Pac-West Telecomm, Inc Form 10-Q
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 March 31, 2006
OR
[
]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
Commission
File Number: 000-27743
PAC-WEST
TELECOMM, INC.
(Exact
name of registrant as specified in its charter)
California
|
68-0383568
|
(State
or other jurisdiction of
|
(I.R.S.
Employer Identification No.)
|
incorporation
or organization)
|
|
1776
W. March Lane, Suite 250 Stockton,
California
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(209)
926-3300
(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 he registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and
large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer [ ] Accelerated
filer [ ] Non-accelerated
filer [X]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes [ ] No [X]
As
of
April 30, 2006, the Company had an aggregate of 37,616,030 shares of common
stock issued and outstanding.
PAC-WEST
TELECOMM, INC.
Report
on Form 10-Q For the Quarterly Period Ended March 31, 2006
Table
of Contents
Part
I.
|
FINANCIAL
INFORMATION
|
Page
|
Item
1.
|
Financial
Statements (Unaudited)
|
|
|
Condensed
Consolidated Balance Sheets
|
|
|
March 31, 2006 and December 31, 2005
|
3
|
|
Condensed
Consolidated Statements of Operations and Comprehensive
Income
|
|
|
(Loss) - Three months ended March 31, 2006 and 2005
|
4
|
|
Condensed
Consolidated Statements of Cash Flows - Three
|
|
|
months ended March 31, 2006 and 2005
|
5
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
6
|
|
|
|
Item
2.
|
Management's
Discussion and Analysis of Financial Condition
|
|
|
and Results of Operations
|
16
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risks
|
25
|
|
|
|
Item
4.
|
Controls
and Procedures
|
26
|
|
|
|
|
|
|
Part
II.
|
OTHER
INFORMATION
|
|
Item
1.
|
Legal
Proceedings
|
26
|
Item
1A.
|
Risk
Factors
|
26
|
Item
5.
|
Other
Information
|
26
|
Item
6.
|
Exhibits
|
26
|
Signatures
|
|
27
|
PART
I. FINANCIAL INFORMATION
|
ITEM
1. FINANCIAL STATEMENTS
|
|
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Balance Sheets
|
(Dollars
in thousands except share and per share
data)
|
|
|
|
|
March
31,
|
|
December
31,
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
|
|
$
|
22,676
|
|
$
|
26,681
|
|
Short-term
investments
|
|
|
|
|
|
1,124
|
|
|
-
|
|
Trade
accounts receivable, net of allowances of
|
|
|
|
|
|
|
|
|
|
|
$300 and $368 at March 31, 2006 and
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005, respectively
|
|
|
|
|
|
7,936
|
|
|
7,806
|
|
Receivable
from transition service agreement
|
|
|
|
|
|
1,152
|
|
|
1,170
|
|
Prepaid
expenses and other current assets
|
|
|
|
|
|
2,953
|
|
|
3,129
|
|
Total current assets
|
|
|
|
|
|
35,841
|
|
|
38,786
|
|
Property
and equipment, net
|
|
47,248
|
|
|
39,458
|
|
Other
assets, net
|
|
913
|
|
|
1,079
|
|
Total assets
|
|
|
|
|
$
|
84,002
|
|
$
|
79,323
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
Accounts
payable
|
|
|
|
|
$
|
9,291
|
|
$
|
6,578
|
|
Current
obligations under notes payable and capital leases
|
|
|
|
|
|
8,595
|
|
|
5,392
|
|
Accrued
interest
|
|
|
|
|
|
910
|
|
|
2,032
|
|
Other
accrued liabilities
|
|
|
|
|
|
8,118
|
|
|
8,492
|
|
Total current liabilities
|
|
|
|
|
|
26,914
|
|
|
22,494
|
|
Senior
Notes
|
|
36,102
|
|
|
36,102
|
|
Notes
payable and capital leases, less current portion
|
|
11,731
|
|
|
7,418
|
|
Other
liabilities, net
|
|
98
|
|
|
72
|
|
Total liabilities
|
|
|
|
|
|
74,845
|
|
|
66,086
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies (Note 7)
|
|
|
|
|
|
|
Stockholders'
Equity:
|
|
|
|
|
|
|
Preferred
stock, no par value, 600,000 shares authorized; none
|
|
|
|
|
|
|
|
|
|
|
issued and outstanding
|
|
|
|
|
|
-
|
|
|
-
|
|
Common
stock, $.001 par value; 100,000,000 shares
|
|
|
|
|
|
|
|
|
|
|
authorized, 37,211,030 and 37,204,093 shares issued
|
|
|
|
|
|
|
|
|
|
|
and outstanding at March 31, 2006 and December 31,
|
|
|
|
|
|
|
|
|
|
|
2005, respectively
|
|
|
|
|
|
37
|
|
|
37
|
|
Additional
paid-in capital
|
|
|
|
|
|
191,095
|
|
|
191,319
|
|
Accumulated
deficit
|
|
|
|
|
|
(181,993
|
)
|
|
(177,721
|
)
|
Accumulated
other comprehensive gain (loss)
|
|
|
|
|
|
18
|
|
|
(25
|
)
|
Deferred
stock compensation
|
|
|
|
|
|
-
|
|
|
(373
|
)
|
Total stockholders' equity
|
|
|
|
|
|
9,157
|
|
|
13,237
|
|
Total liabilities and stockholders' equity
|
|
|
|
|
$
|
84,002
|
|
$
|
79,323
|
|
See
notes
to unaudited condensed consolidated financial statements.
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Statements of Operations
|
and
Comprehensive Income (Loss)
|
(Unaudited,
in thousands except per share
data)
|
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
19,628
|
|
$
|
28,131
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
Network expenses (exclusive of depreciation shown separately
below)
|
|
|
9,000
|
|
|
10,566
|
|
Selling, general and administrative
|
|
|
13,582
|
|
|
14,673
|
|
Reimbursed transition expenses
|
|
|
(2,904
|
)
|
|
-
|
|
Depreciation and amortization
|
|
|
2,832
|
|
|
3,750
|
|
Restructuring charges
|
|
|
15
|
|
|
384
|
|
Total operating expenses
|
|
|
22,525
|
|
|
29,373
|
|
Loss from operations
|
|
|
(2,897
|
)
|
|
(1,242
|
)
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
1,375
|
|
|
2,806
|
|
Gain on sale of enterprise customer base
|
|
|
-
|
|
|
(24,034
|
)
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
2,138
|
|
(Loss) income before income taxes
|
|
|
(4,272
|
)
|
|
17,848
|
|
Income
tax expense
|
|
|
-
|
|
|
509
|
|
Net (loss) income
|
|
$
|
(4,272
|
)
|
$
|
17,339
|
|
|
|
|
|
|
|
|
|
Basic
(loss) income per share
|
|
$
|
(0.11
|
)
|
$
|
0.47
|
|
Diluted
(loss) income per share
|
|
$
|
(0.11
|
)
|
$
|
0.45
|
|
|
|
|
|
|
|
|
|
Weighted
Average Shares Outstanding:
|
|
|
|
|
|
|
|
Basic
|
|
|
37,206
|
|
|
36,803
|
|
Diluted
|
|
|
37,206
|
|
|
38,889
|
|
|
|
|
|
|
|
|
|
Comprehensive
(Loss) Income:
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(4,272
|
)
|
$
|
17,339
|
|
Unrealized gains (losses) on investments, net of tax
|
|
|
51
|
|
|
(22
|
)
|
Reclassification of realized gains on sale of investments, net
of
tax
|
|
|
(8
|
)
|
|
-
|
|
Comprehensive (loss) income
|
|
$
|
(4,229
|
)
|
$
|
17,317
|
|
See
notes
to unaudited condensed consolidated financial statements.
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Statements of Cash Flows
|
(Unaudited,
in thousands)
|
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
Operating
activities:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(4,272
|
)
|
$
|
17,339
|
|
Adjustments
to reconcile net (loss) income to net cash
|
|
|
|
|
|
|
|
provided by operating activities:
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
2,832
|
|
|
3,750
|
|
Amortization of deferred financing costs
|
|
|
57
|
|
|
154
|
|
Amortization of discount on notes payable
|
|
|
-
|
|
|
1,262
|
|
Stock-based compensation
|
|
|
146
|
|
|
48
|
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
2,138
|
|
Gain on sale of enterprise customer base
|
|
|
-
|
|
|
(24,034
|
)
|
Provision for doubtful accounts
|
|
|
12
|
|
|
77
|
|
Other
|
|
|
61
|
|
|
122
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Increase in accounts receivable
|
|
|
(142
|
)
|
|
(84
|
)
|
Decrease in receivable from transition service agreement
|
|
|
18
|
|
|
-
|
|
Decrease in prepaid expenses and other current assets
|
|
|
335
|
|
|
493
|
|
Decrease in accounts payable
|
|
|
(1,800
|
)
|
|
(477
|
)
|
Decrease in accrued interest
|
|
|
(1,122
|
)
|
|
(1,008
|
)
|
Decrease in other current liabilities and other
liabilities
|
|
|
(348
|
)
|
|
(1,039
|
)
|
Net cash used in operating activities
|
|
|
(4,223
|
)
|
|
(1,259
|
)
|
|
|
|
|
|
|
|
|
Investing
activities:
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(5,801
|
)
|
|
(1,600
|
)
|
Redemptions
(purchase) of short-term investments, net
|
|
|
(1,081
|
)
|
|
207
|
|
Proceeds
from sale of enterprise customer base
|
|
|
-
|
|
|
26,953
|
|
Returned
deposits associated with the enterprise customer base sale
|
|
|
-
|
|
|
(3,500
|
)
|
Other
|
|
|
-
|
|
|
50
|
|
Net cash (used in) provided by investing activities
|
|
|
(6,882
|
)
|
|
22,110
|
|
|
|
|
|
|
|
|
|
Financing
activities:
|
|
|
|
|
|
|
|
Repayments
of notes payable
|
|
|
(759
|
)
|
|
(41,441
|
)
|
Proceeds
from the issuance of common stock
|
|
|
3
|
|
|
21
|
|
Principal
payments on capital leases
|
|
|
(116
|
)
|
|
(100
|
)
|
Net
proceeds from borrowing under notes payable
|
|
|
7,972
|
|
|
-
|
|
Net cash provided by (used in) financing activities
|
|
|
7,100
|
|
|
(41,520
|
)
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
|
(4,005
|
)
|
|
(20,669
|
)
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
26,681
|
|
|
32,265
|
|
End
of period
|
|
$
|
22,676
|
|
$
|
11,596
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
2,619
|
|
$
|
2,832
|
|
Non-cash
Operating and Investing Activities:
|
|
|
|
|
|
|
|
Acquisitions
of property and equipment included in accounts payable
|
|
$
|
4,513
|
|
$
|
-
|
|
Non-cash
Operating and Financing Activities:
|
|
|
|
|
|
|
|
Prepaid
maintenance agreement financed by notes payable
|
|
$
|
165
|
|
$
|
-
|
|
Non-cash
Investing and Financing Activities:
|
|
|
|
|
|
|
|
Equipment
acquired with capital lease obligations
|
|
$
|
254
|
|
$
|
-
|
|
See
notes
to unaudited condensed consolidated financial statements.
PAC-WEST
TELECOMM, INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS
OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2006
The
terms
"the Company," "Pac-West," "we," "our," "us," and similar terms used in this
Form 10-Q, refer to Pac-West Telecomm, Inc.
1. |
Organization
and Basis of Presentation
|
The
Company is an independent provider of integrated communication solutions
that
enable communication providers to use the Pac-West network and its services
as
an alternative to building and maintaining their own network. The Company’s
customers currently include Internet service providers (ISPs), enhanced
communication service providers (ESPs) and other direct providers of
communication services to business or residential end-users, collectively
referred to as service providers (SPs). On March 11, 2005, the Company sold
substantially all of its enterprise customer base to U.S. TelePacific Corp.
(TelePacific) while retaining the Company’s associated network
assets.
These
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted for
interim
financial information in the United States of America pursuant to the rules
and
regulations of the Securities and Exchange Commission (SEC). Accordingly,
they
do not include all of the information and notes required by accounting
principles generally accepted in the United States of America (US GAAP) for
complete financial statements. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, considered necessary for
a fair
presentation for the periods indicated, have been included. Operating results
for the three months ended March 31, 2006 are not necessarily indicative
of the
results that may be expected for the year ending December 31, 2006. The
condensed consolidated balance sheet at December 31, 2005 has been derived
from
the audited consolidated balance sheet at that date, but does not include
all of
the information and notes required by US GAAP for complete financial statements.
These unaudited condensed consolidated financial statements should be read
in
conjunction with the audited consolidated financial statements and the notes
thereto of the Company as of and for the year ended December 31, 2005, included
in the Company's Annual Report on Form 10-K filed with the SEC on March 29,
2006.
Based
on
criteria established by Statement of Financial Accounting Standards (SFAS)
No.
131, “Disclosures about Segments of an Enterprise and Related Information,” the
Company has determined that it has one reportable operating segment. While
the
Company monitors the revenue streams of its various services, the revenue
streams share almost all of the various operating expenses. As a result the
Company has determined that it has one reportable operating segment.
These
unaudited condensed consolidated financial statements include the results
of
operations of the Company and its subsidiaries. All intercompany accounts
and
transactions have been eliminated. Certain prior period amounts have been
reclassified to conform to current period presentations.
Application
of Critical Accounting Policies
Critical
Accounting Policies.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to
make
estimates and assumptions that effect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities, and reported
amounts of revenues and expenses for the reporting period. The Company considers
the following accounting policies to be critical policies due to the estimation
processes involved in each:
• revenue
recognition;
• provision
for doubtful accounts receivable;
• estimated
settlement of disputed billings;
• impairment
for long-lived assets; and
• stock-based
compensation.
By
their
nature, these judgments are subject to an inherent degree of uncertainty.
Thus,
actual results could differ from estimates made and these differences could
be
material.
Revenue
Recognition.
The
Company recognizes revenue when:
• there
is
pervasive evidence of an arrangement;
• delivery
of the product or performance of the service has occurred;
• the
selling price is fixed and determined; and
• collectibility
is reasonably assured.
Non-refundable
up-front payments received for installation services and installation related
costs, are recognized as revenue and expensed ratably over the term of the
service contracts, generally 24 to 36 months.
Revenues
from service access agreements are recognized as the service is provided,
except
for intercarrier compensation fees paid by the Company’s intercarrier customers
for completion of their customers’ calls through the Company’s network, and
access charges paid by carriers for long distance traffic terminated on the
Company’s network. The Company’s right to receive this type of compensation is
the subject of numerous regulatory and legal challenges. Until all issues
affecting a given item of revenue are resolved, the Company will continue
to
recognize intercarrier compensation as revenue when the price becomes fixed
and
determinable and collectibility is reasonably assured.
Some
ILECs with which the Company has interconnection agreements have withheld
payments from amounts billed by the Company under their agreements. The process
of collection of intercarrier compensation can be complex and subject to
interpretation of regulations and laws. This can lead to negotiated settlements
between the Company and the ILEC where it agrees to accept a portion of what
it
believes is owed to it.
Provision
for doubtful accounts receivable.
Provisions for allowances for doubtful accounts receivable are estimated
based
upon:
• historical
collection experience;
• customer
delinquencies and bankruptcies;
• information
provided by the Company’s customers;
• observance
of trends in the industry; and
• other
current economic conditions.
Estimated
settlements for disputed billings.
During
the ordinary course of business, the Company may be billed for carrier traffic
for which management believes it is not responsible for. In such instances,
the
Company may dispute with the appropriate vendor and withhold payment until
the
matter is resolved. The Company’s current disputes are primarily related to
incorrect facility rates or incorrect billing elements that the Company believes
are being charged. Management regularly reviews and monitors all disputed
items
and, based on industry experience, records an accrual that represents what
it
estimates it may pay to settle the dispute. Although the Company continues
to
actively try to expedite resolutions, often times the state Public Utilities
Commission must become involved to arbitrate such agreements. This process
is
often not timely and resolutions are often subject to appeal.
Long-lived
assets.
In 2002,
the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets.” The Company evaluates its long-lived assets when events or
changes in circumstances indicate that the carrying amount of such assets
may
not be fully recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the asset. When the Company
considers an asset to be impaired, it is written down to its estimated fair
market value. This is assessed based on factors specific to the type of asset.
In assessing the recoverability of these assets, the Company makes assumptions
regarding, among other things, estimated future cash flows to determine the
fair
value of the respective assets. If these estimates and the related assumptions
change in the future, the Company may be required to record additional
impairment charges for these assets.
Stock-based
compensation.
On
January 1, 2006, the Company adopted SFAS No. 123R and accounts for stock-based
compensation in accordance with the fair value recognition provisions of
SFAS
No. 123R “Share-Based Payment”. The Company uses the Black-Scholes
option-pricing model, which requires the input of subjective assumptions.
These
assumptions include estimating the length of time employees will retain their
stock options (expected term), the estimated volatility of its common stock
price over the expected term and the number of options that will cancel for
failure to complete their vesting requirements (forfeitures). Changes in
these
assumptions could materially affect the estimate of fair value stock-based
compensation and consequently, the related amount recognized on the consolidated
statements of operations and comprehensive income (loss).
2.
Stock-based Compensation
The
Company has stock-based compensation plans that include employee options,
restricted stock and an employee stock purchase plan. Effective January 1,
2006,
the Company adopted the provisions of SFAS No. 123R using the modified
prospective transition method. SFAS No. 123R requires the Company to recognize
the cost of employee services received in exchange for awards of equity
instruments based on the grant-date fair value of those awards, with limited
exceptions. Cost is recognized over the period during which an employee is
required to provide services (usually the vesting period). The Company
previously followed Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees" for its stock-based compensation
plans and adopted the disclosure-only provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," to disclose pro forma information regarding
stock-based compensation based on specified valuation techniques that produce
estimated compensation charges.
The
Company recorded approximately $97,000 in expense during the quarter ended
March
31, 2006 as a result of its adoption of SFAS No. 123R. There was no material
impact on basic and diluted earnings per share or cash flow from either
operations or financing activities due to the adoption of SFAS
123R.
Total
compensation expense recognized for stock-based awards for the three months
ended March 31, 2006 and 2005 was $146,000 and $48,000, respectively, and
is
included in selling, general and administrative expenses in the condensed
consolidated statements of operations and comprehensive income (loss). The
Company recognized approximately $49,000 and $48,000, respectively, for the
quarters ended March 31, 2006 and 2005 related to performance unit awards.
Cash
received for options exercised during the three months ended March 31, 2006
and
2005 was $3,000 and $21,000, respectively.
For
the
three months ended March 31, 2006, potential common stock was anti-dilutive,
as
it decreased the net loss per share. Accordingly, for the three months ended
March 31, 2006, 814,609 shares were excluded from the diluted net loss per
share
calculation.
The
effect of the change from applying the original provisions of SFAS 123 for
the
comparison period is as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2005
|
|
|
|
(Dollars
in thousands except per share amounts)
|
|
|
|
|
|
Net
income (loss) as reported
|
|
$
|
17,339
|
|
Total
stock-based employee compensation included in
|
|
|
|
|
reported net income (loss), net of tax
|
|
|
48
|
|
Total
stock-based employee compensation determined
|
|
|
|
|
under the fair value based method
|
|
|
(155
|
)
|
|
|
|
|
|
Pro
forma
|
|
$
|
17,232
|
|
|
|
|
|
|
Basic
net income (loss) per common share:
|
|
|
|
|
As reported
|
|
$
|
0.47
|
|
Pro forma
|
|
$
|
0.47
|
|
Diluted
net income (loss) per common share:
|
|
|
|
|
As reported
|
|
$
|
0.45
|
|
Pro forma
|
|
$
|
0.44
|
|
Stock
Incentive Plans
In
January 1999, the Company’s Board of Directors approved the terms of the 1999
Stock Incentive Plan which authorizes the granting of stock options, including
restricted stock, stock appreciation rights, dividend equivalent rights,
performance units, performance shares or other similar rights or benefits
to
employees, directors, consultants and advisors. In addition, options have
been
granted to two senior officers (both of whom are no longer officers) pursuant
to
the 1998 Griffin and Bryson Non-Qualified Stock Incentive Plans. In May 2000
the
Board of Directors approved the 2000 Napa Valley Non-Qualified Stock Incentive
Plan. An aggregate of 7,601,750 shares of common stock are currently reserved
for option grants under these plans (the Plans). Option awards are generally
granted with an exercise price equal to the closing market price of the
Company’s stock on the trading day prior to the date of grant; option awards
generally vest ratably based on 4 years of continuous service and have 10-year
contractual terms. Stock awards generally vest over 3 to 4 years. Certain
options and stock awards provide for accelerated vesting if there is a change
in
control (as defined by the Plans). Stock options exercised are settled with
new
issuances of stock.
As
of
March 31, 2006, there was $1.2 million of total unrecognized compensation
cost
related to the nonvested stock-based compensation arrangements granted under
the
Plans. That cost is expected to be recognized over a weighted-average period
of
3 years. The total fair value of shares vested during the quarter ended March
31, 2006 was approximately $40,000. For the period ended March 31, 2006,
there
was no stock-based compensation cost capitalized and no tax benefit
recognized.
Stock
Options
The
fair
value of each stock option award granted under the Plans is estimated using
the
Black-Scholes option-pricing model. The application of this valuation model
involves certain assumptions in the determination of compensation expense.
The
weighted average for key assumptions used in determining the fair value of
options granted during the periods are presented as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
Expected
volatility
|
|
|
110.8%
|
|
|
106.0%
|
|
Risk-free
interest rate
|
|
|
4.5%
|
|
|
3.8%
|
|
Expected
term
|
|
|
6.3
|
|
|
4.0
|
|
Expected
dividend yield
|
|
|
0.0%
|
|
|
0.0%
|
|
Historical
information was the primary basis for the selection of the expected volatility,
dividend yield and the 2005 expected term. The expected term of the options
granted during 2006 is calculated using the simplified formula promulgated
by
the Securities and Exchange Commission staff in Staff Accounting Bulletin No.
107 which allows for the expected term to be calculated as the sum of the
vesting term and the original contractual term divided by 2. The risk-free
interest rate was selected based upon yields of U.S. Treasury issues with a
term
equal to the expected life of the option being valued.
A
summary of
the option activity under the Plans as of March 31, 2006, and changes during
the
period then ended is presented below:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
Aggregate
|
|
|
|
Number
of
|
|
Average
|
|
Remaining
|
|
Intrinsic
|
|
|
|
Shares
|
|
Exercise
|
|
Contractual
|
|
Value
|
|
|
|
(000's)
|
|
Price
|
|
Term
|
|
(000's)
|
|
Outstanding
at January 1, 2006
|
|
|
5,804
|
|
$
|
1.70
|
|
|
|
|
|
|
|
Granted
|
|
|
147
|
|
$
|
0.96
|
|
|
|
|
|
|
|
Exercised
|
|
|
(7
|
)
|
$
|
0.48
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(90
|
)
|
$
|
1.46
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2006
|
|
|
5,854
|
|
$
|
1.68
|
|
|
6.4
|
|
$
|
750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and exercisable at
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31, 2006
|
|
|
3,913
|
|
$
|
1.93
|
|
|
6.4
|
|
$
|
673
|
|
The
weighted-average fair value of options granted during the quarters ended March
31, 2006 and 2005 was $0.85 and $1.09, respectively. The total intrinsic value
of options exercised during the quarters ended March 31, 2006 and 2005 was
approximately $7,000 and $48,000, respectively.
Restricted
Stock
As
of March
31, 2006 and December 31, 2005, the Company had 400,000 nonvested shares
of
restricted stock outstanding. The restricted stock vests on June 30, 2009.
However, 200,000 shares of restricted stock vest at such earlier time as
(a) the
monthly average fair market value of the Company’s common stock exceeds $3.00
per share for a period of six consecutive months and (b) all of the shares
of
restricted stock shall vest at such earlier time as certain change in control
transactions occur with respect to the Company. Total compensation expense
for
the restricted stock award was determined based upon the closing market price
on
the date of the award multiplied by the number of shares awarded. At
March 31, 2006, there was approximately $364,000 of unrecognized compensation
expense associated with this award. The Company expects to recognize this
expense on a straight-line basis through June 30, 2009 or such shorter
period if vesting is accelerated under the terms of the award.
Employee
Stock Purchase Plan
The
Company
established the 2000 Employee Stock Purchase Plan (the Purchase Plan) under
which one million shares of common stock have been reserved for issuance
and
489,004 shares remained available for issuance at March 31, 2006. Full-time
employees may designate up to 10% of their compensation, not to exceed
1,000
shares each six-month period, or $25,000 worth of common stock in any one
calendar year, which is deducted each pay period for the purchase of common
stock under the Purchase Plan. On the last business day of each six-month
period, shares of common stock are purchased with the employees’ payroll
deductions at 85% of the lesser of the market price on the first or last
day of
the six-month period. The Purchase Plan will terminate no later than May
2,
2020. Compensation expense for the three months ended March 31, 2006 and
2005
was computed, for disclosure purposes in 2005 and for recognition in 2006,
based
on the fair value of the employee’s purchase rights estimated using the
Black-Scholes model with the following assumptions:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
Expected
volatility
|
|
|
68.0%
|
|
|
84.0%
|
|
Risk-free
interest rate
|
|
|
4.4%
|
|
|
2.5%
|
|
Expected
term
|
|
|
0.5
|
|
|
0.5
|
|
Expected
dividend yield
|
|
|
0.0%
|
|
|
0.0%
|
|
Expected
volatility is based primarily on historical stock volatility for the most
recent
period equal to the expected term (which is equal to the actual purchase
term).
No dividends were expected during these terms and the risk-free interest
rate is
based on the six-month U.S. Treasury rate in effect at the beginning of the
period. Since actual purchases occur semi-annually, the Company must, during
the
first and third quarters of the year, estimate future purchase levels based
on
observation of historical participation levels. Compensation expense recognized
at March 31, 2006 was approximately $11,000.
3.
Concentration of Customers and Suppliers
For
the
three months ended March 31, 2006 and 2005, the Company had the following
concentrations of revenues and operation costs:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
Largest
customers: Percentage of total
|
|
|
|
|
|
|
|
revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
1
|
|
|
23.7
|
%
|
|
21.1
|
%
|
Customer
2
|
|
|
14.1
|
%
|
|
16.7
|
%
|
|
|
|
|
|
|
|
|
Largest
supplier: Percentage of network
|
|
|
|
|
|
|
|
expenses
|
|
|
34.0
|
%
|
|
38.3
|
%
|
During
each of the comparison periods, no other customer accounted for more than
10% of
total revenues. There were two customers representing 19.4% and 11.4%,
respectively, of trade accounts receivable as of March 31, 2006. At December
31,
2005, no customer represented more than 10% of trade accounts
receivable.
4.
Restructuring Charges
2001
and 2002 Restructuring Plans
A
summary of
the activity for the three months ended March 31, 2006 pertaining to the
Company's 2001 and 2002 restructuring plans, which is included in other accrued
liabilities in the accompanying condensed consolidated balance sheets as
of
March 31, 2006 and December 31, 2005, consist of the
following:
|
|
Restructuring
|
|
Additional
|
|
|
|
Restructuring
|
|
|
|
Liability
|
|
Restructuring
|
|
|
|
Liability
|
|
|
|
as
of
|
|
Expense
|
|
Cash
|
|
as
of
|
|
|
|
Dec.
31, 2005
|
|
Incurred
|
|
Payments
|
|
Mar.
31, 2006
|
|
|
|
(Dollars
in thousands)
|
Rent
expense for vacated premises
|
|
$
|
1,915
|
|
$
|
14
|
|
$
|
(114
|
)
|
$
|
1,815
|
|
The
amount of
the reserve for vacated premises is equal to the monthly lease payment of the
unoccupied space, less any estimated sublease income, multiplied by the
remaining months on the lease. During the three months ended March 31, 2006,
the
Company recorded additional restructuring charges of approximately $14,000
due
to increased common area operating expenses at the Colorado facility. The final
cash payment to be recorded against the restructuring reserve is currently
expected to occur in March 2010.
2005
Restructuring Plan
A
summary of
the activity for the three months ended March 31, 2006 pertaining to the
Company's 2005 plan, which is included in other accrued liabilities in the
accompanying condensed consolidated balance sheets as of March 31, 2006 and
December 31, 2005, consist of the following:
|
|
Restructuring
|
|
Additional
|
|
|
|
Restructuring
|
|
|
|
Liability
|
|
Restructuring
|
|
|
|
Liability
|
|
|
|
as
of
|
|
Expense
|
|
Cash
|
|
as
of
|
|
|
|
Dec.
31, 2005
|
|
Incurred
|
|
Payments
|
|
Mar.
31, 2006
|
|
|
|
(Dollars
in thousands)
|
One-time
employee termination benefits
|
|
$
|
41
|
|
$
|
1
|
|
$
|
(18
|
)
|
$
|
24
|
|
The
amount of
the reserve is for benefits to employees who were or may be involuntarily
terminated in connection with the sale of substantially all of the Company’s
enterprise customer base to TelePacific on March 11, 2005. As of March 31,
2006,
approximately 78 employees had been involuntarily terminated out of the
estimated 80 employees expected to be terminated in connection with such sale.
During the three months ended March 31, 2006, the Company recorded additional
restructuring charges of approximately $1,000 for employee termination benefits.
The
Company
anticipates the total cash paid for employee termination benefits, which is
contingent upon the actual termination date of the remaining employees, and
rent
expense for vacated premises, which ended October 2005, to be approximately
$528,000 and $56,000, respectively. In connection with such sale, the Company
entered into a Transition Service Agreement (TSA) with TelePacific that, among
other things, obligates the Company to provide certain transition services
to
TelePacific. In April 2006, TelePacific exercised the second and last option
to
extend the TSA to September 12, 2006. As a result, the final cash payment to
be
recorded against the 2005 restructuring reserve is expected to occur in
September 2006 in conjunction with the termination of the TSA.
5.
Income Taxes
The
Company's
effective income tax rate for the quarters ended March 31, 2006 and 2005 was
0.0% and 2.9%, respectively. As of March 31, 2006, there was a tax receivable
of
$0.3 million.
6.
Other Comprehensive Income (Loss)
For
the
quarter ended March 31, 2006 there was $51,000 of other comprehensive income
pertaining to net unrealized investment gains on available-for-sale marketable
securities and $8,000 in reclassifications of realized gains on sales of
investments during the period. For the quarter ended March 31, 2005 there
was
$22,000 of other comprehensive loss pertaining to net unrealized investment
losses on available-for-sale marketable securities.
7.
Commitments and Contingencies:
The
Company has a five-year contract (the Contract) with an incumbent local exchange
carrier (ILEC) for transport services that expires in November 2006. The
contract requires that the Company meet certain minimum annual usage levels,
which if met, trigger monthly credits to the Company. While the Company has
met
its minimum usage requirements through March 31, 2006, it has done so primarily
through providing transition services to TelePacific. If TelePacific fully
migrates the enterprise customer base to its system during the current TSA
agreement and should the Company decide to terminate the Contract at such
time,
the Company could incur a termination fee. The amount of the termination
fee, if
any, is dependent on the remaining life of the Contract. The Company estimates
the fee, if any, would approximate $1.0 million.
From
time
to time, the Company is subject to audits with various tax authorities that
arise during the normal course of business. During the third quarter of 2005,
the Company received a tax assessment arising from a tax audit amounting
to $4.8
million. Subsequent to the third quarter of 2005, the Company filed an appeal
against this assessment. The Company believes the resolution to this tax
audit
will not materially harm its business, financial condition or results of
operations.
There
have been no material developments in the litigation previously reported
in the
Company’s Annual Report on Form 10-K for the period ended December 31, 2005 as
filed with the SEC on March 29, 2006. From time to time, the Company is a
party
to litigation that arises in the ordinary course of business. The Company
believes that the resolution of this litigation, and any other litigation
the
Company may be involved with in the ordinary course of business, will not
materially harm its business, financial condition or results of
operations.
8.
Related Party Transactions
Bay
Alarm, a significant stockholder of the Company, together with its subsidiary,
InReach Internet, LLC (InReach), were customers of the Company. As of March
11,
2005, the Bay Alarm customer account was included in the sale of substantially
all of the enterprise customer base to TelePacific. Additionally, as of November
2005, InReach was no longer a subsidiary of Bay Alarm and therefore the table
below does not reflect revenues subsequent to November 2005. Bay Alarm provides
the Company with security monitoring services. The Company also leases a
facility in Oakland, California from Bay Alarm. Certain information concerning
these arrangements is as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands
|
|
Revenues
|
|
$
|
-
|
|
$
|
280
|
|
Revenues
as a percentage of total revenues
|
|
|
-
|
|
|
1.0
|
%
|
Security
monitoring costs
|
|
$
|
8
|
|
$
|
10
|
|
Oakland
property rent payments
|
|
$
|
89
|
|
$
|
88
|
|
All
expenses paid to Bay Alarm are included in selling, general and administrative
expenses in the accompanying condensed consolidated statements of operations
and
comprehensive income (loss).
9.
Debt and interest expense, net
At
March
31, 2006 and December 31, 2005, long-term debt and capital lease obligations
consist of the following:
|
|
March
31,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in thousands)
|
|
Senior
Notes
|
|
$
|
36,102
|
|
$
|
36,102
|
|
Capital
lease obligations
|
|
|
789
|
|
|
651
|
|
Notes
payable
|
|
|
19,537
|
|
|
12,159
|
|
Less
current portion of notes payable and capital leases
|
|
|
(8,595
|
)
|
|
(5,392
|
)
|
|
|
$
|
47,833
|
|
$
|
43,520
|
|
The
Senior Notes of which there is $36.1 million in principal amount outstanding
at
March 31, 2006 and December 31, 2005, mature on February 1, 2009 and bear
interest at 13.5% per annum payable in semiannual installments, with all
principal due in full on February 1, 2009.
During
2004, the Company entered into a secured financing arrangement with Merrill
Lynch Capital (Merrill Lynch), a division of Merrill Lynch Business Financial
Services, Inc., pursuant to which the Company could have borrowed up to
an
aggregate amount of $10.0 million, subject to certain conditions. This
financing
arrangement was structured in a manner that provided for multiple credit
facilities up to an aggregate of $10.0 million with each facility having
separate closing dates and repayment schedules. Additional borrowing under
this
secured financing arrangement expired on December 31, 2004. The principal
and
accrued interest of each facility is payable in 36 equal monthly installments.
The Company has the option to prepay each outstanding facility after 18
months
subject to a maximum premium of 3% of the outstanding facility. Interest
on each
facility was fixed at 5% plus the 3-year swap rate, as published by Bloomberg
Professional Services, determined two business days prior to the closing
date of
each facility. The Company used the proceeds of this financing arrangement
to
acquire a new telecommunication switch and related equipment, which secure
borrowings under this financing arrangement.
As
of
March 31, 2006, the Company had borrowed approximately $5.4 million under
the
Merrill Lynch Capital financing arrangement under two credit facilities
both
with interest rates of 8.6%. As of March 31, 2006 and December 31, 2005,
the
principal balance was $2.6 million and $2.9 million, respectively, and
is
included under Notes Payable in the above table.
The
Company entered into a second secured financing arrangement with Merrill
Lynch
during 2005 pursuant to which the Company borrowed $1.9 million in May
2005 and
$4.5 million in November 2005 at fixed rates of 8.6% and 9.3%, respectively.
In
each case the principal and accrued interest is payable in 36 consecutive
monthly installments. Principal payments on the May loan commenced July
1, 2005
and the November loan commenced January 2006. The Company has the option
to
prepay the outstanding balance after 18 months but prior to 24 months subject
to
a premium of 3%, and if paid thereafter, accompanied by a premium of 1%.
The
borrowing arrangement is secured by telecommunications switching and computer
equipment. As of March 31, 2006 and December 31, 2005 the principal balances
of
$5.7 million and $6.0 million, respectively, are included in the above
table
under Notes Payable.
In
May
2004, the Company completed financing agreements for various network equipment
with Cisco Systems, Inc. (Cisco). These financing agreements were comprised
of
$1.4 million of equipment capital leases and a $1.6 million note payable
exchanged for a 36-month maintenance services agreement. As of March 31,
2006
and December 31, 2005, the principal balance for the capital lease portion
of
the arrangement was $0.5 million and $0.7 million, respectively, and is
included
in the above table under Capital Lease Obligations. As of March 31, 2006
and
December 31, 2005, the principal balance of the note payable was $0.6 million
and $0.7 million, respectively, and is included in the above table under
Notes
Payable.
In
March
2006, the Company completed a new financing agreement with Cisco for various
network equipment and related maintenance. This financing agreement was
comprised of a $0.3 million of equipment capital lease and a $0.2 million
note
payable exchanged for a 36-month maintenance services agreement. As of
March 31,
2006 the principal balance for the capital lease portion of the arrangement
was
$0.3 million, and is included in the above table under Capital Lease
Obligations. As of March 31, 2006 the principal balance of the note payable
was
$0.2 and is included in the above table under Notes Payable.
In
November 2005, the Company entered into a Loan and Security Agreement
(Agreement) with Comerica Bank, which provides for up to $5 million of
revolving
advances and up to $15 million of term loans, subject to certain conditions.
Any
revolving advances are not to exceed 80% of eligible accounts receivables
and
are due and payable in full on November 9, 2007. There were no revolving
advances as of March 31, 2006.
The
term
loan portion of the Agreement, which is to be used within certain limitations
to
finance capital equipment expenditures and acquisitions or to refinance
the
Company’s Senior Notes, is structured into two tranches; the first includes all
term loan borrowings through June 9, 2006, at which point it expires, and
shall
be payable in thirty equal monthly installments commencing July 1, 2006.
The
second tranche starts June 10, 2006 and continues through January 9, 2007
at
which point it expires, and shall be payable in twenty-three equal monthly
installments commencing February 1, 2007.
Rates
for
borrowings under the Agreement float and are based, at the Company’s election,
at 2.75% above a calculated Eurodollar rate for the revolving advances
and 3.75%
above a Eurodollar rate for the term loans or Comerica’s prime rate for the
revolving advances and Comerica’s prime rate plus 0.5% for the term loans. The
Company selected the bank prime rate base for the current term loan resulting
in
an interest rate of 8.25% as of March 31, 2006 and a range of 7.75% to
8.25%
during the three months ended March 31, 2006. The Agreement is secured
by all
personal property of the Company, prevents the distribution of any dividends
without the written consent of Comerica and requires the Company to maintain
certain financial and restrictive covenants including compensating cash
balances. The Company shall maintain 80% of all cash balances with Comerica
and
compensating cash balances of not less than $15.0 million through December
30,
2006, $12.5 million December 31, 2006 through June 29, 2007 and $10.0 million,
thereafter. As of March 31, 2006 and December 31, 2005, the term loan principal
balance was $10.5 million and $2.5 million, respectively, and is included
in the
above table under Notes Payable.
Interest
expense, net for the quarters ended March 31, 2006 and 2005 was as
follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
Interest
on Senior Notes
|
|
$
|
1,218
|
|
$
|
1,218
|
|
Accreted
discount on Senior Secured Note
|
|
|
-
|
|
|
1,262
|
|
Amortization
of deferred financing costs
|
|
|
57
|
|
|
154
|
|
Other
interest expense
|
|
|
280
|
|
|
362
|
|
Less
interest income
|
|
|
(180
|
)
|
|
(190
|
)
|
Interest expense, net
|
|
$
|
1,375
|
|
$
|
2,806
|
|
The
weighted average interest rate on short-term borrowings outstanding as of
March
31, 2006 and 2005 was 7.55% and 6.03%, respectively.
10.
Subsequent Event
Subsequent
to the end of the first quarter of 2006, the Company became aware, and
notified
Comerica, that it was not in compliance with the Adjusted Quick Ratio and
Total
Liabilities to Effective Tangible Net Worth covenants in the Agreement,
in each
case, as of Apri1 30, 2006. On May 11, 2006, the Company received from
Comerica
a waiver of the defaults arising as a result of its non-compliance with
these
two financial covenants. The waiver covers the period from April 1, 2006
through
and including May 31, 2006. The Company expects to negotiate and enter
into an
amendment to the Agreement in order to gain compliance with these two financial
covenants.
Except
for the historical information contained herein, this report contains
forward-looking statements, subject to uncertainties and risks. In this
Quarterly Report on Form 10-Q, our use of the words "outlook," "expect,"
"anticipate," "estimate," "forecast," "project," "likely," "objective," "plan,"
"designed," "goal," "target," and similar expressions is intended to identify
forward-looking statements. While these statements represent our current
judgment on what the future may hold, and we believe these judgments are
reasonable, actual results may differ materially due to numerous important
risk
factors that are described in our Annual Report on Form 10-K for the period
ended December 31, 2005, as filed with the SEC on March 29, 2006, which may
be
revised or supplemented in subsequent reports filed by us with the SEC. Such
risk factors include, but are not limited to: our level of indebtedness;
an
inability to generate sufficient cash to service our indebtedness; regulatory
and legal uncertainty with respect to intercarrier compensation payments
received by us; other regulatory changes; the migration to broadband Internet
access affecting dial-up Internet access; the loss of key executive officers
could negatively impact our business prospects; an increase in our network
expenses; migration of our enterprise customer base to U.S. TelePacific Corp.
occurring sooner than contemplated; the possible delisting of our common
shares
from the Nasdaq Capital Market; customer acceptance of products, such as
VoIP;
and our principal competitors for local services and potential additional
competitors have advantages that may adversely affect our ability to compete
with them.
Introduction
We
are an
independent provider of integrated communication solutions that enable
communication providers to use our network and services as an alternative
to
building and maintaining their own network. Our customers include Internet
service providers (ISPs), enhanced communication service providers (ESPs)
and
other direct providers of communication services to business or residential
end-users, collectively referred to as service providers (SPs).
We
announced
in October 2005 the first phase of a planned national expansion. Under our
expansion plan, we intend to offer our full suite of voice over Internet
protocol (VoIP) and Internet access enabling services in 36 major metropolitan
markets, covering more than 50% of the U.S. population. We are positioning
ourselves as a key player in the SP space with a focus on expansion through
enabling others to become communication service providers. This planned
expansion is designed to provide a nationwide, single source platform that
seamlessly bridges circuit-switching and packet-switching targeted at VoIP
providers, wireless broadband providers, ISPs, carriers and other Next
Generation service providers. We are in the business of enabling any company
to
become a custom telecommunications company. In addition, this planned expansion
is anticipated to increase our market share of dial-up Internet services.
While
we expect that the majority of dial-up Internet service will migrate to
broadband over time, it is a large target market and we remain focused on
serving the needs of our customers.
In
May 2006
we announced that we are now serving customers across our expanded network
in
Washington, D.C. and Denver, Colorado in addition to announcing the availability
of our East Coast SuperPOP to support our nationwide expansion plan. We also
announced in May our increased coverage in Oregon and Washington, as well
as an
initial expansion into Idaho, in response to increasing demand for
infrastructure services.
We
announced
in January 2006 an alliance with VeriSign, Inc. (VeriSign) to provide services
that enable communications providers to offer converged IP, voice and data
communications. The alliance contemplates that VeriSign will facilitate us
with
back office and database services including Calling Party Name, Local Number
Portability, E911 related database updating, SS7 and provisioning services.
Further, it is expected that we will contribute voice and data network services
such as trunking, switching, E911 selective router trunking and IP transport.
Our strategic alliance with VeriSign is expected to enhance our national
expansion plans and strategy of being a single source for converged solutions
offered by VoIP, wireless, broadband and other service providers, allowing
both
companies to drive adoption of next-generation applications.
In
connection
with our transition to a business model based upon enabling other communication
service providers, on March 11, 2005, we sold substantially all of our
enterprise customer base to U.S. TelePacific Corp. (TelePacific) while retaining
our associated network assets. Under the terms of this transaction, TelePacific
acquired certain assets, such as property and equipment with a net book value
of
approximately $3.0 million and other assets of approximately $0.6 million,
and
assumed certain liabilities of approximately $0.7 million, in exchange for
$27.0
million in cash. As a result, we recorded a gain of $24.0 million from this
sale
during the first quarter of 2005. Subsequent to the first quarter of 2005,
we
recorded a net gain of $0.1 million for adjustments associated with this
sale
and an amendment to the Asset Purchase Agreement (APA).
In
addition,
on March 11, 2005, we entered into a Transition Service Agreement (TSA) with
TelePacific that, among other things, obligates us to provide certain transition
services to TelePacific at our estimated cost for a one-year period subject
to
extension for two additional three-month periods. The estimated costs to
be
reimbursed to us include network related and administrative support services
which are provided exclusively to TelePacific and were capped at $10.5 million.
In accordance with the TSA, TelePacific received a $2.0 million credit against
the total amount to be billed that occurred during the second quarter of
2005.
During the third quarter of 2005, we entered into an amendment with TelePacific
to resolve certain disputed matters arising out of the APA and to amend and
modify the TSA. The TSA amendment eliminated the cap of $10.5 million for
certain types of network related services for which TelePacific is obligated
to
reimburse us during the initial 12 month transition period. During April
2006,
TelePacific exercised their second and final option to extend the transition
period for an additional three months. This will extend the TSA transition
period to September 12, 2006.
For
the three
months ended March 31, 2006, we recorded reimbursed transition expenses of
$2.9
million in accordance with the TSA. This amount is recorded as a reduction
to
costs and expenses on a separate line item in the condensed consolidated
statements of operations and comprehensive income (loss). Costs billed under
the
TSA are based upon estimated costs to us, and we anticipate that no profit
will
be recognized on the services performed under the TSA. The enterprise services
are provided by the same network assets and maintained and operated by the
same
employee base as other services provided by us until TelePacific can transition
the enterprise customer base onto its own network. As such, our common network
services or expenses cannot be segregated based upon the services provided
and
therefore the estimated costs have primarily been billed based upon a fixed
fee
per type of service or transaction. Due to the inseparability of our network,
the absence of identifiable shared costs, and as no network assets were sold
to
TelePacific, we determined the transaction with TelePacific did not result
in
discontinued operations.
The
following
table shows our financial performance for the three months ended March 31,
2006
and 2005:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
|
|
|
|
|
|
Total
revenue
|
|
$
|
19,628
|
|
$
|
28,131
|
|
Loss
from operations
|
|
$
|
(2,897
|
)
|
$
|
(1,242
|
)
|
Net
(loss) income
|
|
$
|
(4,272
|
)
|
$
|
17,339
|
|
(Loss)
income per share diluted
|
|
$
|
(0.11
|
)
|
$
|
0.45
|
|
We
derive our
revenues from monthly recurring charges, usage charges and amortization of
initial non-recurring charges. Since the sale of substantially all of the
enterprise customer base on March 11, 2005, we provide services primarily to
SP
customers. Monthly recurring charges include the fees paid by customers for
lines in service and additional features on those lines, as well as equipment
collocation services. Usage charges consist of fees paid by end users for each
call made, fees paid by our intercarrier customers as intercarrier compensation
for completion of their customers’ calls through our network, and access charges
paid by carriers for long distance traffic terminated on our network. Initial
non-recurring charges consist of fees paid by end users for the installation
of
our service. Most installation revenues and costs associated with installation
are recognized as revenue and expensed ratably over the term of the service
contracts, which is generally 24 to 36 months. We recognize revenue when there
is persuasive evidence of an arrangement, delivery of the product or performance
of the service has occurred, the selling price is fixed or determinable and
collectibility is reasonably assured.
We
have
carrier customers who pay us to terminate their originating call traffic
on our
network. These payments consist of meet point access charges, third party
transit traffic and intercarrier compensation payments, collectively referred
to
as intercarrier compensation. Intercarrier compensation payments are a function
of the number of calls we terminate, the minutes of use associated with such
calls and the rates at which we are compensated by the incumbent local exchange
carriers (ILECs). Intercarrier compensation payments have historically been
a
significant portion of our revenues but the intercarrier carriers are not
currently a targeted customer. Intercarrier compensation payments accounted
for
37.7% and 31.0% of our total revenues for the quarters ended March 31, 2006
and
2005, respectively. The failure, for any reason, of one or more carriers
from
which we ordinarily receive intercarrier compensation payments to make all
or a
significant portion of such payments would adversely affect our financial
results.
Our
right
to receive intercarrier compensation payments from other carriers, as well
as
the right of competitive local exchange carriers (CLECs) and other competitors
to receive such payments is the subject of numerous regulatory and legal
challenges.
On
October 20, 2004, we filed a formal complaint with the California Public
Utilities Commission (CPUC) against AT&T. In the complaint proceeding,
we alleged that AT&T owed us over $7.0 million for traffic terminated by us
on behalf of AT&T, plus late payment fees. On September 19, 2005, the
presiding hearing officer released a decision granting our complaint in all
regards, except for our claim for late payment fees. On October 19, 2005,
AT&T filed an appeal with the CPUC, claiming the decision was in
error. We filed a simultaneous appeal with the CPUC, asking for approval
of late payment fees. The CPUC has not established a schedule for
resolving the appeals, affecting the timing, and potentially the collectibility
of these amounts.
As
technology continues to evolve with the corresponding development of new
products and services, there is no guarantee we will retain our customers
with
our existing product and service offerings or with any new products or services
we may develop in the future. Traditional dial-up access to the Internet,
although a mature technology, remains a large target market for us. Major
segments of this market may experience migration to broadband access
technologies where available and competitively priced. While we remain focused
on serving the needs of our customers who provide dial-up access to their
end-users, with the evolution of new technologies many new Internet protocol
(IP) applications are now available, such as VoIP, which have presented us
with
new product development and sales opportunities. We are developing and
overlaying new products and services that take advantage of these new
technologies to further increase the utilization of our network and expect
our
planned national expansion will present additional sales
opportunities.
Competition
in the communication services market has resulted in the consolidation of
companies in our industry, a trend we expect to continue. In order to grow
our
business and better serve our customers, we continue to consider new business
strategies, such as our planned national expansion and alliance with VeriSign,
Inc., and including, but not limited to, potential acquisitions, partnerships,
or new business services. We believe that the footprint of our network, which
encompasses all of the major metropolitan areas of California, in addition
to
Washington, D.C., Denver, Colorado, Oregon, Washington, Nevada, Arizona,
Utah,
as well as an initial expansion into Idaho, and our planned expansion, provides
us with a significant competitive advantage that will enable us to successfully
compete in the future, but we cannot guarantee that we will be able to achieve
future growth.
Application
of Critical Accounting Policies
Critical
Accounting Policies.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to
make
estimates and assumptions that effect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities, and reported
amounts of revenues and expenses for the reporting period. We consider the
following accounting policies to be critical policies due to the estimation
processes involved in each:
• revenue
recognition;
• provision
for doubtful accounts receivable;
• estimated
settlement of disputed billings;
• impairment
for long-lived assets; and
• stock-based
compensation.
By
their
nature, these judgments are subject to an inherent degree of uncertainty.
Thus,
actual results could differ from estimates made and these differences could
be
material.
Revenue
Recognition.
We
recognize revenue when:
• there
is
pervasive evidence of an arrangement;
• delivery
of the product or performance of the service has occurred;
• the
selling price is fixed and determined; and
• collectibility
is reasonably assured.
Non-refundable
up-front payments received for installation services and installation related
costs, are recognized as revenue and expensed ratably over the term of the
service contracts, generally 24 to 36 months.
Revenues
from service access agreements are recognized as the service is provided,
except
for intercarrier compensation fees paid by our intercarrier customers for
completion of their customers’ calls through our network, and access charges
paid by carriers for long distance traffic terminated on our network. Our
right
to receive this type of compensation is the subject of numerous regulatory
and
legal challenges. Until all issues affecting a given item of revenue are
resolved, we will continue to recognize intercarrier compensation as revenue
when the price becomes fixed and determinable and collectibility is reasonably
assured.
Some
ILECs with which we have interconnection agreements have withheld payments
from
amounts billed by us under their agreements. The process of collection of
intercarrier compensation can be complex and subject to interpretation of
regulations and laws. This can lead to negotiated settlements between us
and the
ILEC where we agree to accept a portion of what we believe is owed to us.
Provision
for doubtful accounts receivable.
Provisions for allowances for doubtful accounts receivable are estimated
based
upon:
• historical
collection experience;
• customer
delinquencies and bankruptcies;
• information
provided by our customers;
• observance
of trends in the industry; and
• other
current economic conditions.
Estimated
settlements for disputed billings.
During
the ordinary course of business, we may be billed for carrier traffic for
which
management believes we are not responsible. In such instances, we may dispute
with the appropriate vendor and withhold payment until the matter is resolved.
Our current disputes are primarily related to incorrect facility rates or
incorrect billing elements we believe we are being charged. Management regularly
reviews and monitors all disputed items and, based on industry experience,
records an accrual that represents what we estimate that we owe on the disputed
billings. Although we continue to actively try to expedite resolutions, often
times the state Public Utilities Commission must become involved to arbitrate
such agreements. This process is often not timely and resolutions are often
subject to appeal.
Long-lived
assets.
In 2002,
we adopted Statement of Financial Accounting Standards (SFAS) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets.” We evaluate
our long-lived assets when events or changes in circumstances indicate that
the
carrying amount of such assets may not be fully recoverable. Recoverability
of
assets to be held and used is measured by a comparison of the carrying amount
of
an asset to the future undiscounted cash flows expected to be generated by
the
asset. When we consider an asset to be impaired, it is written down to its
estimated fair market value. This is assessed based on factors specific to
the
type of asset. In assessing the recoverability of these assets, we make
assumptions regarding, among other things, estimated future cash flows to
determine the fair value of the respective assets. If these estimates and
the
related assumptions change in the future, we may be required to record
additional impairment charges for these assets.
Stock-based
compensation.
On
January 1, 2006, we adopted SFAS No. 123R and account for stock-based
compensation in accordance with the fair value recognition provisions of
SFAS
No. 123R. We use the Black-Scholes option-pricing model, which requires the
input of subjective assumptions. These assumptions include estimating the
length
of time employees will retain their stock options (expected term), the estimated
volatility of the our common stock price over the expected term and the number
of options that will cancel for failure to complete their vesting requirements
(forfeitures). Changes in these assumptions could materially affect the estimate
of fair value stock-based compensation and consequently, the related amount
recognized on the consolidated statements of operations and comprehensive
income
(loss).
Results
of Operations
Quarter
Ended March 31, 2006 Compared to the Quarter Ended March 31,
2005
Our
significant revenue components and operational metrics for the quarters ended
March 31, 2006 and 2005 are as follows:
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
Intercarrier
compensation
|
|
$
|
9.3
|
|
$
|
10.0
|
|
(7.0
|
)%
|
Mature
Products
|
|
|
8.6
|
|
|
17.3
|
|
(50.3
|
)%
|
Growth
Products
|
|
|
1.7
|
|
|
0.8
|
|
112.5
|
%
|
Total
revenues
|
|
$
|
19.6
|
|
$
|
28.1
|
|
(30.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
Operational
metrics:
|
|
|
|
|
|
|
|
|
|
Minutes
of use (in billions)
|
|
|
|
|
|
|
|
|
|
Intercarrier
|
|
|
11.04
|
|
|
12.1
|
|
(8.8
|
)%
|
Mature Products
|
|
|
0.05
|
|
|
0.06
|
|
(16.7
|
)%
|
Growth Products
|
|
|
0.10
|
|
|
0.06
|
|
66.7
|
%
|
Total minutes of use
|
|
|
11.19
|
|
|
12.22
|
|
(8.4
|
)%
|
Total
revenues, which is composed of intercarrier, mature products and growth
products, decreased 30.2% to $19.6 million in the quarter ended March 31,
2006.
This decrease was primarily attributable to the sale of our enterprise customer
base to TelePacific in the same period in 2005 as well as the disconnection
of
lines no longer used by certain existing customers.
Intercarrier
compensation decreased 7.0% to $9.3 million in the quarter ended March 31,
2006
from $10.0 million during the same period in 2005 primarily due to a 8.8%
decrease in minutes of use compared to the same period in 2005.
Mature
products include dial access services, collocation, and all enterprise
products.
Revenues from mature products decreased $8.7 million, or 50.3% in the quarter
ended March 31, 2006 from $17.3 million during the same period in 2005.
The
decrease was primarily due to the sale of substantially all of our enterprise
customer base to TelePacific on March 11, 2005 in addition to customers
disconnecting lines not in use.
Growth
products include the VoiceSource suite (PSTN on Ramp, IFEX, PSTN on Ramp
with
NDS and Driver’s Seat), exchange advantage and enhanced dial access. Revenues
from growth products increased $0.9 million, or 112.5% in the quarter ended
March 31, 2006 from $0.8 million during the same period in 2005. The increase
was due primarily to volume growth in addition to new products introduced
subsequent to the quarter ended March 31, 2005.
Total
minutes of use, which is composed of intercarrier, mature products and growth
products declined 8.4% to 11.19 billion in the quarter ended March 31, 2006.
Intercarrier minutes of use are composed of minutes of use resulting from
both
mature products and growth products that are initiated on another carrier’s
network but terminated on our network. Intercarrier minutes of use decreased
8.8% due to a customer moving the majority of their traffic onto their own
network. Mature products minutes of use decreased to 0.05 billion for the
quarter ended March 31, 2006. Growth products minutes of use increased to
0.10
billion for the quarter ended March 31, 2006. We believe that the decrease
in
the minutes of use for mature products and the increase in the minutes of
use
related to growth products reflects the changing focus of our business as
well
as the recent introduction of new products.
The
significant costs and expenses for the quarters ended March 31, 2006 and
2005
are as follows:
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
$
|
9.0
|
|
$
|
10.6
|
|
|
(15.1
|
)%
|
Selling,
general and administrative
|
|
|
13.6
|
|
|
14.7
|
|
|
(7.5
|
)%
|
Reimbursed
transition expenses
|
|
|
(2.9
|
)
|
|
-
|
|
|
100.0
|
%
|
Depreciation
and amortization
|
|
|
2.8
|
|
|
3.7
|
|
|
(24.3
|
)%
|
Restructuring
charges
|
|
|
-
|
|
|
0.4
|
|
|
(100.0
|
)%
|
Total
costs and expenses
|
|
$
|
22.5
|
|
$
|
29.4
|
|
|
(23.5
|
)%
|
Consolidated
network expenses decreased $1.6 million, or 15.1% during the quarter ended
March
31, 2006 compared to $10.6 million during the same period in 2005 due primarily
to negotiated supplier credits received in 2006 in addition to former customers
transitioning off our network as a result of the sale of substantially all
of
our enterprise customer base to TelePacific’s network. During this transition
period, we are obligated under the TSA, among other things, to provide certain
transition services to TelePacific at our estimated cost. The estimated costs
to
be reimbursed to us include network related services and are included under
“Reimbursed transition expenses.”
Consolidated
selling, general and administrative expenses decreased 7.5% to $13.6 million
for
the quarter ended March 31, 2006 from $14.7 million during the same period
in
2005. The decrease was due primarily to the reduction in full-time equivalent
employees, primarily sales employees, as a result of the sale of substantially
all of our enterprise customer base during the first quarter of 2005, partially
offset by costs associated with the expansion plan.
Effective
January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment” utilizing the
modified prospective method. We recorded approximately $97,000 in selling,
general and administrative expense during the quarter ended March 31, 2006
as a
result of this adoption. Total compensation expense recognized for stock-based
awards for the three months ended March 31, 2006 and 2005 was $146,000 and
$48,000, respectively. Previously, we followed Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" for our
stock-based compensation plans and the disclosure-only provisions of SFAS
No.
123, "Accounting for Stock-Based Compensation." As of March 31, 2006, we
had
unrecognized stock-based compensation of $1.2 million outstanding, which
we
expect to recognize over a weighted-average period of 3 years.
Reimbursed
transition expenses were $2.9 million for the quarter ended March 31, 2006
and
no such reimbursed expenses were recorded during the same period in 2005.
The
reimbursed transition expenses relate to network and administrative services
provided to TelePacific in accordance with the TSA. Costs billed under the
TSA
are based upon estimated costs to us, and we anticipate that no profit will
be
recognized on the services performed under the TSA. The enterprise services
are
provided by the same network assets and maintained and operated by the same
employee base as other services provided by us until TelePacific can transition
the enterprise customer base onto its own network. As such, our common network
services or expenses cannot be segregated based upon the services provided
and
therefore the estimated costs have primarily been billed based upon a fixed
fee
per type of service or transaction. Due to the inseparability of our network,
the absence of identifiable shared costs, and as no network assets were sold
to
TelePacific, we determined the transaction with TelePacific did not result
in
discontinued operations.
Estimates
and assumptions are used in setting depreciable lives. Assumptions are based
on
internal studies of use, industry data on average asset lives, recognition
of
technological advancements and understanding of business strategy. Consolidated
depreciation and amortization expense decreased 24.3% to $2.8 million in
the
quarter ended March 31, 2006 from $3.7 million during the same period in
2005.
The decrease in depreciation and amortization expense was primarily due to
some
assets becoming fully depreciated during the period in addition to the sale
of
some assets as part of the sale of substantially all of our enterprise customer
base. Approximately 54% of the property and equipment purchased during the
period, primarily for the planned expansion, were not placed in service as
of
March 31, 2006, and therefore no depreciation expense was recognized for
these
assets.
Restructuring
charges were approximately $15,000 for the quarter ended March 31, 2006
primarily due to increased common area operating expenses at the Colorado
facility. Restructuring charges were $0.4 million for the same period in
2005.
These charges related primarily to the completion of the sale of substantially
all of our enterprise customer base for employee termination benefits and
rent
expense for vacated premises.
Consolidated
loss from operations increased to $2.9 million for the quarter ended March
31,
2006 from $1.2 million during the same period in 2005 primarily due to the
factors discussed in the preceding paragraphs.
Consolidated
interest expense, net decreased to $1.4 million for the quarter ended March
31,
2006 compared to $2.8 million for the same period in 2005 due primarily from
the
extinguishment of the Senior Secured Note during the first quarter of 2005.
Our
interest expense, net was as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
Interest
on Senior Notes
|
|
$
|
1,218
|
|
$
|
1,218
|
|
Accreted
discount on Senior Secured Note
|
|
|
-
|
|
|
1,262
|
|
Amortization
of deferred financing costs
|
|
|
57
|
|
|
154
|
|
Other
interest expense
|
|
|
280
|
|
|
362
|
|
Less
interest income
|
|
|
(180
|
)
|
|
(190
|
)
|
Interest expense, net
|
|
$
|
1,375
|
|
$
|
2,806
|
|
For
the
quarters ended March 31, 2006 and 2005, our effective income tax rate was
0.0%
and 2.9%, respectively.
Consolidated
net loss was $4.3 million for the quarter ended March 31, 2006 compared to
net
income of $17.3 million during the same period in 2005 primarily due to the
factors discussed in the preceding paragraphs.
Quarterly
Operating and Statistical Data:
The
following tables summarize the unaudited results of operations as a percentage
of revenues for the quarters ended March 31, 2006 and 2005. The following
data
should be read in conjunction with the unaudited condensed consolidated
financial statements and notes thereto included elsewhere in this
report:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
Consolidated
Statements of Operations
|
|
|
|
|
|
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
100.0
|
%
|
|
100.0
|
%
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
|
45.9
|
%
|
|
37.6
|
%
|
Selling,
general and administrative expenses
|
|
|
69.2
|
%
|
|
52.2
|
%
|
Reimbursed
transition expenses
|
|
|
(14.8
|
)%
|
|
-
|
%
|
Depreciation
and amortization expenses
|
|
|
14.4
|
%
|
|
13.3
|
%
|
(Loss)
income from operations
|
|
|
(14.8
|
)%
|
|
(4.4
|
)%
|
Net
(loss) income
|
|
|
(21.8
|
)%
|
|
61.6
|
%
|
The
following table sets forth unaudited statistical data for each of the specified
quarters of 2006 and 2005. The operating and statistical data for any quarter
are not necessarily indicative of results for any future period.
|
Three
Months Ended
|
|
2006
|
|
2005
|
|
March
31,
|
|
Dec.
31,
|
|
Sept.
30,
|
|
June
30,
|
|
March
31,
|
|
(unaudited)
|
|
(unaudited)
|
|
(unaudited)
|
|
(unaudited)
|
|
(unaudited)
|
Ports
equipped
|
1,151,616
|
|
1,151,616
|
|
1,054,848
|
|
1,052,400
|
|
1,052,400
|
Quarterly
minutes of use
|
|
|
|
|
|
|
|
|
|
switched (in billions)
|
0.1
|
|
12.0
|
|
12.2
|
|
12.2
|
|
12.2
|
Capital
additions
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
$
10,568
|
|
$
5,797
|
|
$
3,259
|
|
$
1,575
|
|
$
1,600
|
Employees
|
305
|
|
296
|
|
273
|
|
248
|
|
250
|
Liquidity
and Capital Resources:
Sources
and uses of cash. At
March
31, 2006, cash and short-term investments decreased $2.9 million to $23.8
million from $26.7 million at December 31, 2005. The decrease was primarily
due
to the semi-annual interest payment on the Senior Notes.
Net
cash
used in operating activities was $4.2 million for the quarter ended March
31,
2006 as compared $1.3 million for the same period ended in 2005. The increase
was primarily due to an increase in loss from operations and a decrease in
accounts payable.
Net
cash
used in investing activities was $6.9 million for the quarter ended March
31,
2006 due primarily to the purchase of property and equipment. Net cash provided
by investing activities was $22.1 million during the quarter ended March
31,
2005 due to the sale of substantially all of our enterprise customer base
in
March 2005.
Net
cash
provided by financing activities was $7.1 million for the quarter ended March
31, 2006 primarily due to proceeds from borrowings under notes payable. Net
cash
used in financing activities was $41.5 million during the quarter ended March
31, 2005 primarily due to the prepayment of the Senior Secured Note with
proceeds from the sale of the enterprise customer base and cash on hand.
Cash
requirements.
The
telecommunications service business is capital intensive. Our operations
have
required the expenditure of substantial amounts of cash for the design,
acquisition, construction and implementation of our network. We continue
to seek
further ways to enhance our infrastructure in 2006 and beyond. As a result
of
various capital projects and our business plan, as currently contemplated,
we
anticipate making capital expenditures, excluding acquisitions, if any,
of
approximately $13.2 million for the next twelve months. However, the actual
cost
of capital expenditures will depend on a variety of factors. Accordingly,
our
actual capital requirements may exceed, or fall below this
amount.
During
the
normal course of business, we may enter into agreements with some suppliers,
which allow these suppliers to have equipment or inventory available for
purchase based upon criteria as defined by us. As of March 31, 2006, we did
not
have any material future purchase commitments to purchase equipment from
any of
our vendors.
Debt
outstanding.
At March
31, 2006 and December 31, 2005, long-term debt and capital lease obligations
consist of the following:
|
|
March
31,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in thousands)
|
|
Senior
Notes
|
|
$
|
36,102
|
|
$
|
36,102
|
|
Capital
lease obligations
|
|
|
789
|
|
|
651
|
|
Notes
payable
|
|
|
19,537
|
|
|
12,159
|
|
Less
current portion of notes payable and capital leases
|
|
|
(8,595
|
)
|
|
(5,392
|
)
|
|
|
$
|
47,833
|
|
$
|
43,520
|
|
The
Senior Notes of which there is $36.1 million in principal amount outstanding
at
March 31, 2006 and December 31, 2005, mature on February 1, 2009 and bear
interest at 13.5% per annum payable in semiannual installments, with all
principal due in full on February 1, 2009.
In
March
2006, we completed a new financing agreement with Cisco Systems, Inc. for
various network equipment and related maintenance. This financing agreement
was
comprised of a $0.3 million equipment capital lease and a $0.2 million
note
payable exchanged for a 36-month maintenance services agreement. As of
March 31,
2006 the principal balance for the capital lease portion of the arrangement
was
$0.3 million, and is included in the above table under Capital Lease
Obligations. As of March 31, 2006 the principal balance of the note payable
was
$0.2 and is included in the above table under Notes Payable.
In
November
2005, we entered into a Loan and Security Agreement (Agreement) with Comerica
Bank, which provides for up to $5 million of revolving advances and up
to $15
million of term loans, subject to certain conditions. Any revolving advances
are
not to exceed 80% of eligible accounts receivables and are due and payable
in
full on November 9, 2007. There were no revolving advances as of March
31,
2006.
The
term loan
portion of the Agreement, which is to be used within certain limitations
to
finance capital equipment expenditures and acquisitions or to refinance
our
Senior Notes, is structured into two tranches; the first includes all term
loan
borrowings through June 9, 2006, at which point it expires, and shall be
payable
in thirty equal monthly installments commencing July 1, 2006. The second
tranche
starts June 10, 2006 and continues through January 9, 2007 at which point
it
expires, and shall be payable in twenty-three equal monthly installments
commencing February 1, 2007.
Rates
for
borrowings under the Agreement float and are based, at our election,
at 2.75%
above a calculated Eurodollar rate for the revolving advances and 3.75%
above a
Eurodollar rate for the term loans or Comerica’s prime rate for the revolving
advances and Comerica’s prime rate plus 0.5% for the term loans. The Agreement
is secured by all of our personal property and requires us to maintain
certain
financial and restrictive covenants. As of March 31, 2006 and December
31, 2005,
the term loan principal balance was $10.5 million and $2.5 million,
respectively, and is included in the above table under Notes Payable
and we were
in compliance with all required covenants.
Subsequent
to the end of the first quarter of 2006, we became aware, and notified
Comerica,
that we were not in compliance with the Adjusted Quick Ratio and Total
Liabilities to Effective Tangible Net Worth covenants in the Agreement,
in each
case, as of April 30, 2006. On May 11, 2006, we received from Comerica
a waiver
of the defaults arising as a result of our non-compliance with these
two
financial covenants. The waiver covers the period from April 1, 2006
through and
including May 31, 2006. We expect to negotiate and enter into an amendment
to
the Agreement in order to gain compliance with these two financial covenants.
However, we cannot assure you that we will be able to enter into such
an
amendment, or do so on terms favorable to us, or that we will be able
to gain
and/or maintain compliance with these financial covenants, whether or
not
amended.
Future
uses
and sources of cash.
Our
principal sources of funds for the remainder of 2006 are anticipated to
be
current cash and short-term investment balances, cash flows from operating
activities and borrowings under existing and any future financing agreements.
We
believe that these funds will provide us with sufficient liquidity and
capital
resources for us to fund our business plan for the next 12 months. No assurance
can be given, however, that this will be the case. We may also seek to
obtain
leases or additional lines of credit in 2006. There can be no assurance
that
additional lines of credit or leases will be made available to us on terms
that
we find acceptable. As currently contemplated, we expect to fund, among
other
things:
• interest
payments of approximately $6.2 million on Senior Notes and other
notes;
• anticipated
capital expenditures of approximately $13.2 million; and
• capital
lease payments (including interest) of approximately $0.6 million.
The
foregoing
statements do not take into account (i) acquisitions, which, if made, are
expected to be funded through a combination of cash and equity (ii) the
repurchase of any of our remaining outstanding Senior Notes or (iii) any
potential payments made in respect of adjustments which may arise from
our
ongoing tax audits. Depending upon our rate of growth and profitability,
among
other things, we may require additional equity or debt financing to meet
our
working capital requirements or capital needs. There can be no assurance
that
additional financing will be available when required, or, if available,
will be
on terms satisfactory to us. Key factors which could affect our liquidity
include:
• future
demand of our services;
• financial
stability of our customers;
• outcomes
of regulatory proceedings involving intercarrier compensation;
• capital
expenditures;
• our
debt
payments;
• capital
lease repayments;
• interest
expense on debt; and
• development
and market rollout of new service offerings.
We
are in the
process of exploring strategic alternatives with a goal of enhancing stockholder
value. Possible strategic alternatives include raising additional debt
or equity
financing, entry into strategic relationships or joint ventures and merger
and
acquisitions.
ITEM
3. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
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. At March 31, 2006, we had
an
outstanding note payable of $10.5 million to Comerica Bank (Comerica).
This note
is at Comerica’s prime rate plus 0.5%, which was 8.25 % as of March 31, 2006. A
hypothetical 1% point increase in short-term interest rates would reduce
the
annualized income before tax by approximately $0.1 million as a result
of higher
interest expense.
We
are
exposed to changes in interest rates on our investments in cash equivalents
and
short-term investments. Approximately $22.7 million of our total cash and
investments are in cash equivalents with original maturities of less than
three
months and the remainder in short-term investments with maturities of less
than
12 months. A hypothetical 1% decrease in short-term interest rates would
reduce
the annualized pretax interest income on our $23.8 million cash, cash
equivalents and short-term investments at March 31, 2006 by approximately
$0.2
million.
There
have been no changes in the Company's internal control over financial reporting
that occurred during the quarter ended March 31, 2006 that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting. It should be recognized that the design
of any
system of controls is based upon certain assumptions about the scope of
the
tasks to be performed and the environment in which the tasks are to be
performed. As such, the Company's internal controls provide the Company
with a
reasonable assurance of achieving their intended effect.
PART
II
OTHER
INFORMATION
See
Note 7 to
the Unaudited Condensed Consolidated Financial Statements included elsewhere
in
this Form 10-Q and “Management's Discussion and Analysis of Financial Condition
and Results of Operations—Introduction” for a description of certain legal
proceedings involving the Company.
ITEM
1A. Risk
Factors
There
have been no material changes in the previously reported risk factors as
noted
in the Company’s Annual Report on Form 10-K for the period ended December 31,
2005 filed with the SEC on March 29, 2006.
ITEM
5. Other Information
(a)
On
May 11, 2006, we received from Comerica Bank a waiver of certain defaults
(the
Waiver) arising as a result of our non-compliance with two financial
covenants
set forth in the Loan and Security Agreement, dated as of November 9,
2005,
between us and Comerica Bank (as amended, the Agreement). In particular,
we were
not in compliance with the Adjusted Quick Ratio and Total Liabilities
to
Effective Tangible Net Worth covenants in the Agreement, in each case,
as of
April 30, 2006. The Waiver covers the period from April 1, 2006 through
and
including May 31, 2006. A copy of the Waiver is filed as exhibit 10.61
to this
Report.
Exhibits
|
10.60
|
Second
Amendment to
Loan and Security Agreement dated as of February 17, 2006,
by and between
Comerica Bank and the Company.
|
|
10.61
|
Waiver
dated May 11, 2006
to
Loan and Security Agreement between Comerica Bank and the
Company dated as of November 9, 2005, as amended by the First
Amendment to the Loan and Security Agreement, dated as of
November 30,
2005, as further amended by the Second Amendment to the Loan
and Security
Agreement, dated as of February 17, 2006.
|
|
31.1
|
Certification
by Henry R. Carabelli, Chief Executive Officer pursuant to Section
302 of
the Sarbanes-Oxley Act of 2002.
|
|
31.2
|
Certification
by H. Ravi Brar, Chief Financial Officer and Vice President of
Human
Resources pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
32.1
|
Certification
by Henry R. Carabelli, Chief Executive Officer pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002.
|
|
32.2
|
Certification
by H. Ravi Brar, Chief Financial Officer and Vice President of
Human
Resources pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
Note:
ITEMS 2, 3, and 4 are not applicable and have been
omitted.
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 on May 12, 2006.
PAC-WEST
TELECOMM, INC.
/s/
Henry
R. Carabelli
_____________________________
Henry
R.
Carabelli
President
and Chief Executive Officer
/s/
H.
Ravi Brar
______________________________
H.
Ravi
Brar
Chief
Financial Officer and Vice President of Human Resources