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 June 30, 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
|
95207
|
(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 the 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
July 31, 2006, the Company had an aggregate of 37,667,528 shares of common
stock
issued and outstanding.
PAC-WEST
TELECOMM, INC.
Report
on Form 10-Q For the Quarterly Period Ended June 30, 2006
Table
of Contents
Part
I.
|
FINANCIAL
INFORMATION
|
Page
|
Item
1.
|
Financial
Statements (Unaudited)
|
|
|
Condensed
Consolidated Balance Sheets
|
|
|
June
30, 2006 and December 31, 2005
|
3
|
|
Condensed
Consolidated Statements of Operations and Comprehensive
Income
|
|
|
(Loss)
- Three and six months ended June 30, 2006 and 2005
|
|
|
Condensed
Consolidated Statements of Cash Flows - Six
|
|
|
months
ended June 30, 2006 and 2005
|
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
|
|
|
|
Item
2.
|
Management's
Discussion and Analysis of Financial Condition
|
|
|
and
Results of Operations
|
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risks
|
37
|
|
|
|
Item
4.
|
Controls
and Procedures
|
|
|
|
|
|
|
|
Part
II.
|
OTHER
INFORMATION
|
|
Item
1.
|
Legal
Proceedings
|
38
|
Item 1A.
|
Risk
Factors
|
38
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
38
|
Item
6.
|
Exhibits
|
40
|
Signatures
|
|
41
|
|
|
|
PART
I. FINANCIAL INFORMATION
|
|
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Balance Sheets
|
(Dollars
in thousands except share and per share
data)
|
|
|
|
|
June
30,
|
|
December
31,
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
|
|
$
|
20,199
|
|
$
|
26,681
|
|
Short-term
investments
|
|
|
|
|
|
295
|
|
|
-
|
|
Trade
accounts receivable, net of allowances of
|
|
|
|
|
|
|
|
|
|
|
$838 and $368 at June 30, 2006 and
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005, respectively
|
|
|
|
|
|
16,076
|
|
|
7,806
|
|
Receivable
from transition service agreement
|
|
|
|
|
|
142
|
|
|
1,170
|
|
Prepaid
expenses and other current assets
|
|
|
|
|
|
3,296
|
|
|
3,129
|
|
Total
current assets
|
|
|
|
|
|
40,008
|
|
|
38,786
|
|
Property
and equipment, net
|
|
44,729
|
|
|
39,458
|
|
Other
assets, net
|
|
858
|
|
|
1,079
|
|
Total assets
|
|
|
|
|
$
|
85,595
|
|
$
|
79,323
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
Accounts
payable
|
|
|
|
|
$
|
11,711
|
|
$
|
6,578
|
|
Current
obligations under notes payable and capital leases
|
|
|
|
|
|
15,760
|
|
|
5,392
|
|
Accrued
interest
|
|
|
|
|
|
2,193
|
|
|
2,032
|
|
Other
accrued liabilities
|
|
|
|
|
|
7,610
|
|
|
8,492
|
|
Total current liabilities
|
|
|
|
|
|
37,274
|
|
|
22,494
|
|
Senior
Notes
|
|
36,102
|
|
|
36,102
|
|
Notes
payable and capital leases, less current portion
|
|
3,578
|
|
|
7,418
|
|
Other
liabilities, net
|
|
124
|
|
|
72
|
|
Total liabilities
|
|
|
|
|
|
77,078
|
|
|
66,086
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies (Note 8)
|
|
|
|
|
|
|
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, 37,667,528 and 37,204,093 shares issued
|
|
|
|
|
|
|
|
|
|
|
and outstanding at June 30, 2006 and December 31,
|
|
|
|
|
|
|
|
|
|
|
2005, respectively
|
|
|
|
|
|
37
|
|
|
37
|
|
Additional
paid-in capital
|
|
|
|
|
|
191,255
|
|
|
191,319
|
|
Accumulated
deficit
|
|
|
|
|
|
(182,820
|
)
|
|
(177,721
|
)
|
Accumulated
other comprehensive gain (loss)
|
|
|
|
|
|
45
|
|
|
(25
|
)
|
Deferred
stock compensation
|
|
|
|
|
|
-
|
|
|
(373
|
)
|
Total stockholders' equity
|
|
|
|
|
|
8,517
|
|
|
13,237
|
|
Total liabilities and stockholders' equity
|
|
|
|
|
$
|
85,595
|
|
$
|
79,323
|
|
See
notes
to unaudited condensed consolidated financial statements.
PAC-WEST
TELECOMM, INC.
|
|
and
Comprehensive Income (Loss)
|
(Unaudited,
in thousands except per share
data)
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenues
|
|
$
|
27,028
|
|
$
|
21,869
|
|
$
|
46,656
|
|
$
|
50,000
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Network expenses (exclusive of depreciation shown separately
below)
|
|
|
10,805
|
|
|
9,707
|
|
|
19,805
|
|
|
20,273
|
|
Selling, general and administrative
|
|
|
14,940
|
|
|
12,448
|
|
|
28,522
|
|
|
27,121
|
|
Reimbursed transition expenses
|
|
|
(2,766
|
)
|
|
(2,848
|
)
|
|
(5,670
|
)
|
|
(2,848
|
)
|
Depreciation and amortization
|
|
|
3,113
|
|
|
3,234
|
|
|
5,945
|
|
|
6,984
|
|
Restructuring charges
|
|
|
250
|
|
|
222
|
|
|
265
|
|
|
606
|
|
Total operating expenses
|
|
|
26,342
|
|
|
22,763
|
|
|
48,867
|
|
|
52,136
|
|
Income (loss) from operations
|
|
|
686
|
|
|
(894
|
)
|
|
(2,211
|
)
|
|
(2,136
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
1,529
|
|
|
1,301
|
|
|
2,904
|
|
|
4,107
|
|
Other income, net
|
|
|
(16
|
)
|
|
(62
|
)
|
|
(16
|
)
|
|
(62
|
)
|
Loss (gain) on sale of enterprise customer base
|
|
|
-
|
|
|
169
|
|
|
-
|
|
|
(23,865
|
)
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
2,138
|
|
(Loss) income before income taxes
|
|
|
(827
|
)
|
|
(2,302
|
)
|
|
(5,099
|
)
|
|
15,546
|
|
Income
tax expense
|
|
|
-
|
|
|
13
|
|
|
-
|
|
|
522
|
|
Net (loss) income
|
|
$
|
(827
|
)
|
$
|
(2,315
|
)
|
$
|
(5,099
|
)
|
$
|
15,024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
(loss) income per share
|
|
$
|
(0.02
|
)
|
$
|
(0.06
|
)
|
$
|
(0.14
|
)
|
$
|
0.41
|
|
Diluted
(loss) income per share
|
|
$
|
(0.02
|
)
|
$
|
(0.06
|
)
|
$
|
(0.14
|
)
|
$
|
0.39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average Shares Outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
37,599
|
|
|
36,896
|
|
|
37,404
|
|
|
36,870
|
|
Diluted
|
|
|
37,599
|
|
|
36,896
|
|
|
37,404
|
|
|
38,867
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
(Loss) Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(827
|
)
|
$
|
(2,315
|
)
|
$
|
(5,099
|
)
|
$
|
15,024
|
|
Net unrealized gains on investments, net of tax
|
|
|
5
|
|
|
42
|
|
|
56
|
|
|
20
|
|
Reclassification of net realized losses on sale of investments,
net of
tax
|
|
|
22
|
|
|
-
|
|
|
14
|
|
|
-
|
|
Comprehensive (loss) income
|
|
$
|
(800
|
)
|
$
|
(2,273
|
)
|
$
|
(5,029
|
)
|
$
|
15,044
|
|
See
notes
to unaudited condensed consolidated financial statements.
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Statements of Cash Flows
|
(Unaudited,
in thousands)
|
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
Operating
activities:
|
|
|
|
|
|
|
|
Net
(loss) income
|
|
$
|
(5,099
|
)
|
$
|
15,024
|
|
Adjustments
to reconcile net (loss) income to net cash
|
|
|
|
|
|
|
|
provided by operating activities:
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
5,945
|
|
|
6,984
|
|
Amortization of deferred financing costs
|
|
|
114
|
|
|
205
|
|
Amortization of discount on notes payable
|
|
|
-
|
|
|
1,262
|
|
Stock-based compensation
|
|
|
278
|
|
|
96
|
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
2,138
|
|
Gain on sale of enterprise customer base
|
|
|
-
|
|
|
(23,865
|
)
|
Provision for doubtful accounts
|
|
|
552
|
|
|
(18
|
)
|
Net loss (gain) on disposal of property
|
|
|
17
|
|
|
(29
|
)
|
Other
|
|
|
(33
|
)
|
|
-
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Increase in accounts receivable
|
|
|
(8,822
|
)
|
|
(145
|
)
|
Decrease (increase) in receivable from transition service
agreement
|
|
|
1,028
|
|
|
(1,751
|
)
|
Decrease in prepaid expenses and other assets
|
|
|
168
|
|
|
2,657
|
|
Increase in accounts payable
|
|
|
2,008
|
|
|
984
|
|
Increase in accrued interest
|
|
|
161
|
|
|
203
|
|
Decrease in other current liabilities and other
liabilities
|
|
|
(830
|
)
|
|
(1,242
|
)
|
Net cash (used in) provided by operating activities
|
|
|
(4,513
|
)
|
|
2,503
|
|
Investing
activities:
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(7,664
|
)
|
|
(3,175
|
)
|
Proceeds
from disposal of property and equipment
|
|
|
-
|
|
|
95
|
|
(Purchases)
redemptions of short-term investments, net
|
|
|
(225
|
)
|
|
287
|
|
Proceeds
from sale of enterprise customer base
|
|
|
-
|
|
|
26,953
|
|
Returned
deposits associated with the enterprise customer base sale
|
|
|
-
|
|
|
(3,536
|
)
|
Other
|
|
|
33
|
|
|
200
|
|
Net cash (used in) provided by investing activities
|
|
|
(7,856
|
)
|
|
20,824
|
|
Financing
activities:
|
|
|
|
|
|
|
|
Repayments
of notes payable
|
|
|
(1,860
|
)
|
|
(42,050
|
)
|
Proceeds
from the issuance of common stock
|
|
|
31
|
|
|
213
|
|
Principal
payments on capital leases
|
|
|
(256
|
)
|
|
(407
|
)
|
Net
proceeds from borrowing under notes payable
|
|
|
7,972
|
|
|
1,949
|
|
Net cash provided by (used in) financing activities
|
|
|
5,887
|
|
|
(40,295
|
)
|
Net
decrease in cash and cash equivalents
|
|
|
(6,482
|
)
|
|
(16,968
|
)
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
26,681
|
|
|
32,265
|
|
End
of period
|
|
$
|
20,199
|
|
$
|
15,297
|
|
(continued)
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Statements of Cash Flows
|
(Unaudited,
in thousands)
|
(continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
3,000
|
|
$
|
2,997
|
|
Income
taxes
|
|
$
|
-
|
|
$
|
335
|
|
Non-cash
Operating and Investing Activities:
|
|
|
|
|
|
|
|
Acquisitions
of property and equipment included in accounts payable
|
|
$
|
3,125
|
|
$
|
-
|
|
Non-cash
Operating and Financing Activities:
|
|
|
|
|
|
|
|
Prepaid
maintenance agreement financed by notes payable
|
|
$
|
335
|
|
$
|
-
|
|
Non-cash
Investing and Financing Activities:
|
|
|
|
|
|
|
|
Equipment
acquired with capital lease obligations
|
|
$
|
297
|
|
$
|
-
|
|
Equipment
acquired with notes payable obligations
|
|
$
|
39
|
|
$
|
-
|
|
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 AND SIX MONTHS ENDED JUNE 30, 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 and 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 six months ended June 30, 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. The Company considers
such issues in evaluating the four criteria above.
Some
incumbent local exchange carriers (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 such intercarrier
compensation is subject to complex contracts, regulations and laws, and is
routinely the subject of judicial and/or administrative processes. Often,
disputes concerning intercarrier compensation are settled by the Company
and the
ILEC in a manner that results in the Company accepting 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, “Share-Based Payment,” and
accounts for stock-based compensation in accordance with the fair value
recognition provisions of SFAS No. 123R. 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. |
Need
to Raise Additional Capital
|
The
Company’s principal sources of operating funds for the remainder of 2006 and the
first half of 2007 are anticipated to be current cash and short-term investment
balances and cash flows from operating activities. However, the Company believes
that its requirements for operating funds over the next twelve months will
cause
its current cash and short-term investment balances to fall below those required
by the terms of its financing arrangement with Comerica Bank (see Note 10).
As a
result, if the Company continues to fund its operations without obtaining
an
additional source of financing, Comerica Bank may exercise its rights under
the
Loan and Security Agreement, including the right to accelerate, or declare
the
entire loan amount due and payable. If Comerica accelerates the debt, the
Company believes that other sources of its existing financing arrangements
will
have, and may exercise, similar rights and the Company will not have sufficient
liquidity and capital resources for it to operate for the next 12 months.
In
an
effort to address its financing needs, the Company has retained the services
of
a financial advisory firm, and together with such firm is in the process
of
exploring strategic alternatives, including raising additional debt or equity
financing, entry into strategic relationships or joint ventures and merger
and
acquisitions. While the Company has successfully raised capital in the past,
there can be no assurance that sources of financing will continue to be
available to the Company in amounts sufficient to meet its financial needs,
or
that any such financing will be available on terms acceptable to the
Company.
If
the
Company is unable to secure additional financing, (1) it may not be able
to take
advantage of business opportunities or respond to competitive pressures,
or may
be required to reduce the scope of its planned national expansion and other
product development and marketing initiatives, any of which could have a
negative impact on its business and operating results; (2) it could become
necessary for the Company to significantly curtail its operations in order
to
meet its debt service obligations and (3) even if the Company did take such
actions to permit it to service its debt, the Company might still violate
certain covenants under the terms of its financing arrangements. Any action
by
the providers of the Company’s financing arrangements to declare the Company in
default and accelerate its obligations under such financing arrangements
would
substantially and adversely impact the Company’s ability to continue to operate
and to meet other obligations.
3.
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.
As a result of adopting SFAS No. 123R, the Company recorded approximately
$105,000 and $202,000 in expense during the three and six months ended
June 30,
2006, respectively. 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 June 30, 2006 and 2005 was $132,000 and $48,000, respectively. Total
compensation expense recognized for stock-based awards for the six months
ended
June 30, 2006 and 2005 was $278,000 and $96,000, respectively. Total
compensation expense recognized for stock-based awards is included in selling,
general and administrative expenses in the condensed consolidated statements
of
operations and comprehensive income (loss). The Company recognized approximately
$27,000 and $76,000 for the three and six months ended June 30, 2006,
respectively, related to restricted stock awards. The Company recognized
approximately $48,000 and $96,000 for the three and six months ended June
30,
2005, respectively, related to performance unit awards. Cash received for
options exercised during the six months ended June 30, 2006 and 2005 was
$31,000
and $213,000, respectively.
For
the
three and six months ended June 30, 2006 and the three months ended June
30,
2005, there was no impact on earnings per share from employee stock options
since such options were anti-dilutive. Accordingly, for the three and six
months
ended June 30, 2006, 593,609 and 699,197 shares, respectively, were excluded
from the diluted net loss per share calculation. In addition, 1,759,349 shares
were excluded from the diluted net loss per share calculation for the three
months ended June 30, 2005.
The
effect of the change from applying the original provisions of SFAS 123 for
the
comparison periods are as follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30, 2005
|
|
June
30, 2005
|
|
|
|
(Dollars
in thousands except per share amounts)
|
|
|
|
|
|
|
|
|
|
Net
(loss) income as reported
|
|
$
|
(2,315
|
)
|
$
|
15,024
|
|
Total
stock-based employee compensation included in
|
|
|
|
|
|
|
|
reported net (loss) income, net of tax
|
|
|
48
|
|
|
93
|
|
Total
stock-based employee compensation determined
|
|
|
|
|
|
|
|
under the fair value based method
|
|
|
(134
|
)
|
|
(278
|
)
|
|
|
|
|
|
|
|
|
Pro
forma
|
|
$
|
(2,401
|
)
|
$
|
14,839
|
|
|
|
|
|
|
|
|
|
Basic
net income (loss) per common share:
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(0.06
|
)
|
$
|
0.41
|
|
Pro forma
|
|
$
|
(0.07
|
)
|
$
|
0.40
|
|
Diluted
net income (loss) per common share:
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(0.06
|
)
|
$
|
0.39
|
|
Pro forma
|
|
$
|
(0.07
|
)
|
$
|
0.38
|
|
Stock
Incentive Plans
In
January 1999, the Company’s Board of Directors approved the terms of the 1999
Stock Incentive Plan (the “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 pursuant to the Non-Qualified Stock Incentive Plans
approved in 1998 and 2000. 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. Restricted stock awards 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
June 30, 2006, there was $1.4 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
2.8 years. The total fair value of shares vested during the three and six
months
ended June 30, 2006 was approximately $223,000 and $263,000, respectively.
For
the periods ended June 30, 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 three and six months ended June 30, 2006 and 2005
are
presented as follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
Expected
volatility
|
|
|
109.2
|
%
|
|
106.0
|
%
|
|
110.0
|
%
|
|
106.0
|
%
|
Risk-free
interest rate
|
|
|
5.0
|
%
|
|
3.9
|
%
|
|
4.8
|
%
|
|
3.8
|
%
|
Expected
term (years)
|
|
|
5.9
|
|
|
4.0
|
|
|
6.1
|
|
|
4.0
|
|
Expected
dividend yield
|
|
|
0.0
|
%
|
|
0.0
|
%
|
|
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 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 June 30, 2006, and changes during
the period then ended is presented below:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
Aggregate
|
|
|
|
Number
of
|
|
Average
|
|
Remaining
|
|
Intrinsic
|
|
|
|
Shares
|
|
Exercise
|
|
Contractual
|
|
Value
|
|
|
|
|
|
|
|
Price
|
|
|
Term
|
|
|
(000's)
|
|
Outstanding
at January 1, 2006
|
|
|
5,804
|
|
$
|
1.70
|
|
|
|
|
|
|
|
Granted
|
|
|
298
|
|
$
|
0.91
|
|
|
|
|
|
|
|
Exercised
|
|
|
(16
|
)
|
$
|
0.50
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(278
|
)
|
$
|
1.39
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2006
|
|
|
5,808
|
|
$
|
1.67
|
|
|
6.2
|
|
$
|
104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and exercisable at
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30, 2006
|
|
|
4,148
|
|
$
|
1.88
|
|
|
4.9
|
|
$
|
94
|
|
The
weighted-average fair value of options granted during the three months ended
June 30, 2006 and 2005 was $0.71 and $0.98, respectively. The weighted-average
fair value of options granted during the six months ended June 30, 2006 and
2005
was $0.78 and $1.03, respectively. The total intrinsic value of options
exercised during three months ended June 30, 2006 and 2005 was approximately
$2,000 and $132,000, respectively. The total intrinsic value of options
exercised during the six months ended June 30, 2006 and 2005 was approximately
$6,000 and $179,000, respectively.
Restricted
Stock
As
of
June 30, 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
June 30, 2006, there was approximately $337,000 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 441,256 shares remained available for issuance as of June 30, 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 periods ended June 30, 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
and Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
Expected
volatility
|
|
|
68.0
|
%
|
|
84.0
|
%
|
Risk-free
interest rate
|
|
|
4.4
|
%
|
|
2.5
|
%
|
Expected
term (years)
|
|
|
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
for the three and six months ended June 30, 2006 was approximately ($2,000)
and
$9,000, respectively.
4.
Concentration of Customers and Suppliers
For
the
three and six months ended June 30, 2006 and 2005, the Company had the following
concentrations of revenues and operation costs:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Largest
customers: Percentage of total
|
|
|
|
|
|
|
|
|
|
revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
1
|
|
|
39.2
|
%
|
|
25.7
|
%
|
|
32.7
|
%
|
|
23.1
|
%
|
Customer
2
|
|
|
11.0
|
%
|
|
21.5
|
%
|
|
12.3
|
%
|
|
18.8
|
%
|
Customer
3
|
|
|
9.5
|
%
|
|
10.5
|
%
|
|
9.2
|
%
|
|
8.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Largest
supplier: Percentage of network
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expenses
|
|
|
40.1
|
%
|
|
40.2
|
%
|
|
40.3
|
%
|
|
39.2
|
%
|
During
each of the comparison periods, no other customers accounted for more than
10%
of total revenues. Customer one represented 48.4% of trade accounts receivable
as of June 30, 2006 and no other customers represented more than 10% of trade
accounts receivable. At December 31, 2005, no customers represented more than
10% of trade accounts receivable.
5.
Restructuring Charges
2001
and 2002 Restructuring Plans
A
summary
of the activity for the six months ended June 30, 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 June
30, 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
|
|
June
30, 2006
|
|
|
|
(Dollars
in thousands)
|
Rent
expense for vacated premises
|
|
$
|
1,915
|
|
$
|
16
|
|
$
|
(229
|
)
|
$
|
1,702
|
|
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 six months ended June 30,
2006,
the Company recorded additional restructuring charges of approximately $16,000
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 six months ended June 30, 2006 pertaining to the
Company's 2005 restructuring plan, which is included in other accrued
liabilities in the accompanying condensed consolidated balance sheets as
of June
30, 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
|
|
|
|
|
|
(Dollars
in thousands)
|
One-time
employee termination benefits
|
|
$
|
41
|
|
$
|
11
|
|
$
|
(49
|
)
|
$
|
3
|
|
The amount of the reserve is for benefits to employees who were involuntarily
terminated in connection with the sale of substantially all of the Company’s
enterprise customer base to TelePacific on March 11, 2005. Approximately
80
employees were terminated as part of this restructuring plan. During the
six
months ended June 30, 2006, the Company recorded additional restructuring
charges of approximately $11,000 for employee termination benefits.
The
Company anticipates the total cash paid for employee termination benefits
and
rent expense for vacated premises to be approximately $530,000 and $56,000,
respectively. Rent expense for vacated premises ended October 2005. The final
cash payment to be recorded against the 2005 restructuring reserve is expected
to occur in August 2006.
2006
Restructuring Plan
In June 2006, the Company implemented another restructuring plan, which included
a workforce reduction of approximately 32 employees as part of a cost
containment strategy. As a result of implementing this restructuring plan,
the
Company recorded $238,000 in restructuring charges related to employee
termination benefits during the second quarter of 2006. The workforce reduction
was completed in June 2006. The Company anticipates total cash paid for employee
termination benefits to be $238,000. The final cash payment to be recorded
against the 2006 restructuring reserve is expected to occur in September
2006. A
summary of the activity for the six months ended June 30, 2006 pertaining
to the
Company’s 2006 restructuring plan which is included in other accrued liabilities
in the accompanying condensed consolidated balance sheets as of June 30,
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
|
|
|
|
|
|
(Dollars
in thousands)
|
One-time
employee termination benefits
|
|
$
|
-
|
|
$
|
238
|
|
$
|
(210
|
)
|
$
|
28
|
|
6.
Income Taxes
The
Company's effective income tax rate for the three months ended June 30, 2006
and
2005 was 0.0% and 1.0%, respectively. The Company’s effective income tax rate
for the six months ended June 30, 2006 and 2005 was 0.0% and 3.4%, respectively.
As of June 30, 2006, there was an income tax receivable of $0.3
million.
7.
Other Comprehensive Income (Loss)
For
the
three months ended June 30, 2006 and 2005, there was $5,000 and $42,000,
respectively, of other comprehensive income pertaining to net unrealized
investment gains on available-for-sale marketable securities. Reclassifications
of net realized losses on sales of investments during the three months ended
June 30, 2006 and 2005 were $22,000 and $0, respectively. For the six months
ended June 30, 2006 and 2005, there was $56,000 and $20,000, respectively,
of
other comprehensive income pertaining to net unrealized investment gains
on
available-for-sale marketable securities. Reclassification of net realized
losses on sales of investments during the six months ended June 30, 2006
was
$14,000 and $0, respectively.
8.
Commitments and Contingencies:
The
Company has a five-year contract (the Contract) with an 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
June 30, 2006, it has done so primarily through providing transition services
to
TelePacific. As TelePacific migrates the enterprise customer base to its
system
prior to September 12, 2006, which is the end of the current term of the
TSA,
the Company may decide to terminate the Contract. As a result, 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 $0.5 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.
On
October 20, 2004, the Company filed a formal complaint with the California
Public Utilities Commission (CPUC) against AT&T. In the complaint
proceeding, the Company alleged that AT&T owed the Company over $7.0 million
for traffic terminated by the Company on behalf of AT&T, plus late payment
fees. On September 19, 2005, the presiding hearing officer released a
decision granting the Company’s complaint in all regards, except for the
Company’s claim for late payment fees. On October 19, 2005, AT&T filed
an appeal with the CPUC, claiming the decision was in error. The Company
filed a simultaneous appeal with the CPUC, asking for approval of late payment
fees. On June 29, 2006, the CPUC rejected both appeals, and reaffirmed the
award of over $7.1 million to Pac-West. The Company received $7.1 million
from
AT&T on July 31, 2006.
There
have been no other 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.
9.
Related Party Transactions
Bay
Alarm, a significant stockholder of the Company, together with its subsidiary,
InReach Internet, LLC (InReach), were customers of the Company. The Bay Alarm
customer account was sold with the enterprise customer base to TelePacific
on
March 11, 2005. Additionally, as of November 2005, InReach was no longer
a
subsidiary of Bay Alarm and therefore the table below does not reflect revenues
received from InReach 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
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands)
|
(Dollars
in thousands)
|
Revenues
|
|
$
|
-
|
|
$
|
253
|
|
$
|
-
|
|
$
|
533
|
|
Revenues
as a percentage of total revenues
|
|
|
-
|
|
|
1.2
|
%
|
|
-
|
|
|
1.1
|
%
|
Security
monitoring costs
|
|
$
|
8
|
|
$
|
9
|
|
$
|
16
|
|
$
|
19
|
|
Oakland
property rent payments
|
|
$
|
129
|
|
$
|
89
|
|
$
|
218
|
|
$
|
177
|
|
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).
10.
Debt and interest expense, net
At
June
30, 2006 and December 31, 2005, long-term debt and capital lease obligations
consist of the following:
|
|
June
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands)
|
Senior
Notes
|
|
$
|
36,102
|
|
$
|
36,102
|
|
Capital
lease obligations
|
|
|
691
|
|
|
651
|
|
Notes
payable
|
|
|
24,958
|
|
|
12,159
|
|
Less
current portion of notes payable and capital leases
|
|
|
(22,071
|
)
|
|
(5,392
|
)
|
|
|
$
|
39,680
|
|
$
|
43,520
|
|
The
Senior Notes of which there is $36.1 million in principal amount outstanding
at
June 30, 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
June 30, 2006, the Company had borrowed approximately $5.4 million under
the
Merrill Lynch arrangement under two credit facilities both with interest
rates
of 8.6%. As of June 30, 2006 and December 31, 2005, the principal balance
was
$2.1 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
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 June 30, 2006 and December 31, 2005 the principal balances
of
$5.2 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 June 30,
2006 and
December 31, 2005, the principal balance for the capital lease portion
of the
arrangement was $0.4 million and $0.7 million, respectively, and is included
in
the above table under Capital Lease Obligations. As of June 30, 2006 and
December 31, 2005, the principal balance of the note payable was $0.5 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 $0.3 million of equipment capital lease and a $0.2 million
note
payable exchanged for a 36-month maintenance services agreement. As of
June 30,
2006 the principal balance for the capital lease portion of the arrangement
was
$0.2 million, and is included in the above table under Capital Lease
Obligations. As of June 30, 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 June 30, 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 included all
term loan borrowings through June 9, 2006, at which point it expired, and
is
payable in thirty equal monthly installments commencing July 1, 2006. The
second
tranche started 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 term loans resulting
in an
interest rate of 8.75% as of June 30, 2006 and a range of 7.75% to 8.75%
during
the six months ended June 30, 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 June 30, 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.
On
May
30, 2006, the Company entered into the Third Amendment to the Loan and
Security
Agreement (Third Amendment) with Comerica Bank. The Third Amendment provided
in
part that the financial covenants based upon the adjusted quick ratio,
debt
service coverage ratio and total liabilities to effective tangible net
worth
under the Loan and Security Agreement were amended such that the Company
would
not be required to comply with such covenants as they were in effect prior
to
the amendment during the period commencing on May 1, 2006 through and including
June 30, 2006.
On
July
31, 2006, the Company entered into a Fourth Amendment to the Loan and Security
Agreement (Fourth Amendment) with Comerica Bank. The Fourth Amendment provides
in part that the financial covenants based upon the adjusted quick ratio,
the
debt service coverage ratio and the total liabilities to effective tangible
net
worth covenants under the Loan and Security Agreement were amended such
that the
Company would not be required to comply with such covenants as they were
in
effect prior to the amendment during the compliance periods through and
including September 30, 2006; provided that the Company remains in compliance
with the minimum cash covenant, as amended by the Fourth Amendment. As
amended,
the minimum cash covenant specifies that the Company is required to maintain
a
minimum balance of cash at Comerica Bank equal to $2.5 million in excess
of the
outstanding indebtedness during the period beginning July 1, 2006 through
and
including September 30, 2006. The Fourth Amendment also provides that the
Company cannot request additional extensions of credit under the Loan and
Security Agreement until it is in compliance with all of the financial
covenants.
If
the
Company violates the financial covenants in the Loan and Security Agreement,
and
Comerica Bank is unwilling to grant a waiver or enter into an amendment
that
relieves or modifies our obligation to comply with these financial covenants,
Comerica Bank will have available to it all of the remedies provided for
under
the Loan and Security Agreement, including the right to accelerate, or
declare
due and payable, all outstanding amounts under the Loan and Security Agreement.
Furthermore, the Company does not believe that it will be able to meet
the
original covenants included in the Loan and Security Agreement with Comerica
Bank for periods following September 30, 2006, absent obtaining additional
financing. As a result, the Company has classified its Comerica Bank debt
as of
June 30, 2006 of $10.5 million as a current liability in accordance with
Emerging Issues Task Force No. (EITF) 86-30, “Classification of Obligations when
a Violation is Waived by the Creditor.” EITF 86-30 reached a consensus that debt
should be classified as current if a covenant violation has occurred at
the
balance sheet date or would have occurred absent a loan modification and
it is
probable that the borrower will not be able to comply with the covenants
at
measurement dates that are within the next 12 months.
Interest
expense, net for the three and six months ended June 30, 2006 and 2005
was as
follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
(Dollars
in thousands)
|
Interest
on Senior Notes
|
|
$
|
1,218
|
|
$
|
1,218
|
|
$
|
2,437
|
|
$
|
2,437
|
|
Accreted
discount on Senior Secured Note
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,262
|
|
Amortization
of deferred financing costs
|
|
|
57
|
|
|
51
|
|
|
114
|
|
|
205
|
|
Other
interest expense
|
|
|
446
|
|
|
158
|
|
|
725
|
|
|
519
|
|
Less
interest income
|
|
|
(192
|
)
|
|
(126
|
)
|
|
(372
|
)
|
|
(316
|
)
|
Interest expense, net
|
|
$
|
1,529
|
|
$
|
1,301
|
|
$
|
2,904
|
|
$
|
4,107
|
|
The
weighted average interest rate on short-term borrowings outstanding as of
June
30, 2006 and 2005 was 8.36% and 6.06%, respectively.
11.
Subsequent Event
On July 31, 2006, the Company entered into a Fourth Amendment to the Loan
and
Security Agreement (Fourth Amendment) with Comerica Bank. The Fourth Amendment
provides in part that the financial covenants based upon the adjusted quick
ratio, the debt service coverage ratio and the total liabilities to effective
tangible net worth covenants under the Loan and Security Agreement were amended
such that the Company would not be required to comply with such covenants
as
they were in effect prior to the amendment during the period commencing on
July
1, 2006 through and including September 30, 2006; provided that the Company
remains in compliance with the minimum cash covenant, as amended by the Fourth
Amendment. As amended, the minimum cash covenant specifies that the Company
is
required to maintain a minimum balance of cash at Comerica Bank equal to
$2.5
million in excess of the outstanding indebtedness during the period beginning
July 1, 2006 through and including September 30, 2006. The Fourth Amendment
also
provides that the Company cannot request additional extensions of credit
under
the Loan and Security Agreement until it is in compliance with all of the
financial covenants. Cash, cash equivalents and short-term investments as
of
June 30, 2006 were $20.5 million and the outstanding loan obligation to Comerica
Bank as of June 30, 2006 was $10.5 million.
The
Company does not currently expect to be in compliance with all of the financial
covenants in the Loan and Security Agreement for periods after September
30,
2006. As such, the Company expects that it will be necessary to negotiate
with
Comerica Bank an additional amendment to the Loan and Security Agreement
to
comply with these financial covenants for periods after September 30, 2006.
There can be no assurances that Comerica Bank will agree to such a request.
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 and residential
end-users, collectively referred to as service providers (SPs).
While
services that provide traditional dial-up access to the Internet have been
and
continue to be an important aspect of the services we provide SPs, we believe
increased demand for access to the Internet, the desire for one-stop integrated
communication services by end-users and new communications technologies such
as
voice over Internet protocol (VoIP) present significant growth opportunities
for
us. We are developing and overlaying new products and services that take
advantage of these new technologies in an effort to increase the utilization
of
our network, particularly in light of reduced utilization as SP customers
continue to migrate from dial-up access to broadband access. While we expect
that the majority of dial-up Internet service will migrate to broadband over
time and believe it is occurring more rapidly than expected, it is a target
market for us and we remain focused on serving the needs of our
customers.
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.
Prior
to
commencing our planned national expansion, we served customers in California,
Arizona, Nevada, Oregon, Utah and Washington. We have subsequently placed
into
service network assets necessary to begin serving, and have begun to serve,
customers in Alabama, Colorado, Florida, Idaho, Maryland, New Jersey, New
York,
North Carolina, Pennsylvania, South Carolina and Washington, D.C. In
addition, our East Coast SuperPOP became operational in May 2006 in order
to
support customers in these markets. Our planned national expansion contemplates
further investment in these markets as network traffic increases.
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
June
2006, we implemented another restructuring plan, which included a workforce
reduction of approximately 32 employees as part of a cost containment strategy.
As a result of implementing this restructuring plan, we recorded $238,000
in
restructuring charges related to employee termination benefits during the
second
quarter of 2006. The workforce reduction was completed in June 2006. We
anticipate total cash paid for employee termination benefits to be $238,000.
The
final cash payment to be recorded against the 2006 restructuring reserve
is
expected to occur in September 2006.
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 and six months ended June 30, 2006, we recorded reimbursed transition
expenses of $2.8 million and $5.7 million, respectively, 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. 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 and six months
ended June 30, 2006 and 2005:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
(Dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
$
|
27,028
|
|
$
|
21,869
|
|
$
|
46,656
|
|
$
|
50,000
|
|
Income
(loss) from operations
|
|
$
|
686
|
|
$
|
(894
|
)
|
$
|
(2,211
|
)
|
$
|
(2,136
|
)
|
Net
(loss) income
|
|
$
|
(827
|
)
|
$
|
(2,315
|
)
|
$
|
(5,099
|
)
|
$
|
15,024
|
|
(Loss)
income per share diluted
|
|
$
|
(0.02
|
)
|
$
|
(0.06
|
)
|
$
|
(0.14
|
)
|
$
|
0.39
|
|
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
54.3% and 41.0% of our total revenues for the six months ended June 30, 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 $7.1 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. On June 29, 2006, the CPUC rejected both appeals,
and reaffirmed to award of over $7.1 million to us. We received $7.1 million
from AT&T on July 31, 2006.
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
New York, Philadelphia, Baltimore, Jacksonville, Denver, Alabama, North
Carolina, South Carolina, New Jersey, Washington, D.C., 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. We consider such issues in evaluating the four criteria
above.
Some
ILECs with which we have interconnection agreements have withheld payments
from
amounts billed by us under their agreements. The process of collection of
such
intercarrier compensation is subject to complex contracts, regulations and
laws,
and is routinely the subject of judicial and/or administrative processes.
Often,
disputes concerning intercarrier compensation are settled by us and the ILEC
in
a manner that results in accepting 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, “Share-Based Payment,” 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 June 30, 2006 Compared to the Quarter Ended June 30,
2005
Our significant revenue components and operational metrics for the quarters
ended June 30, 2006 and 2005 are as follows:
|
|
Three
Months Ended
|
|
|
|
|
|
June
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
compensation
|
|
$
|
16.0
|
|
$
|
10.5
|
|
|
52.4
|
%
|
Mature
Products
|
|
$
|
8.1
|
|
$
|
10.7
|
|
|
(24.3
|
)%
|
Growth
Products
|
|
$
|
2.9
|
|
$
|
0.7
|
|
|
314.3
|
%
|
Total revenues
|
|
$
|
27.0
|
|
$
|
21.9
|
|
|
23.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Operational
metrics:
|
|
|
|
|
|
|
|
|
|
|
Minutes
of use (in billions)
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
|
|
|
8.57
|
|
|
12.04
|
|
|
(28.8
|
)%
|
Mature
Products
|
|
|
0.02
|
|
|
0.07
|
|
|
(71.4
|
)%
|
Growth
Products
|
|
|
0.17
|
|
|
0.06
|
|
|
183.3
|
%
|
Total minutes of use
|
|
|
8.76
|
|
|
12.17
|
|
|
(28.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues, which is composed of intercarrier, mature products and growth
products, increased 23.3% to $27.0 million in the quarter ended June 30,
2006
from $21.9 million during the same period in 2005. This increase was primarily
attributable to an increase in intercarrier compensation revenue resulting
from
receipt of administrative orders to make disputed payments and settlements
for
prior disputed billings of $9.4 million during the second quarter of 2006,
offset by lower revenue resulting from lower minutes of use and a reduction
in
mature products services.
Our
mature products in our western footprint currently drive the majority of
our
intercarrier revenues. We anticipate continued declines due to a more rapid
decline than expected in the Internet dial-up business as customers transition
from dial-up to broadband in addition to competitive pressure for these
businesses. However, we expect these declines to be gradually offset by
increasing both our mature and growth products across our expanded
footprint.
Intercarrier
compensation revenues increased 52.4% to $16.0 million in the quarter ended
June
30, 2006 from $10.5 million during the same period in 2005 primarily due
to the
receipt of administrative orders to make disputed payments and settlements
for
prior disputed billings of $9.4 million during the period, offset by lower
revenues from a decrease in intercarrier minutes of use primarily due to
a
competitor, who is a customer, building out their own network and a more
rapid
than expected decline in the Internet dial-up business.
Mature
products revenues include dial access services, collocation, and all enterprise
products. Revenues from mature products decreased $2.6 million, or 24.3%
in the
quarter ended June 30, 2006 from $10.7 million during the same period in
2005.
The decrease was primarily due to lower revenues from lower minutes of
use in
addition to Internet dial-up ISPs reducing services.
Growth
products revenues 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 $2.2 million, or 314.3% in the
quarter
ended June 30, 2006 from $0.7 million during the same period in 2005. The
increase was due primarily to volume growth from existing products in addition
to new products introduced subsequent to the quarter ended June 30, 2005.
This
increase is currently in the western footprint and we expect gradual increases
in our eastern footprint along with our VeriSign alliance by the end of
the
year.
Total
minutes of use, which is composed of intercarrier, mature products and
growth
products declined 28.0% to 8.76 billion in the quarter ended June 30, 2006
from
12.17 billion for the same period in 2005. 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 to 8.57 billion in the quarter
ended June 30, 2006 from 12.04 billion for the same period in 2005, primarily
due to a competitor, who is a customer, building out their own network
and a
more rapid than expected decline in the Internet dial-up business. Mature
products minutes of use decreased to 0.02 billion for the quarter ended
June 30,
2006 from 0.07 billion during the same period in 2005. Growth products
minutes
of use increased to 0.17 billion for the quarter ended June 30, 2006 from
0.06
billion during the same period in 2005. 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 June 30, 2006
and 2005
are as follows:
|
|
Three
Months Ended
|
|
|
|
|
|
June
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
$
|
10.8
|
|
$
|
9.7
|
|
|
11.3
|
%
|
Selling,
general and administrative
|
|
|
14.9
|
|
|
12.4
|
|
|
20.2
|
%
|
Reimbursed
transition expenses
|
|
|
(2.8
|
)
|
|
(2.8
|
)
|
|
0.0
|
%
|
Depreciation
and amortization
|
|
|
3.1
|
|
|
3.2
|
|
|
(3.1
|
)%
|
Restructuring
charges
|
|
|
0.3
|
|
|
0.2
|
|
|
50.0
|
%
|
Total costs and expenses
|
|
$
|
26.3
|
|
$
|
22.7
|
|
|
15.9
|
%
|
Consolidated
network expenses increased $1.1 million, or 11.3% during the quarter ended
June
30, 2006 compared to $9.7 million during the same period in 2005 due primarily
to increased expenses related to our national expansion, partially offset
by
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, which ends September 12, 2006, 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 increased 20.2% to $14.9 million
for the quarter ended June 30, 2006 from $12.4 million during the same period
in
2005. The increase was due primarily to the increase in full-time equivalent
employees, primarily related to our national expansion plans and other expansion
costs.
We
expect
selling, general and administrative expenses to decline after the second
quarter
of 2006 primarily as a result of the 2006 restructuring plan, in which
approximately 32 employees were terminated, a 10% reduction in pay for officers
beginning in the third quarter of 2006 and other cost reduction activities
implemented in the second quarter of 2006.
Effective
January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” utilizing the
modified prospective method. We recorded approximately $105,000 in selling,
general and administrative expense during the quarter ended June 30, 2006
as a
result of this adoption. Total compensation expense recognized for stock-based
awards for the three months ended June 30, 2006 and 2005 was $132,000 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 June 30, 2006, we had
unrecognized stock-based compensation of $1.4 million outstanding, which
we
expect to recognize over a weighted-average period of 2.8 years.
Reimbursed
transition expenses were $2.8 million for both quarters ended June 30, 2006
and
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 TSA ends
on
September 12, 2006 and expect reimbursement of transition expenses to end
at
that time. 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 3.1% to $3.1 million in the
quarter ended June 30, 2006 from $3.2 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, slightly offset by an
increase in depreciation for new assets acquired in connection with our national
expansion.
Restructuring
charges were approximately $0.3 million for the quarter ended June 30, 2006
primarily due to employee termination benefits related to the June 2006
reduction in force. Restructuring charges were $0.2 million for the same
period
in 2005. The 2005 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
income from operations was $0.7 million for the quarter ended June 30, 2006
compared to a loss of $0.9 million during the same period in 2005 primarily
due
to the factors discussed in the preceding paragraphs.
Consolidated
interest expense, net increased to $1.5 million for the quarter ended June
30,
2006 compared to $1.3 million for the same period in 2005 due primarily to
higher debt levels and increasing interest rates during 2006.
|
|
Three
Months Ended
|
|
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
Interest
on Senior Notes
|
|
$
|
1,218
|
|
$
|
1,218
|
|
Amortization
of deferred financing costs
|
|
|
57
|
|
|
51
|
|
Other
interest expense
|
|
|
446
|
|
|
158
|
|
Less
interest income
|
|
|
(192
|
)
|
|
(126
|
)
|
Interest expense, net
|
|
$
|
1,529
|
|
$
|
1,301
|
|
For
the
quarters ended June 30, 2006 and 2005, our effective income tax rate was
0.0%
and 1.0%, respectively.
Consolidated
net loss was $0.8 million for the quarter ended June 30, 2006 compared
to a loss
of $2.3 million during the same period in 2005 primarily due to the factors
discussed in the preceding paragraphs.
Six
Months Ended June 30, 2006 Compared to the Six Months Ended June 30,
2005
Our
significant revenue components and operational metrics for the six months
ended
June 30, 2006 and 2005 are as follows:
|
|
Six
Months Ended
|
|
|
|
|
|
June
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
compensation
|
|
$
|
25.4
|
|
$
|
20.5
|
|
|
23.9
|
%
|
Mature
Products
|
|
|
16.7
|
|
|
28.0
|
|
|
(40.4
|
)%
|
Growth
Products
|
|
|
4.6
|
|
|
1.5
|
|
|
206.7
|
%
|
Total revenues
|
|
$
|
46.7
|
|
$
|
50.0
|
|
|
(6.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
Operational
metrics:
|
|
|
|
|
|
|
|
|
|
|
Minutes
of use (in billions)
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
|
|
|
19.61
|
|
|
24.14
|
|
|
(18.8
|
)%
|
Mature
Products
|
|
|
0.07
|
|
|
0.13
|
|
|
(46.2
|
)%
|
Growth
Products
|
|
|
0.27
|
|
|
0.12
|
|
|
125.0
|
%
|
Total minutes of use
|
|
|
19.95
|
|
|
24.39
|
|
|
(18.2
|
)%
|
Total
revenues, which are composed of intercarrier, mature products and growth
products, decreased 6.6% to $46.7 million in the six months ended June 30,
2006
compared to $50.0 million for the same period in 2005. This decrease was
primarily attributable to the sale of our enterprise customer base to
TelePacific during the first quarter of 2005 as well as lower revenue resulting
from lower minutes of use and a reduction in mature products services. These
revenue decreases were offset by an increase in intercarrier compensation
revenue resulting from receipt of administrative orders to make disputed
payments and settlements for prior disputed billings of $10.3 million during
2006.
Our
mature products in our western footprint currently drive the majority of
our
intercarrier revenues. We anticipate continued declines due to a more rapid
decline than expected in the Internet dial-up business as customers transition
from dial-up to broadband in addition to competitive pressure for these
businesses. However, we expect these declines to be gradually offset by
increasing both our mature and growth products across our expanded
footprint.
Intercarrier
compensation revenues increased 23.9% to $25.4 million in the six months
ended
June 30, 2006 from $20.5 million during the same period in 2005 primarily
due to
the receipt of administrative orders to make disputed payments and settlements
for prior disputed billings of $10.3 million during 2006, offset by lower
revenues from a decrease in intercarrier minutes of use primarily due to
a
competitor, who is a customer, building out their own network and a more
rapid
than expected decline in the Internet dial-up business.
Mature
products revenues include dial access services, collocation, and all enterprise
products. Revenues from mature products decreased $11.3 million, or 40.4%
in the
six months ended June 30, 2006 from $28.0 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, lower revenues
from
lower minutes of use and Internet dial-up ISPs reducing services.
Growth
products revenues 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 $3.1 million, or 206.7% in the six
months ended June 30, 2006 from $1.5 million during the same period in 2005.
The
increase was due primarily to volume growth from existing products in addition
to new products introduced subsequent to the six months ended June 30, 2005.
This increase is currently in the western footprint and we expect gradual
increases in our eastern footprint along with our VeriSign alliance by the
end
of the year.
Total
minutes of use, which is composed of intercarrier, mature products and growth
products declined 18.2% to 19.95 billion in the six months ended June 30,
2006
from 24.39 billion for the same period in 2005. 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 18.8% to 19.61 billion during
the
six months ended June 30, 2006 from 24.14 billion for the same period in
2005,
due to a competitor, who is a customer, building out their own network and
a
more rapid than expected decline in the Internet dial-up business. Mature
products minutes of use decreased to 0.07 billion for the six months ended
June
30, 2006 from 0.13 billion for the same period in 2005. Growth products minutes
of use increased to 0.27 billion for the six months ended June 30, 2006 from
0.12 billion for the same period in 2005. 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 six months ended June 30, 2006 and
2005
are as follows:
|
|
Six
Months Ended
|
|
|
|
|
|
June
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
$
|
19.8
|
|
$
|
20.3
|
|
|
(2.5
|
)%
|
Selling,
general and administrative
|
|
|
28.5
|
|
|
27.1
|
|
|
5.2
|
%
|
Reimbursed
transition expenses
|
|
|
(5.6
|
)
|
|
(2.8
|
)
|
|
100.0
|
%
|
Depreciation
and amortization
|
|
|
5.9
|
|
|
7.0
|
|
|
(15.7
|
)%
|
Restructuring
charges
|
|
|
0.3
|
|
|
0.6
|
|
|
(50.0
|
)%
|
Total costs and expenses
|
|
$
|
48.9
|
|
$
|
52.2
|
|
|
(6.3
|
)%
|
Consolidated
network expenses decreased $0.5 million, or 2.5% during the six months ended
June 30, 2006 compared to $20.3 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, offset slightly by
our national expansion. During this transition period, which ends September
12,
2006, 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 increased 5.2% to $28.5 million
for
the six months ended June 30, 2006 from $27.1 million during the same period
in
2005. The increase was due primarily to costs associated with the national
expansion plan.
We
expect
selling, general and administrative expenses to decline after the second
quarter
of 2006 primarily as a result of the 2006 restructuring plan, in which
approximately 32 employees were terminated, a 10% reduction in pay for officers
beginning in the third quarter of 2006 and other cost reduction activities
implemented in the second quarter of 2006.
Effective
January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” utilizing the
modified prospective method. We recorded approximately $202,000 in selling,
general and administrative expense during the six months ended June 30, 2006
as
a result of this adoption. Total compensation expense recognized for stock-based
awards for the six months ended June 30, 2006 and 2005 was $278,000 and $96,000,
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 June 30, 2006, we had
unrecognized stock-based compensation of $1.4 million outstanding, which
we
expect to recognize over a weighted-average period of 2.8 years.
Reimbursed
transition expenses were $5.7 million for the six months ended June 30, 2006
compared to $2.8 million 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. This increase in reimbursed expenses
during 2006 reflects six months of reimbursements during 2006 compared to
three
months during 2005 since the sale occurred during March 2005. The TSA ends
on
September 12, 2006 and expect reimbursement of transition expenses to end
at
that time. 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 15.7% to $5.9 million in
the six
months ended June 31, 2006 from $7.0 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, partially offset by an increase in depreciation for new assets acquired
in
connection with our national expansion.
Restructuring
charges were approximately $0.3 million for the six months ended June 30,
2006
primarily due to employee termination benefits related to the June 2006
reduction in force. Restructuring charges were $0.6 million for the same
period
in 2005. The 2005 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 was $2.2 million and $2.1 million for the six months
ended
June 30, 2006 and 2005, respectively.
Consolidated
interest expense, net decreased to $2.9 million for the six months ended
June
30, 2006 compared to $4.1 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:
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
Interest
on Senior Notes
|
|
$
|
2,437
|
|
$
|
2,437
|
|
Accreted
discount on Senior Secured Note
|
|
|
-
|
|
|
1,262
|
|
Amortization
of deferred financing costs
|
|
|
114
|
|
|
205
|
|
Other
interest expense
|
|
|
725
|
|
|
519
|
|
Less
interest income
|
|
|
(372
|
)
|
|
(316
|
)
|
Interest expense, net
|
|
$
|
2,904
|
|
$
|
4,107
|
|
During
the six months ended June 30, 2005, we recorded a gain of $23.9 million from
the
sale of substantially all of our enterprise customer base that occurred during
the first quarter of 2005.
On
March
11, 2005, pursuant to the terms of a Payoff Letter, by and between us and
Deutsche Bank, we utilized $26.9 million of the proceeds from the sale of
substantially all of our enterprise customer base to TelePacific, as well
as
$13.8 million cash on hand, to prepay in full the $40 million Senior Secured
Note (including all outstanding principal and accrued and unpaid interest)
we
had issued to Deutsche Bank on December 19, 2003. In addition, pursuant to
the
terms of the Payoff Letter, we retired the warrants to acquire up to 26,666,667
shares of our common stock that were issued to Deutsche Bank in connection
with
the issuance of the Senior Secured Note, which decreased additional paid
in
capital by approximately $13.5 million. The prepayment of the Senior Secured
Note and the retirement of the related warrants resulted in a $2.1 million
loss
on the extinguishment of debt.
For
the
six months ended June 30, 2006 and 2005, our effective income tax rate was
0.0%
and 3.4%, respectively.
Consolidated
net loss was $5.1 million for the six months ended June 30, 2006 compared
to net
income of $15.0 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 three and six months ended June 30, 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
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
Consolidated
Statements of Operations
|
|
|
|
|
|
|
|
|
|
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
|
40.0
|
%
|
|
44.4
|
%
|
|
42.4
|
%
|
|
40.5
|
%
|
Selling,
general and administrative expenses
|
|
|
55.3
|
%
|
|
56.9
|
%
|
|
61.1
|
%
|
|
54.2
|
%
|
Reimbursed
transition expenses
|
|
|
(10.2
|
)%
|
|
(13.0
|
)%
|
|
(12.2
|
)%
|
|
(5.7
|
)%
|
Depreciation
and amortization expenses
|
|
|
11.5
|
%
|
|
14.8
|
%
|
|
12.7
|
%
|
|
14.0
|
%
|
Income
(loss) from operations
|
|
|
2.5
|
%
|
|
(4.1
|
)%
|
|
(4.7
|
)%
|
|
(4.3
|
)%
|
Net
(loss) income
|
|
|
(3.1
|
)%
|
|
(10.6
|
)%
|
|
(10.9
|
)%
|
|
30.0
|
%
|
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
|
|
|
|
June
30,
|
|
March
31,
|
|
Dec.
31,
|
|
Sept.
30,
|
|
June
30,
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Ports
equipped
|
|
|
1,288,704
|
|
|
1,151,616
|
|
|
1,151,616
|
|
|
1,054,848
|
|
|
1,052,400
|
|
Quarterly
minutes of use
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
switched (in billions)
|
|
|
8.8
|
|
|
11.2
|
|
|
12.0
|
|
|
12.2
|
|
|
12.2
|
|
Capital
additions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
$557
|
|
|
$10,568
|
|
|
$5,797
|
|
|
$3,259
|
|
|
$1,575
|
|
Employees
|
|
|
265
|
|
|
305
|
|
|
296
|
|
|
273
|
|
|
248
|
|
Liquidity
and Capital Resources:
Sources
and uses of cash. At
June
30, 2006, cash and short-term investments decreased $6.2 million to $20.5
million from $26.7 million at December 31, 2005. The decrease was primarily
due
to costs associated with our national expansion, debt interest payments and
lower customer receipts.
Net
cash
used in operating activities was $4.5 million for the six months ended June
30,
2006 as compared to cash provided of $2.5 million for the same period ended
in
2005. The cash used for 2006 was primarily due to a loss from operations.
Net
cash
used in investing activities was $7.9 million for the six months ended June
30,
2006 due primarily to the purchase of property and equipment. Net cash provided
by investing activities was $20.8 million during the six months ended June
30,
2005 due primarily to proceeds from the sale of substantially all of our
enterprise customer base in March 2005.
Net
cash
provided by financing activities was $5.9 million for the six months ended
June
30, 2006 was primarily due to proceeds from borrowings under notes payable.
Net
cash used in financing activities was $40.3 million during the six months
ended
June 30, 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, particularly
in
connection with the national expansion. We continue to seek further ways
to
implement our national expansion and otherwise enhance our infrastructure
in
2006 and beyond. As a result of the national expansion, various other capital
projects and our business plan, as currently contemplated, we anticipate
making
capital expenditures, excluding acquisitions, if any, of approximately $11.5
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 June 30, 2006, we did
not
have any material future purchase commitments to purchase equipment from
any of
our vendors.
Debt
outstanding.
At June
30, 2006 and December 31, 2005, long-term debt and capital lease obligations
consist of the following:
|
|
June
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands)
|
Senior
Notes
|
|
$
|
36,102
|
|
$
|
36,102
|
|
Capital
lease obligations
|
|
|
691
|
|
|
651
|
|
Notes
payable
|
|
|
24,958
|
|
|
12,159
|
|
Less
current portion of notes payable and capital leases
|
|
|
(22,071
|
)
|
|
(5,392
|
)
|
|
|
$
|
39,680
|
|
$
|
43,520
|
|
The
Senior
Notes of which there is $36.1 million in principal amount outstanding at
June
30, 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
June 30,
2006 the principal balance for the capital lease portion of the arrangement
was
$0.2 million, and is included in the above table under Capital Lease
Obligations. As of June 30, 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 June
30, 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 included all term
loan
borrowings through June 9, 2006, at which point it expired, and is payable
in
thirty equal monthly installments commencing July 1, 2006. The second tranche
started 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 June 30, 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.
On
May
30, 2006, we entered into the Third Amendment to the Loan and Security
Agreement
(Third Amendment) with Comerica Bank. The Third Amendment provided in part
that
the financial covenants based upon the adjusted quick ratio, debt service
coverage ratio and total liabilities to effective tangible net worth under
the
Loan and Security Agreement were amended such that we would not be required
to
comply with such covenants as they were in effect prior to the amendment
during
the period commencing on May 1, 2006 through and including June 30, 2006.
On
July
31, 2006, we entered into a Fourth Amendment to the Loan and Security Agreement
(Fourth Amendment) with Comerica Bank. The Fourth Amendment provides in
part
that the financial covenants based upon the adjusted quick ratio, the debt
service coverage ratio and the total liabilities to effective tangible
net worth
covenants under the Loan and Security Agreement were amended such that
we would
not be required to comply with such covenants as they were in effect prior
to
the amendment during the period commencing on July 1, 2006 through and
including
September 30, 2006; provided that we remain in compliance with the minimum
cash
covenant. As amended, the minimum cash covenant specifies that we are required
to maintain a minimum balance of cash at Comerica Bank equal to $2.5 million
in
excess of the outstanding indebtedness during the period beginning July
1, 2006
through and including September 30, 2006. The Fourth amendment also provides
that we cannot request additional extensions of credit under the Loan and
Security Agreement until we are in compliance with all of the financial
covenants prior to giving effect to the amendments.
We
do not
currently expect to be in compliance with all of the financial covenants
in the
Loan and Security Agreement for periods after September 30, 2006. As such,
we
expect that it will be necessary to negotiate with Comerica Bank an additional
amendment to the Loan and Security Agreement to comply with these financial
covenants for periods after September 30, 2006. There can be no assurances
that
Comerica Bank will agree to such a request.
If
we
violate the financial covenants in the Loan and Security Agreement, and
Comerica
Bank is unwilling to grant a waiver or enter into an amendment that relieves
or
modifies our obligation to comply with these financial covenants, Comerica
Bank
will have available to it all of the remedies provided for under the Loan
and
Security Agreement, including the right to accelerate, or declare due and
payable, all outstanding amounts under the Loan and Security Agreement.
Furthermore, we do not believe that we will be able to meet the original
covenants included in the Loan and Security Agreement with Comerica Bank
for
periods following September 30, 2006, absent obtaining additional financing.
As
a result, we have classified our Comerica Bank debt as of June 30, 2006
of $10.5
million as a current liability in accordance with Emerging Issues Task
Force No.
(EITF) 86-30, “Classification of Obligations when a Violation is Waived by the
Creditor.” EITF 86-30 reached a consensus that debt should be classified as
current if a covenant violation has occurred at the balance sheet date
or would
have occurred absent a loan modification and it is probable that the borrower
will not be able to comply with the covenants at measurement dates that
are
within the next 12 months.
Future
uses and sources of cash.
Our
principal sources of operating funds for the remainder of 2006 and the
first
half of 2007 are anticipated to be current cash and short-term investment
balances and cash flows from operating activities. However, we believe
that our
requirements for operating funds over the next twelve months will cause
our
current cash and short-term investment balances to fall below those required
by
the terms of our financing arrangement with Comerica Bank. As a result,
if we
continue to fund our operations without obtaining an additional source
of
financing, Comerica Bank may exercise its rights under the Loan and Security
Agreement, including the right to accelerate, or declare the entire loan
amount
due and payable. If Comerica accelerates the debt, we believe that other
sources
of our existing financing arrangements will have, and may exercise, similar
rights and we will not have sufficient liquidity and capital resources
to
operate for the next 12 months. We currently expect to fund the following
expenditures during the next 12 months:
•
interest
payments of approximately $6.1 million on Senior Notes and other
notes;
•
anticipated
capital expenditures of approximately $11.5 million;
•
debt
principal payments of approximately $8.9 million; and
•
capital
lease payments (including interest) of approximately $0.6 million.
In
an
effort to address our financing needs, we have retained the services of
a
financial advisory firm, and together with such firm are in the process
of
exploring strategic alternatives, including raising additional debt or
equity
financing, entry into strategic relationships or joint ventures and merger
and
acquisitions. While we have successfully raised capital in the past, their
can
be no assurance that sources of financing will continue to be available
to us in
amounts sufficient to meet our financial needs, or that any such financing
will
be available on terms acceptable to us.
If
we are
unable to secure additional financing, (1) we may not be able to take advantage
of business opportunities or respond to competitive pressures, or may be
required to reduce the scope of our planned national expansion and other
product
development and marketing initiatives, any of which could have a negative
impact
on our business and operating results; (2) it could become necessary for
us to
significantly curtail our operations in order to meet our debt service
obligations and (3) even if we did take such actions to permit us to service
our
debt , we would not meet any of the debt covenants required under the Comerica
loan agreement.
In the event of our non-compliance with the covenants of the loan agreement,
at
any future time, Comerica could exercise its rights under the agreement,
and
call the loan. Such action would substantially and adversely impact our
ability
to continue to operate and to meet other obligations.
To
the
extent that we raise additional financing through the sale of equity or
convertible debt securities, the issuance of such securities may result
in
dilution to existing stockholders. If additional financing is raised through
the
issuance of debt securities, these securities may have rights; preferences
and
privileges senior to holders of common stock and the terms of such debt
could
impose restrictions on our operations.
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 June 30, 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 8.75% as of June 30, 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 $20.2 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 $20.5 million cash, cash
equivalents and short-term investments at June 30, 2006 by approximately
$0.2
million.
As
of the
end of the period covered by this Report, the Company carried out an evaluation,
under the supervision and with the participation of the Company's management,
including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's “disclosure controls and procedures” (as defined
in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”), in accordance with Rule 13a-15 of the Exchange Act. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer,
together with the other members of management participating in the evaluation,
concluded that the Company's disclosure controls and procedures are effective
at
the reasonable assurance level.
There
have been no changes in the Company's internal control over financial reporting
that occurred during the quarter ended June 30, 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
8 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
4. Submission of Matters to a Vote of Security Holders
The
Company’s Annual Meeting of Shareholders was held on June 14, 2006 and
considered the following proposals:
The
first
proposal was to elect nine directors to the Board of Directors. Votes cast
were
as follows:
|
|
|
|
Percentage
|
|
|
|
Votes
cast
|
|
of
total
|
|
|
|
(thousands)
|
|
votes
cast
|
|
|
|
|
|
|
|
Wallace
W. Griffin
|
|
|
|
|
|
|
|
For
|
|
|
31,186
|
|
|
85.5
|
%
|
Withheld
|
|
|
5,274
|
|
|
14.5
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
Henry
R. Carbelli
|
|
|
|
|
|
|
|
For
|
|
|
31,162
|
|
|
85.5
|
%
|
Withheld
|
|
|
5,298
|
|
|
14.5
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
David
G. Chandler
|
|
|
|
|
|
|
|
For
|
|
|
35,467
|
|
|
97.3
|
%
|
Withheld
|
|
|
993
|
|
|
2.7
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
Jerry
L. Johnson
|
|
|
|
|
|
|
|
For
|
|
|
31,202
|
|
|
85.6
|
%
|
Withheld
|
|
|
5,258
|
|
|
14.4
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
Samuel
A. Plum
|
|
|
|
|
|
|
|
For
|
|
|
31,209
|
|
|
85.6
|
%
|
Withheld
|
|
|
5,251
|
|
|
14.4
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
Thomas
A. Munro
|
|
|
|
|
|
|
|
For
|
|
|
35,228
|
|
|
96.6
|
%
|
Withheld
|
|
|
1,232
|
|
|
3.4
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
Timothy
A. Samples
|
|
|
|
For
|
|
|
35,228
|
|
|
96.6
|
%
|
Withheld
|
|
|
1,232
|
|
|
3.4
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
Frederick
D. Lawernce
|
|
|
|
For
|
|
|
35,458
|
|
|
97.3
|
%
|
Withheld
|
|
|
1,002
|
|
|
2.7
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
William
H. Davidson
|
|
|
|
For
|
|
|
35,467
|
|
|
97.3
|
%
|
Withheld
|
|
|
993
|
|
|
2.7
|
|
|
|
|
36,460
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
The
second proposal was the approval of (a) an amendment to the Company’s Amended
and Restated Articles of Incorporation giving effect to a reverse split
of our
common shares and (b) all ministerial actions required in connection with
effecting such reverse share split. Votes cast were as follows:
|
|
|
Votes
cast (thousands)
|
|
|
Percentage
of total votes cast
|
|
For
|
|
|
34,711
|
|
|
95.2
|
%
|
Against
|
|
|
1,711
|
|
|
4.7
|
|
Abstain
|
|
|
39
|
|
|
0.1
|
|
|
|
|
36,461
|
|
|
100.0
|
%
|
The
third
proposal was to approve amendments to the Company’s Amended and Restated Bylaws
authorizing our board of directors to (a) establish the size of the
board and
(b) divide the board members into either two or three classes if and
when we are
qualified as a listed company under California law. This proposal did
not pass,
as it required the majority of the issued and outstanding shares voting
in favor
of the proposal. Votes cast were as follows:
|
|
|
Votes
cast (thousands)
|
|
|
Percentage
of total votes cast
|
|
For
|
|
|
15,898
|
|
|
62.1
|
%
|
Against
|
|
|
5,976
|
|
|
23.3
|
|
Abstain
|
|
|
3,722
|
|
|
14.5
|
|
|
|
|
25,596
|
|
|
100.0
|
%
|
Exhibits
|
10.62
|
Fourth
Amendment to Loan and Security Agreement dated as of July 31, 2006,
by and
between Comerica Bank and the
Company.
|
|
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 Michael
L. Sarina,
Chief Financial Officer 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 Michael
L. Sarina,
Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002.
|
Note:
ITEMS 2, 3 and 5 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 August 11, 2006.
PAC-WEST
TELECOMM, INC.
/s/
Henry
R. Carabelli
_____________________________
Henry
R.
Carabelli
President
and Chief Executive Officer
/s/
Michael
L. Sarina
______________________________
Michael
L. Sarina
Chief
Financial Officer