounts due under our variable rate
senior secured credit facility and our other fixed interest rate debt. The fair
value of our variable rate senior secured credit facility and our fixed interest
rate debt is not determinable at this time.
Interest Rate Sensitivity
As of September 30, 2003
Principal Amount by Expected Maturity
Average Interest Rate
October 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 $ -
Average interest rate 6.00% 10.75%
Variable rate $-- $11,700 $25,350 $50,700 $39,000 $29,350 $156,100 $ -
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%.
36
ITEM 4. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures - The Company's management,
with the participation of the Company's Chief Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of
the Company's disclosure controls and procedures (as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this report. Based on such
evaluation, the Company's Chief Executive Officer and Chief
Financial Officer have concluded that, as of the end of such
period, the Company's disclosure controls and procedures are
effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange
Act.
(b) Internal Control Over Financial Reporting - There have not been
any changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the fiscal quarter to
which this report relates that have materially affected, or are
reasonably likely to materially affect, the Company's internal
control over financial reporting.
37
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 and other telecommunications carriers, some of whom we depend
upon for certain services, those carriers have and will likely continue to
threaten service disruptions or terminations from time to time. 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 fails to recognize 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.
38
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. On November 14,
2003, Verizon filed a motion with the Court seeking permission for Verizon
to file an amendment to its complaint. A draft of the amendment that
accompanied Verizon's request indicates that Verizon intends to assert that
defendants now owe Verizon $40 million in alleged unpaid charges. The draft
also indicates that Verizon desires to amend its complaint to specify new
claims arising out of certain alleged misconduct arising out of purported
sales, billing, revenue and other practices as more fully described in the
amendment. The defendants have notified Verizon that they will not consent
to the filing of the amendment and defendants are currently preparing to
file an opposition to Verizon's motion asking the Court to reject Verizon's
effort to supplement its claims. 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.
39
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 By letters dated October 31, 2003, our operating subsidiaries in Virginia,
Maryland, and the District of Columbia received notices from Verizon
asserting that those entities are in default of their respective payment
obligations under an August 28, 2002 Settlement Agreement, demanding that
those subsidiaries pay Verizon the aggregate sum of $764,000 in order to
cure the alleged payment defaults, and threatening to proceed with the
remedies set forth under applicable contracts in the absence of payment
within ten days after receipt of the notices. In response, our subsidiaries
notified Verizon that they are disputing the accuracy of Verizon claims and
challenging its right to payment of the amounts specified in its letters.
Among other things, the subsidiaries notified Verizon that it claims are
inconsistent with the claims made in a sworn affidavit from Verizon
asserting that Verizon is unable to accurately compute the amounts
allegedly owed by us, that the demand letters fail to account for hundreds
of thousands of dollars of outstanding billing disputes, and that Verizon
has refused our request for additional information to substantiate
Verizon's claims. The subsidiaries intend to contest any charges that they
believe are not properly owed and to vigorously defend themselves and
pursue all appropriate claims and remedies. However, we are not able to
predict how or when these matters will be resolved.
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.
40
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.
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.
41
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.
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.
42
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.
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. On November 13, 2003, the Court issued a ruling on GECC's motion for
summary judgment in which it: a) denied GECC's request for summary judgment
against all defendants on its contracts claims, b) granted GECC's request
for summary judgment against all defendants on its claims of conversion but
declined to rule on the issue of liability under those claims, c)denied our
motion objecting to the court's jurisdiction over that entity, and d)
granted defendant's request for discovery against GECC on the issue of
alleged damages. As a result of the Court's ruling, the defendants
anticipate that the litigation will proceed with additional discovery on
GECC's contracts claims and alleged damages for conversion, which
defendants intend to pursue vigorously. However, it is impossible at this
time to predict how or when this matter will be resolved. 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 contended that it was owed approximately $2
million, primarily in respect of alleged early termination liabilities,
under a services agreement and a co-location agreement with MegsINet. 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 had also initiated coverage under
an insurance policy designed to protect against such claims. On September
9, 2003, this matter was fully settled by agreement of the parties,
predominantly out of proceeds from insurance.
43
o On October 10, 2003, APCC Services, Inc. and several of its clients,
referred to as APCC, filed a formal complaint with the Federal
Communications Commission ("FCC") against us and several of our affiliated
companies claiming we are responsible for payphone surcharge compensation
for the period between November 1996 to the present, in the amount of
$1,533,949, as calculated pursuant to the 5th Report and Order issued by
the FCC, currently on appeal in the D.C. Circuit Court of Appeals. On
October 23, 2003, the FCC directed APCC to correct deficiencies in its
allegations and to refile its complaint on or before November 7, 2003. In
response to the complaint, the defendants expect to vigorously defend
against the asserted claims and pursue all available remedies. However, it
is not possible at this time to predict the outcome of the litigation.
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 had previously been pursuing discovery in
aid of execution on its judgment but has not been active in this area for
some time. On November 10, 2003, plaintiff filed a motion asking the Court
to appoint a receiver for the purpose of marshalling defendants' assets and
liquidating them to satisfy plaintiff's judgment. The defendants believe
that the motion is procedurally defective and substantively without merit
and defendants are in the process of preparing to file an opposition to
plaintiff's motion seeking its denial. Although defendants believe that
Easton's motion will be denied, it is not possible at this time to predict
with any certainty how or when this matter will be resolved. 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.
44
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 have filed objections to the bankruptcy
court's report and recommendation with the District Court. In addition, on
August 21, 2003, at the defendants' request, the bankruptcy court granted a
stay of the pending summary adjudication motions for services allegedly
provided to our subsidiaries operating in Pennsylvania, Delaware and New
York pending resolution of the Illinois matter by the District Court. Focal
subsequently filed a motion asking the bankruptcy court to lift the stay
and asserting that its claims now stand at approximately $2 million. Upon
our opposition, the bankruptcy court denied Focal's motion but authorized
it to take additional discovery in support of its claims. 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.
45
o On September 9, 2003, Electronic Data Systems Corp., referred to as EDS,
filed a civil action in the Common Pleas Court Montgomery County,
Pennsylvania alleging breach of contract arising out of alleged billing
services provided to CoreComm-ATX, Inc. in the amount of $555,526. On
October 22, 2003, CoreComm-ATX answered the complaint and asserted
counterclaims against EDS for breach of contract, fraudulent
misrepresentation and negligent misrepresentation. CoreComm-ATX expects to
vigorously defend itself against the asserted claims, while simultaneously
pursing its counterclaims against EDS. However, it is not possible at this
time to predict the outcome of the litigation.
o On October 8, 2003, a complaint was filed by the Wisconsin Attorney
General's Office in the Circuit Court, Dane County against CoreComm
Wisconsin, Inc. In the Complaint, the Attorney General alleges that
CoreComm Wisconsin failed to properly disclose to certain of its Internet
customers policies relating to subscription cancellation and renewal,
resulting in the improper billing of customers, in violation of provisions
of the Wisconsin Administrative Code. The Attorney General's office is
seeking injunctive relief as well as penalties and customer refunds.
CoreComm Wisconsin is currently reviewing these allegations and believes it
has meritorious defenses to the Attorney General's complaint. CoreComm
Wisconsin expects to vigorously defend itself against the asserted claims,
however, at this time it is impossible to predict the outcome of this
matter.
o A subsidiary of ours, ATX Licensing, Inc. ("ALI"), is presently in
discussions with regulatory authorities concerning a request to enter into
an extended payment plan in connection with an outstanding obligation of
approximately $4.8 million. ALI is not presently able to agree to all of
the terms of the proposed plan in light of certain restrictions set forth
in our credit facility with our senior secured lenders. We have made a
request to our lenders that ALI be permitted to participate in the plan
under the terms proposed by the regulatory authorities and is currently
waiting for a final response to that request. ALI has been advised by the
regulatory authorities that if it is not accepted to participate in an
extended payment plan, then the entire amount of the obligation will become
due and payable within thirty days from the date that ALI receives notice
that it is not able to participate in the plan. If ALI is not able to
participate in an extension plan with the approval of its lenders, and in
the absence of additional funding to satisfy the obligation, we do not
believe that ALI will be able to pay the obligation within the period of
time specified by the regulatory authorities. A failure to pay the
obligation could result in the imposition of regulatory penalties,
including substantial fines, the revocation or imposition of conditions on
regulatory authorizations, and/or other penalties.
46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Form of Indemnification agreement
10.2 Waiver dated as of November 14, 2003 to the Credit Agreement
dated as of April 11, 2001 (as further amended, restated or
otherwise supplemented from time to time), among CCL Historical,
Inc., ATX Communications, Inc., CoreComm Communications, Inc.,
the lenders from time to time party thereto and the
administrative agent for the lenders.
31.1 Certification dated November 19, 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 November 19, 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 November 19, 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 September 30, 2003, ATX Communications
filed the following reports on Form 8-K:
(i) Report dated July 2, 2003, reporting under Item
9, Regulation FD Disclosure, ATX Communications,
Inc. and its subsidiaries (collectively, the
"Company") had engaged Credit Suisse First
Boston LLC as and advisor in connection with the
Company's ongoing review of the Company's
strategic alternatives
(ii) Report dated August 14, 2003, reporting under
Item 12, Results of Operations and Financial
Condition, that ATX Communications, Inc.
announced its consolidated operating results for
the quarter ended June 30, 2003.
No financial statements were filed with these reports.
47
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: November 19, 2003 By: /s/ Michael A. Peterson
-----------------------------------
Michael A. Peterson
Executive Vice President -
Chief Operating Officer and
Chief Financial Officer
Date: November 19, 2003 By: /s/ Neil Peritz
-----------------------------
Neil Peritz
Senior Vice President - Controller and Treasurer
(Principal Accounting Officer)
48