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 September 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
October 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 September 30,
2006
Table
of Contents
Part
I.
|
FINANCIAL
INFORMATION
|
Page
|
Item
1.
|
Financial
Statements (Unaudited)
|
|
|
Condensed
Consolidated Balance Sheets
|
|
|
September 30, 2006 and December 31, 2005
|
3
|
|
Condensed
Consolidated Statements of Operations and Comprehensive
Income
|
|
|
(Loss) - Three and nine months ended September 30, 2006 and
2005
|
4
|
|
Condensed
Consolidated Statements of Cash Flows - Nine
|
|
|
months ended September 30, 2006 and 2005
|
5
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
7
|
|
|
|
Item
2.
|
Management's
Discussion and Analysis of Financial Condition
|
|
|
and Results of Operations
|
23
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risks
|
41
|
|
|
|
Item
4.
|
Controls
and Procedures
|
42
|
|
|
|
Part
II.
|
OTHER
INFORMATION
|
|
Item
1.
|
Legal
Proceedings
|
42
|
Item 1A.
|
Risk
Factors
|
42
|
Item
6.
|
Exhibits
|
43
|
Signatures
|
|
44
|
|
|
|
PART
I. FINANCIAL INFORMATION
|
|
|
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Balance Sheets
|
(In
thousands except share and per share
data)
|
|
|
|
|
September
30,
|
|
December
31,
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
|
|
$
|
21,738
|
|
$
|
26,681
|
|
Trade
accounts receivable, net of allowances of
|
|
|
|
|
|
|
|
|
|
|
$1,034 and $368 at September 30, 2006 and
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005, respectively
|
|
|
|
|
|
13,770
|
|
|
7,806
|
|
Receivable
from transition service agreement
|
|
|
|
|
|
270
|
|
|
1,170
|
|
Prepaid
expenses and other current assets
|
|
|
|
|
|
3,019
|
|
|
3,129
|
|
Total current assets
|
|
|
|
|
|
38,797
|
|
|
38,786
|
|
Property
and equipment, net
|
|
|
|
|
|
43,068
|
|
|
39,458
|
|
Other
assets, net
|
|
|
|
|
|
787
|
|
|
1,079
|
|
Total assets
|
|
|
|
|
$
|
82,652
|
|
$
|
79,323
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
|
|
|
$
|
10,939
|
|
$
|
6,578
|
|
Current
obligations under notes payable and capital leases
|
|
|
|
|
|
5,404
|
|
|
5,392
|
|
Accrued
interest
|
|
|
|
|
|
974
|
|
|
2,032
|
|
Other
accrued liabilities
|
|
|
|
|
|
6,573
|
|
|
8,492
|
|
Total current liabilities
|
|
|
|
|
|
23,890
|
|
|
22,494
|
|
Senior
Notes
|
|
|
|
|
|
36,102
|
|
|
36,102
|
|
Notes
payable and capital leases, less current portion
|
|
|
|
|
|
11,568
|
|
|
7,418
|
|
Other
liabilities, net
|
|
|
|
|
|
135
|
|
|
72
|
|
Total liabilities
|
|
|
|
|
|
71,695
|
|
|
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 September 30, 2006 and December 31,
|
|
|
|
|
|
|
|
|
|
|
2005, respectively
|
|
|
|
|
|
37
|
|
|
37
|
|
Additional
paid-in capital
|
|
|
|
|
|
191,373
|
|
|
191,319
|
|
Accumulated
deficit
|
|
|
|
|
|
(180,496
|
)
|
|
(177,721
|
)
|
Accumulated
other comprehensive gain (loss)
|
|
|
|
|
|
43
|
|
|
(25
|
)
|
Deferred
stock compensation
|
|
|
|
|
|
-
|
|
|
(373
|
)
|
Total stockholders' equity
|
|
|
|
|
|
10,957
|
|
|
13,237
|
|
Total liabilities and stockholders' equity
|
|
|
|
|
$
|
82,652
|
|
$
|
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
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
26,171
|
|
$
|
22,383
|
|
$
|
72,827
|
|
$
|
72,383
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Network expenses (exclusive of depreciation shown separately
below)
|
|
|
9,906
|
|
|
9,628
|
|
|
29,711
|
|
|
29,901
|
|
Selling, general and administrative
|
|
|
11,465
|
|
|
13,006
|
|
|
39,987
|
|
|
40,127
|
|
Reimbursed transition expenses
|
|
|
(1,501
|
)
|
|
(4,470
|
)
|
|
(7,171
|
)
|
|
(7,318
|
)
|
Depreciation and amortization
|
|
|
2,980
|
|
|
3,365
|
|
|
8,925
|
|
|
10,349
|
|
Restructuring charges, net of reversals
|
|
|
(11
|
)
|
|
24
|
|
|
254
|
|
|
630
|
|
Total operating expenses
|
|
|
22,839
|
|
|
21,553
|
|
|
71,706
|
|
|
73,689
|
|
Income (loss) from operations
|
|
|
3,332
|
|
|
830
|
|
|
1,121
|
|
|
(1,306
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
1,424
|
|
|
1,091
|
|
|
4,328
|
|
|
5,198
|
|
Other (income) expense, net
|
|
|
(298
|
)
|
|
216
|
|
|
(314
|
)
|
|
154
|
|
Gain on sale of enterprise customer base
|
|
|
-
|
|
|
(267
|
)
|
|
-
|
|
|
(24,132
|
)
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
2,138
|
|
Income (loss) before income taxes
|
|
|
2,206
|
|
|
(210
|
)
|
|
(2,893
|
)
|
|
15,336
|
|
Income
tax (benefit) expense
|
|
|
(118
|
)
|
|
(84
|
)
|
|
(118
|
)
|
|
438
|
|
Net income (loss)
|
|
$
|
2,324
|
|
$
|
(126
|
)
|
$
|
(2,775
|
)
|
$
|
14,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per share
|
|
$
|
0.06
|
|
$
|
(0.00
|
)
|
$
|
(0.07
|
)
|
$
|
0.40
|
|
Diluted
income (loss) per share
|
|
$
|
0.06
|
|
$
|
(0.00
|
)
|
$
|
(0.07
|
)
|
$
|
0.38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average Shares Outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
37,268
|
|
|
37,132
|
|
|
37,230
|
|
|
36,958
|
|
Diluted
|
|
|
37,293
|
|
|
37,132
|
|
|
37,230
|
|
|
38,718
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income (Loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
2,324
|
|
$
|
(126
|
)
|
$
|
(2,775
|
)
|
$
|
14,898
|
|
Net unrealized (losses) gains on investments, net of tax
|
|
|
(58
|
)
|
|
31
|
|
|
(2
|
)
|
|
51
|
|
Reclassification of net realized losses on sale of investments,
net of
tax
|
|
|
56
|
|
|
-
|
|
|
70
|
|
|
-
|
|
Comprehensive income (loss)
|
|
$
|
2,322
|
|
$
|
(95
|
)
|
$
|
(2,707
|
)
|
$
|
14,949
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
notes
to unaudited condensed consolidated financial statements.
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Statements of Cash Flows
|
(Unaudited,
in thousands)
|
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Operating
activities:
|
|
|
|
|
|
|
|
Net
(loss) income
|
|
$
|
(2,775
|
)
|
$
|
14,898
|
|
Adjustments
to reconcile net (loss) income to net cash
|
|
|
|
|
|
|
|
provided by operating activities:
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
8,925
|
|
|
10,349
|
|
Amortization of deferred financing costs
|
|
|
171
|
|
|
255
|
|
Amortization of discount on notes payable
|
|
|
-
|
|
|
1,262
|
|
Stock-based compensation
|
|
|
396
|
|
|
144
|
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
2,138
|
|
Gain on sale of enterprise customer base
|
|
|
-
|
|
|
(24,132
|
)
|
Provision for doubtful accounts
|
|
|
764
|
|
|
172
|
|
Net loss on disposal of property
|
|
|
18
|
|
|
187
|
|
Other
|
|
|
(33
|
)
|
|
-
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
(Increase) decrease in accounts receivable
|
|
|
(6,728
|
)
|
|
964
|
|
Decrease (increase) in receivable from transition service
agreement
|
|
|
900
|
|
|
(2,181
|
)
|
Decrease in prepaid expenses and other assets
|
|
|
405
|
|
|
2,814
|
|
Increase in accounts payable
|
|
|
1,397
|
|
|
417
|
|
Decrease in accrued interest
|
|
|
(1,058
|
)
|
|
(1,116
|
)
|
Decrease in other current liabilities and other
liabilities
|
|
|
(1,856
|
)
|
|
(1,203
|
)
|
Net cash provided by operating activities
|
|
|
526
|
|
|
4,968
|
|
|
|
|
|
|
|
|
|
Investing
activities:
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(9,091
|
)
|
|
(6,434
|
)
|
Proceeds
from disposal of property and equipment
|
|
|
-
|
|
|
99
|
|
Redemptions
of short-term investments, net
|
|
|
68
|
|
|
3,547
|
|
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
|
|
|
(8,990
|
)
|
|
20,829
|
|
|
|
|
|
|
|
|
|
Financing
activities:
|
|
|
|
|
|
|
|
Repayments
of notes payable
|
|
|
(4,081
|
)
|
|
(42,766
|
)
|
Proceeds
from the issuance of common stock
|
|
|
31
|
|
|
225
|
|
Principal
payments on capital leases
|
|
|
(401
|
)
|
|
(518
|
)
|
Net
proceeds from borrowing under notes payable
|
|
|
7,972
|
|
|
1,949
|
|
Net cash provided by (used in) financing activities
|
|
|
3,521
|
|
|
(41,110
|
)
|
Net decrease in cash and cash equivalents
|
|
|
(4,943
|
)
|
|
(15,313
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
26,681
|
|
|
32,265
|
|
End
of period
|
|
$
|
21,738
|
|
$
|
16,952
|
|
(continued)
PAC-WEST
TELECOMM, INC.
|
Condensed
Consolidated Statements of Cash Flows
|
(Unaudited,
in thousands)
|
(continued)
|
|
|
|
|
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Supplemental
Disclosure of Cash Flow Information:
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
Interest
|
|
$
|
5,843
|
|
$
|
5,572
|
|
Income
taxes
|
|
$
|
-
|
|
$
|
495
|
|
Non-cash
Operating and Investing Activities:
|
|
|
|
|
|
|
|
Acquisitions
of property and equipment included in accounts payable
|
|
$
|
2,964
|
|
$
|
-
|
|
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 NINE MONTHS ENDED SEPTEMBER 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.
On
November 15, 2006, after considering a variety of restructuring alternatives,
including seeking court protection from creditors, and conducting an extensive
search for financing sources, the Company completed a comprehensive
restructuring of its financial obligations centered around an investment
and
refinancing provided by Columbia Ventures Corporation (Columbia Ventures),
a
private investment company focused principally on the domestic and international
telecommunications industry (see Note 2).
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 nine months ended September 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.
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 condensed
consolidated statements of operations and comprehensive income
(loss).
2. |
Restructuring
of the Company
|
On
November 15, 2006, the Company completed a comprehensive restructuring of
the
Company’s financial obligations centered around an investment and refinancing
provided by Columbia Ventures, a private investment company focused principally
on the domestic and international telecommunications industry.
As
part
of the financial restructuring on November 15, 2006, an affiliate of Columbia
Ventures purchased the Company’s Senior Secured Credit Facility, which had an
outstanding balance at purchase of $8,795,638, from its senior lender, Comerica
Bank (Comerica). In connection with this purchase, Comerica assigned its
rights
and obligations under the Senior Secured Credit Facility to the loan purchaser
and, concurrently with such purchase and assignment, such facility was amended
and restated to provide, among other things, an increase in the maximum loan
commitment to $24,000,000, consisting of an $8,805,638 (Tranche A), a $7,194,361
term loan (Tranche B) and a revolving credit facility of $8,000,000. Tranche
A
was drawn on November 15, 2006 to fund the purchase from Comerica of the
outstanding balance under the Senior Secured Credit Facility and reimburse
Comerica for $10,000 in legal expenses associated with the purchase. Tranche
B
is generally expected to become available to the Company at the later to
occur
of (1) February 1, 2007, (2) the commercial availability of the Company’s DIDOD
product release, and (3) the effective date of a long term binding agreement
between the Company and VeriSign, Inc., a strategic alliance partner of the
Company. The revolving line of credit is generally expected to become available
to the Company after February 1, 2007.
The
Senior Secured Credit Facility is expected to be one of the principal sources
of
operating funds for the Company. However, there can be no assurance that
the
conditions to availability of borrowing under the Senior Secured Credit Facility
will be satisfied. If such conditions are not satisfied, the Company will not
be
able to rely on its Senior Secured Credit Facility for operating funds, which
may materially and adversely impact its ability to pursue its business plans
and
objectives.
In
addition, another affiliate of Columbia Ventures purchased 48,158 newly issued
shares of Series B-1 Preferred Stock and 830,959 shares of newly issued shares
of Series B-2 Preferred Stock, non-voting, convertible preferred stock for
$999,999.98. Series B-1 Preferred Stock was issued at closing. The Series
B-2
Preferred Stock will be issued upon receipt of shareholder approval of an
amendment to the Company’s articles of incorporation to authorize sufficient
additional common stock to permit the conversion in full of the Series B-2
Preferred Stock. The Series B-1 and B-2 Preferred Stock are convertible into
approximately 51% and 95%, respectively, of the Company’s common stock on a
fully-diluted basis, subject to satisfaction of certain conditions, including
receipt of requisite regulatory approvals. The Company intends to use the
proceeds for working capital and general corporate purposes.
On
November 14, 2006, the Company entered into a letter agreement with SMH Capital
Advisors, Inc., an investment advisor who has represented that it has investment
discretion with respect to approximately $21.0 million in principal amount
of
the 13.5% Senior Notes due 2009 (the Senior Notes), in which such investment
advisor has agreed to exchange all Senior Notes for which it holds investment
discretion for new 13.5% Notes due 2009 (the New Notes) as part of an exchange
offer made to all holders of Senior Notes. The exchange is expected to be
completed by February 1, 2007. The terms and conditions of the New Notes
are
expected to be substantially identical to the Senior Notes, except that the
New
Notes will provide that interest under the New Notes will not be payable
until
maturity and the holders of the New Notes will have the right to receive
payment
of all outstanding principal and accrued interest before the holders of the
Senior Notes will have the right to receive any outstanding principal. Assuming
SMH Capital Advisors, tenders $21.0 million in principal amount into such
exchange offer, the affect of this transaction would be to defer payment
of $2.9
million of interest in 2007, and $2.9 million of interest in 2008 until
maturity, which is February of 2009.
This
communication is not an offer to exchange Senior Notes for New Notes or a
solicitation of an offer to exchange Senior Notes for New Notes. The offer
to
exchange Senior Notes for New Notes is expected to be made pursuant to an
exemption from registration pursuant to Section 3(a)(9) under the Securities
Act
of 1933, as amended, solely by means of an offering circular and disclosure
statement and other documents provided to holders of the Senior
Notes.
The
Company also reached an agreement with Merrill Lynch Capital to restructure
approximately $5.7 million of its obligations to them. Such agreement provides
for, among other things, deferral of payments of principal and interest due
to
them in January and February of 2007, waiver of compliance with certain
covenants and a commitment to restructure the maturity date and payment terms
on
the remaining obligations should certain conditions be met. Pursuant to such
agreement, subject to satisfaction of certain conditions, including the
condition that both the revolving and term loan facilities under the Senior
Secured Credit Facility as amended and restated, are available to the Company,
the Company may elect to restructure its current obligations to Merrill Lynch
of
an aggregate of approximately $5.7 million into a single obligation bearing
interest at a rate of 9.11% per annum to be paid over 30 months, with $75,000
due each month for the first 15 months and $125,000 due each month for the
next
14 months with the balance due August 1, 2009. If the conditions to such
restructuring are not met, the Company must continue to make its currently
scheduled payments of principal and interest, with Merrill Lynch reserving
all
of its current rights and remedies. In addition, under such agreement, the
Company agreed to pay Merrill Lynch Capital in respect of the Company’s
obligations an amount equal to 20% of any interest savings achieved as a
result
of the tender of more than $21.0 million in principal amount of Senior Notes
as
part of the exchange offer the Company intends to conduct in respect of its
Senior Notes.
In
addition, the Company reached an agreement with Tekelec, one of its key
suppliers, to restructure approximately $1.9 million of its obligation to
them.
As part of its agreement with Tekelec, the Company paid them $535,000 to
settle
in full such obligation.
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 $90,000
and
$292,000 in expense during the three and nine months ended September 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 September 30, 2006 and 2005 was $118,000 and $48,000, respectively.
Total
compensation expense recognized for stock-based awards for the nine months
ended
September 30, 2006 and 2005 was $396,000 and $140,000, 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
$28,000 and $105,000 for the three and nine months ended September 30, 2006,
respectively, related to restricted stock awards. The Company recognized
approximately $48,000 and $140,000 for the three and nine months ended September
30, 2005, respectively, related to performance unit awards. Cash received
for
options exercised during the nine months ended September 30, 2006 and 2005
was
$31,000 and $225,000, respectively.
For
the
nine months ended September 30, 2006 and the three months ended September
30,
2005, there was no impact on earnings per share from employee stock options
since such options were anti-dilutive. Accordingly, for the nine months ended
September 30, 2006, 430,226 shares were excluded from the diluted net loss
per
share calculation. In addition, 1,181,326 shares were excluded from the diluted
net loss per share calculation for the three months ended September 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
|
|
Nine
Months Ended
|
|
|
|
September
30, 2005
|
|
September
30, 2005
|
|
|
|
(Dollars
in thousands except per share amounts)
|
|
Net
(loss) income as reported
|
|
$
|
(126
|
)
|
$
|
14,898
|
|
Total
stock-based employee compensation included in
|
|
|
|
|
|
|
|
reported net (loss) income, net of tax
|
|
|
48
|
|
|
140
|
|
Total
stock-based employee compensation determined
|
|
|
|
|
|
|
|
under the fair value based method
|
|
|
(168
|
)
|
|
(442
|
)
|
|
|
|
|
|
|
|
|
Pro
forma
|
|
$
|
(246
|
)
|
$
|
14,596
|
|
|
|
|
|
|
|
|
|
Basic
net income (loss) per common share:
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(0.00
|
)
|
$
|
0.40
|
|
Pro forma
|
|
$
|
(0.01
|
)
|
$
|
0.39
|
|
Diluted
net income (loss) per common share:
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(0.00
|
)
|
$
|
0.38
|
|
Pro forma
|
|
$
|
(0.01
|
)
|
$
|
0.38
|
|
Stock
Incentive Plans
In
January 1999, the
Company’s Board of Directors approved the terms of the 1999 Stock Incentive Plan
which authorizes the granting of stock options, including restricted stock,
stock appreciation rights, dividend equivalent rights, performance units,
performance shares or other similar rights or benefits to employees, directors,
consultants and advisors. In addition, options have been granted 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 September 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 2.6 years.
The total fair value of shares vested during the three and nine months ended
September 30, 2006 was approximately $27,000 and $289,000, respectively.
For the
periods ended September 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 nine months ended September 30, 2006 and 2005 are presented
as
follows:
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
Expected
volatility
|
|
|
108.5
|
%
|
|
106.0
|
%
|
|
109.6
|
%
|
|
106.0
|
%
|
Risk-free
interest rate
|
|
|
5.0
|
%
|
|
3.9
|
%
|
|
4.8
|
%
|
|
3.8
|
%
|
Expected
term
|
|
|
6.2
|
|
|
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 September 30, 2006, and changes during the nine
months then ended is presented below:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
Aggregate
|
|
|
Number
of
|
|
Average
|
|
Remaining
|
|
Intrinsic
|
|
|
Shares
|
|
Exercise
|
|
Contractual
|
|
Value
|
|
|
(000's)
|
|
Price
|
|
Term
|
|
(000's)
|
Outstanding
at January 1, 2006
|
|
|
5,804
|
|
$
|
1.70
|
|
|
|
|
|
|
Granted
|
|
|
415
|
|
$
|
0.81
|
|
|
|
|
|
|
Exercised
|
|
|
(16
|
)
|
$
|
0.50
|
|
|
|
|
|
|
Cancelled
|
|
|
(549
|
)
|
$
|
1.24
|
|
|
|
|
|
|
Outstanding
at September 30, 2006
|
|
|
5,654
|
|
$
|
1.67
|
|
|
6.0
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and exercisable at
|
|
|
|
|
|
|
|
|
|
|
|
|
September
30, 2006
|
|
|
4,042
|
|
$
|
1.91
|
|
|
4.8
|
|
$
|
0
|
The
weighted-average fair
value of options granted during the three months ended September 30, 2006
and
2005 was $0.46 and $0.64, respectively. The weighted-average fair value of
options granted during the nine months ended September 30, 2006 and 2005
was
$0.69 and $.90, respectively. The total intrinsic value of options exercised
during the three months ended September 30, 2006 and 2005 was approximately
$0
and $14,000, respectively. The total intrinsic value of options exercised
during
the nine months ended September 30, 2006 and 2005 was approximately $6,000
and
$193,000, respectively.
Restricted
Stock
As
of September 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 September 30, 2006,
there was approximately $309,000 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 September 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.
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 for the periods ended September
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:
|
|
First
Semi-Annual Period
|
|
Second
Semi-Annual Period
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
Expected
volatility
|
|
|
68.0
|
%
|
|
84.0
|
%
|
|
74.0
|
%
|
|
84.0
|
%
|
Risk-free
interest rate
|
|
|
4.4
|
%
|
|
2.5
|
%
|
|
5.1
|
%
|
|
3.2
|
%
|
Expected
term
|
|
|
0.5
|
|
|
0.5
|
|
|
0.5
|
|
|
0.5
|
|
Expected
dividend yield
|
|
|
0.0
|
%
|
|
0.0
|
%
|
|
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.
Compensation
expense
recognized for the three and nine months ended September 30, 2006 was
approximately $5,000 and $13,000, respectively.
4.
Concentration of Customers and Suppliers
For
the three and nine
months ended September 30, 2006 and 2005, the Company had the following
concentrations of revenues and operation costs:
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Largest
customers: Percentage of total revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
1
|
|
|
22.0
|
%
|
|
25.2
|
%
|
|
28.8
|
%
|
|
23.8
|
%
|
Customer
2
|
|
|
36.3
|
%
|
|
14.3
|
%
|
|
20.9
|
%
|
|
17.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Largest
supplier: Percentage of network expenses
|
|
|
32.6
|
%
|
|
60.2
|
%
|
|
37.8
|
%
|
|
45.9
|
%
|
During
each of the
comparison periods, no other customers accounted for more than 10% of
total
revenues. Customer two represented 50.9% of trade accounts receivable
as of
September 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 nine months ended September 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 September
30, 2006
and December 31, 2005, consist of the following:
|
|
Restructuring
|
|
Additional
|
|
|
|
Restructuring
|
|
|
Liability
|
|
Restructuring
|
|
|
|
Liability
|
|
|
as
of
|
|
Expense
|
|
Cash
|
|
as
of
|
|
|
31-Dec-05
|
|
Incurred
|
|
Payments
|
|
30-Sep-06
|
|
|
(Dollars
in thousands)
|
Rent
expense for vacated premises
|
|
$
|
1,915
|
|
$
|
16
|
|
$
|
(342
|
)
|
$
|
1,589
|
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 nine months ended September 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 nine months ended September 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 September
30, 2006 and
December 31, 2005, consist of the following:
|
|
Restructuring
|
|
Additional
|
|
|
|
Restructuring
|
|
|
Liability
|
|
Restructuring
|
|
|
|
Liability
|
|
|
as
of
|
|
Expense
|
|
Cash
|
|
as
of
|
|
|
31-Dec-05
|
|
Incurred
|
|
Payments
|
|
30-Sep-06
|
|
|
(Dollars
in thousands)
|
One-time
employee termination benefits
|
|
$
|
41
|
|
$
|
9
|
|
$
|
(50
|
)
|
$
|
-
|
The
amount of the reserve
was 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 nine months ended September
30,
2006, the Company recorded additional restructuring charges of approximately
$9,000 for employee termination benefits.
Total
cash paid for
employee termination benefits and rent expense was approximately
$528,000 and
$56,000, respectively. Rent expense for vacated premises ended October
2005. The
final cash payment for employee termination benefits was recorded
against the
2005 restructuring reserve in September 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. During the
third quarter of 2006 the Company recorded a reduction of termination
benefits
of approximately $9,000 primarily related to forfeited benefits.
The Company
anticipates total cash paid for employee termination benefits to
be
approximately $229,000. The final cash payment to be recorded against
the 2006
restructuring reserve is expected to occur in November 2006. A
summary of the
activity for the nine months ended September 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
September 30,
2006 and December 31, 2005, consists of the following:
|
|
Restructuring
|
|
Additional
|
|
|
|
Restructuring
|
|
|
Liability
|
|
Restructuring
|
|
|
|
Liability
|
|
|
as
of
|
|
Expense
|
|
Cash
|
|
as
of
|
|
|
31-Dec-05
|
|
Incurred
|
|
Payments
|
|
30-Sep-06
|
|
|
(Dollars
in thousands)
|
One-time
employee termination benefits
|
|
$
|
-
|
|
$
|
229
|
|
$
|
(214
|
)
|
$
|
15
|
6.
Income Taxes
The
Company's effective
income tax rate for the three months ended September 30, 2006 and 2005
was 5.3%
and 40.0%, respectively. The Company’s effective income tax rate for the nine
months ended September 30, 2006 and 2005 was 4.1% and 2.9%, respectively.
As of
September 30, 2006, there was an income tax receivable of $0.4
million.
Due
to the financial
restructuring discussed (See Note 2), the Company believes that it is
likely an ownership change, as defined by Section 382 of the Internal Revenue
Code, has either occurred or will occur in conjunction with the completion
of
the transaction. As a result, the Company’s ability to utilize its net
operating loss carryforwards in the future may be significantly
reduced.
7.
Other Comprehensive Income (Loss)
For
the three months
ended September 30, 2006 and 2005, there was $58,000 unrealized losses and
$31,000 unrealized gains, respectively, of other comprehensive income pertaining
to net unrealized investment gains and losses on available-for-sale marketable
securities. Reclassifications of net realized losses on sales of investments
during the three months ended September 30, 2006 and 2005 was $56,000 and
$0,
respectively. For the nine months ended September 30, 2006 and 2005, there
was
$2,000 unrealized losses and $51,000 unrealized gains, respectively, of other
comprehensive income pertaining to net unrealized investment gains and losses
on
available-for-sale marketable securities. Reclassification of net realized
losses on sales of investments during the nine months ended September 30,
2006
and 2005 was $70,000 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
September 30, 2006, it has done so primarily through providing transition
services to TelePacific. Although the TSA ended with TelePacific on September
12, 2006, TelePacific is continuing to migrate the enterprise customer base
to
its system. Based upon current estimates and given that the Contract ends
at the
end of November 2006, the Company believes that it will meet certain minimum
annual usage levels and therefore will have no need to terminate the Contract
and hence not incur a termination fee.
From
time to time, the Company is
subject to audits with various tax authorities that arise during the normal
course of business. During the third quarter of 2005, the Company received
a tax
assessment arising from a tax audit amounting to $4.8 million. Subsequent
to the
third quarter of 2005, the Company filed an appeal against this assessment.
The
Company believes the resolution to this tax audit will not materially harm
its
business, financial condition or results of operations.
There
have been no 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
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands)
|
|
Revenues
|
|
$
|
-
|
|
$
|
218
|
|
$
|
-
|
|
$
|
751
|
|
Revenues
as a percentage of total revenues
|
|
|
-
|
|
|
1.0
|
%
|
|
-
|
|
|
1.0
|
%
|
Security
monitoring costs
|
|
$
|
12
|
|
$
|
7
|
|
$
|
29
|
|
$
|
26
|
|
Oakland
property rent payments
|
|
$
|
99
|
|
$
|
88
|
|
$
|
317
|
|
$
|
265
|
|
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
September 30, 2006 and December 31, 2005, long-term debt and capital lease
obligations consisted of the following:
|
|
September
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands)
|
|
Senior
Notes
|
|
$
|
36,102
|
|
$
|
36,102
|
|
Capital
lease obligations
|
|
|
548
|
|
|
651
|
|
Notes
payable
|
|
|
16,424
|
|
|
12,159
|
|
Less
current portion of notes payable and capital leases
|
|
|
(5,404
|
)
|
|
(5,392
|
)
|
|
|
$
|
47,670
|
|
$
|
43,520
|
|
The
Senior Notes, of which there was $36.1 million in principal amount outstanding
at September 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.
On
November 15, 2006, the Company completed a comprehensive restructuring
of its
financial obligations centered around an investment and refinancing provided
by
Columbia Ventures, a private investment company focused principally on
the
domestic and international telecommunications industry (see Note 2).
As part of
the financial restructuring, the Company has received a commitment from
SMH
Capital Advisors, Inc., an investment advisor who has represented to
the Company
that it has discretion over approximately $21.0 million of the $36.1
million of
outstanding principal amount of the Senior Notes to tender into an exchange
offer made to all holders of Senior Notes for New Notes expected to be
completed
prior to February 1, 2007.
This
communication is not an offer to exchange Senior Notes for New Notes
or a
solicitation of an offer to exchange Senior Notes for New Notes. The
offer to
exchange Senior Notes for New Notes is expected to be made pursuant to
an
exemption from registration pursuant to Section 3(a)(9) under the Securities
Act
of 1933, as amended, solely by means of an offering circular and disclosure
statement and other documents provided to holders of the Senior
Notes.
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
September 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 September 30, 2006 and December 31, 2005, the principal
balance was $1.7 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 September 30, 2006 and December 31, 2005 the principal
balances
of $4.7 million and $6.0 million, respectively, are included in the above
table
under Notes Payable.
As
part
of the financial restructuring, the Company reached an agreement with
Merrill
Lynch Capital to restructure approximately $5.7 million of its obligations
to
them. Such agreement provides for, among other things, deferral of payments
of
principal and interest due to them in January and February of 2007, waiver
of
compliance with certain covenants and a commitment to restructure the
maturity
date and payment terms on the remaining obligations should certain conditions
be
met. In addition, under such agreement, the Company agreed to pay Merrill
Lynch
Capital in respect of the Company’s obligations an amount equal to 20% of any
interest savings achieved as a result of the tender of more than $21.0
million
in principal amount of Senior Notes as part of the exchange offer the
Company
intends to conduct in respect of its Senior Notes (see Note 2).
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 September
30,
2006 and December 31, 2005, the principal balance for the capital lease
portion
of the arrangement was $0.3 million and $0.7 million, respectively, and
is
included in the above table under Capital Lease Obligations. As of September
30,
2006 and December 31, 2005, the principal balance of the note payable
was $0.3
million and $0.7 million, respectively, and is included in the above
table under
Notes Payable. In March 2006, the Company completed a 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 September 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 September 30, 2006 the principal balance of
the note
payable was $0.1 and is included in the above table under Notes Payable.
The
Company’s obligations to Cisco were not restructured as part of the financial
restructuring.
In
November 2005, the Company entered into a Senior Secured Credit Facility
with
Comerica, which provided for up to $5 million of revolving advances and
up to
$15 million of term loans, subject to certain conditions. Any revolving
advances
were not to exceed 80% of eligible accounts receivables and were due
and payable
in full on November 9, 2007. There were no revolving advances as of September
30, 2006.
The
term
loan portion of the Senior Secured Credit Facility, which was to be used
within
certain limitations to finance capital equipment expenditures and acquisitions
or to refinance the Senior Notes, was structured into two tranches; the
first
included all term loan borrowings through June 9, 2006, at which point
it
expired, and was payable in thirty equal monthly installments commencing
July 1,
2006. The second tranche started June 10, 2006 and continued through
January 9,
2007 at which point it expired, and was payable in twenty-three equal
monthly
installments commencing February 1, 2007.
Rates
for
borrowings under the Senior Secured Credit Facility floated and were
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 September 30,
2006 and a
range of 7.75% to 8.75% during the nine months ended September 30, 2006.
Borrowings under the Senior Secured Credit Facility were secured by all
personal
property of the Company. In addition, the Company was prevented from
distributing dividends without the written consent of Comerica and was
required
to maintain certain financial and restrictive covenants including compensating
cash balances. In particular, the Company was required to 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 September 30, 2006
and
December 31, 2005, the term loan principal balance was $9.5 million and
$2.5
million, respectively, and is included in the above table under Notes
Payable.
On
May
30, 2006, July 31, 2006 and September 25, 2006, the Company entered into
amendments to the Senior Secured Credit Facility with Comerica that provided,
among other things, 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 Senior Secured Credit Facility
were
amended such that the Company would not be required to comply with such
covenants as they were in effect prior to the amendments during the compliance
periods through and including November 30, 2006; provided that the Company
remained in compliance with the minimum cash covenant, which, as amended,
required that the Company maintain a minimum balance of cash at Comerica
equal
to $2.5 million in excess of the outstanding indebtedness. The amendments
also
provided that the Company could not request additional extensions of
credit
under the Senior Secured Credit Facility until it was in compliance with
all of
the financial covenants.
As
part
of the financial restructuring, an affiliate of Columbia Ventures purchased
the
Company’s Senior Secured Credit Facility, which had an outstanding balance at
such time of approximately $8.8 million, from Comerica (see Note 2).
In
connection with this purchase, Comerica assigned its rights and obligations
under the Senior Secured Credit Facility to the loan purchaser and, concurrently
with such purchase and assignment, such facility was amended and restated
to
provide, among other things, an increase in the maximum loan commitment
to $24.0
million, consisting of Tranche A, an $8.8 million term loan, Tranche
B, a $7.2
million term loan, and an $8.0 million revolving credit facility. Tranche
A was
drawn on November 15, 2006 to fund the purchase from Comerica of the
outstanding
balance under the Senior Secured Credit Facility and reimburse Comerica
for
$10,000 in legal expenses associated with the purchase. The availability
of the
undrawn balance of such revolving and term loan commitments of approximately
$8.0 million and $7.2 million, respectively, are subject to certain conditions,
the earliest of which could be satisfied on February 1, 2007. However,
as of
November 15, 2006, the Company obtained access to cash in the amount
of
approximately $11.3 million previously held by Comerica under the terms
of a
compensating balance arrangement. As a result of the financial restructuring,
the Company classified the majority of the outstanding balance of the
Senior
Secured Credit Facility as of September 30, 2006 as long-term.
Interest
expense, net for the three and nine months ended September 30, 2006 and
2005 was
as follows:
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
(Dollars
in thousands)
|
|
Interest
on Senior Notes
|
|
$
|
1,218
|
|
$
|
1,218
|
|
$
|
3,655
|
|
$
|
3,655
|
|
Accreted
discount on Senior Secured Note
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,262
|
|
Amortization
of deferred financing costs
|
|
|
57
|
|
|
50
|
|
|
171
|
|
|
255
|
|
Other
interest expense
|
|
|
406
|
|
|
5
|
|
|
1,131
|
|
|
524
|
|
Less
interest income
|
|
|
(257
|
)
|
|
(182
|
)
|
|
(629
|
)
|
|
(498
|
)
|
|
|
$
|
1,424
|
|
$
|
1,091
|
|
$
|
4,328
|
|
$
|
5,198
|
|
The
weighted average interest rate on short-term borrowings outstanding
as of
September 30, 2006 and 2005 was 8.44% and 7.21%, respectively.
11.
Recent Accounting Pronouncements
In
July
2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes—an
interpretation of FASB Statement No. 109.” FIN 48 clarifies the
accounting for uncertainty in tax positions by prescribing a financial
statement
recognition threshold and measurement attribute for tax positions taken
or
expected to be taken in a tax return. Further, FIN 48 expands the required
disclosures associated with such uncertain tax positions. The provisions of
FIN 48 are effective for fiscal years beginning after December 15,
2006. The Company is currently evaluating the impact on the financial
statements of adopting FIN 48.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which
is effective for fiscal years beginning after November 15, 2007, and
interim
periods within those fiscal years. The standard applies whenever other
standards
require (or permit) assets or liabilities to be measured at fair value.
The
standard does not expand the use of fair value in any new circumstances.
SFAS
No. 157 clarifies the definition of fair value, provides enhanced guidance
for
using fair value to measure assets and liabilities, and requires expanded
disclosures about fair value measurements. The Company does not expect
the
adoption of SFAS No. 157 to have a material impact on its financial
position,
results of operations, or cash flows.
In
September 2006, the SEC issued Staff Accounting Bulletin (SAB) No.
108,
“Considering the Effects of Prior Year Misstatements When Quantifying
Misstatements in Current Year Financial Statements,” to clarify how the effects
of the carryover or reversal of prior year misstatements should be
considered in
quantifying a current year misstatement. The staff believes that registrants
must quantify the impact of correcting all misstatements using two
common
approaches and would require adjustment when either approach results
in
quantifying a misstatement that is material, after considering all
relevant
quantitative and qualitative factors. SAB No. 108 is effective for
annual
financial statements covering the first fiscal year ending after November
15,
2006.
In
September 2006, the SEC issued new rule No. 33-8732A regarding Executive
Compensation and Related Person Disclosure, adopting amendments to
the
disclosure requirements for executive and director compensation, related
person
transactions, director independence and other corporate governance
matters and
security ownership of officers and directors. Among other changes,
the rule
requires that disclosure under the amended items generally be provided
in plain
English. The rule is effective for Forms 8-K for triggering events
that occur on
or after November 7, 2006, and in Forms 10-K and in any proxy or information
statements for fiscal years ending on or after December 15, 2006.
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, including risk factors 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; our inability to comply with the covenants contained
in, or the
possibility of triggering a default under, our borrowing arrangements,
our
inability to execute our business plans and objectives, regulatory
and legal
uncertainty with respect to intercarrier compensation payments received
by us;
declines in liquidity and/or increases in volatility in the markets
for
securities; the migration to broadband Internet access affecting dial-up
Internet access; the loss of key executive officers that could negatively
impact
our business prospects; an increase in our network expenses; our principal
competitors for local services and potential additional competitors,
which may
have advantages that may adversely affect our ability to compete with
them.
Introduction
We
are a
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.
On
November 14, 2006, we filed a Form 12b-25 to extend the time to file
our form
10-Q for the quarterly period ended September 30, 2006, which was due
on
November 14, 2006. We required additional time to file our Form 10-Q
in order
for us to complete the preparation of our financial statements. In
particular,
in the course of preparing financial statements for inclusion in the
Form 10-Q,
we were unable to complete our assessment of certain long-lived assets
that may
have been impaired and were in the process of gathering information
necessary to
determine the extent, if any, of such an impairment. Based upon our
analysis,
the carrying amount of the asset group did not exceed the sum of the
projected
undiscounted net cash flows and therefore determined that the asset
group was
not impaired.
Restructuring
of the Company
After
considering a variety of restructuring alternatives, including seeking
court
protection from creditors, and conducting an extensive search for financing
sources, on November 15, 2006, we completed a comprehensive restructuring
of our
financial obligations centered around an investment and refinancing
provided by
Columbia Ventures Corporation (Columbia Ventures), a private investment
company
focused principally on the domestic and international telecommunications
industry. With assistance from our financial advisor, restructuring
advisor, and
legal counsel, we concluded that the interests of all of our stakeholders,
including shareholders, creditors, employees, customers and suppliers,
were
enhanced by this restructuring when compared to other alternatives
available to
us at that time.
As
part
of the restructuring, an affiliate of Columbia Ventures purchased our
Senior
Secured Credit Facility, which had an outstanding balance at such time
of
approximately $8.8 million, from our senior lender, Comerica Bank (Comerica).
In
connection with this purchase, Comerica assigned its rights and obligations
under the Senior Secured Credit Facility to the loan purchaser and,
concurrently
with such purchase and assignment, such facility was amended and restated
to
provide, among other things, an increase in the maximum loan commitment
to $24.0
million, consisting of an $8.0 million revolving credit facility and
a $16.0
million term loan in two tranches of approximately $8.8 million and
$7.2
million. The first tranche of the term loan, or approximately $8.8
million, was
used to purchase the senior credit facility. The availability of the
undrawn
balance of such revolving and term loan commitments of approximately
$8.0
million and $7.2 million, respectively, are subject to certain conditions,
the
earliest of which could be satisfied on February 1, 2007. However,
there can be
no assurance that we will be able to comply with the conditions allowing
it to
draw upon these funds. As of November 15, 2006, we obtained access
to cash in
the amount of approximately $11.3 million previously held by Comerica
under the
terms of a compensating balance arrangement.
In
addition, another affiliate of Columbia Ventures purchased an aggregate
of
879,117 shares of two series of newly-designated, non-voting, convertible
preferred stock for aggregate consideration of approximately $1.0 million.
The
two series of preferred stock, one of which was issued at closing and
the other
of which will be issued upon receipt of shareholder approval of an
amendment to
our articles of incorporation to permit the issuance of the common
stock
issuable upon conversion of such series of preferred stock, are generally
convertible into approximately 51% and 95%, respectively, of our outstanding
common stock on a fully-diluted basis, subject to satisfaction of certain
conditions, including receipt of requisite regulatory approvals.
We
are
required to hold a shareholder meeting to seek approval for an amendment
to our
articles of corporation within 90 calendar days of receipt of a written
request
from the equity purchaser. We do not expect the equity purchaser to
exercise
such right until such time as they have converted the first series
of preferred
stock, which is expected to result in the equity purchaser holding
51% of our
outstanding common stock, on a fully-diluted basis, which is sufficient
voting
power under current applicable law and our articles of incorporation
and bylaws
to approve such amendment without participation from other
shareholders.
As
part
of the restructuring, we reached an agreement with Merrill Lynch Capital
to
restructure approximately $5.7 million of our obligations to them.
Such
agreement provides for, among other things, deferral of payments of
principal
and interest due to them in January and February of 2007, waiver of
compliance
with certain covenants and a commitment to restructure the maturity
date and
payment terms on the remaining obligations should certain conditions
be met. In
addition, we reached an agreement with Tekelec, one of our key suppliers,
to
restructure approximately $1.9 million of our obligation to them. As
part of our
agreement with Tekelec, we paid them approximately $535,000 to settle
in full
such obligation.
In
addition, we have received a commitment from SMH Capital Advisors,
Inc., an
investment advisor who has represented to us that it has discretion
over
approximately $21.0 million of the $36.1 million of outstanding principal
amount
of our 13.5% Senior Notes due 2009 to tender into an exchange offer
made to all
holders of Senior Notes for newly designated 13.5% Notes due 2009.
We expect to
complete such exchange offer by February 1, 2007. This
communication is not an offer to exchange Senior Notes for New Notes
or a
solicitation of an offer to exchange Senior Notes for New Notes. The
offer to
exchange Senior Notes for New Notes is expected to be made pursuant
to an
exemption from registration pursuant to Section 3(a)(9) under the Securities
Act
of 1933, as amended, solely by means of an offering circular and disclosure
statement and other documents provided to holders of the Senior
Notes.
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 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 to complete our network and to
support
increased levels of network traffic.
On
September 25, 2006, our common stock was delisted from the Nasdaq Capital
Market
due to noncompliance with Nasdaq’s minimum bid price requirement. Our stock is
now quoted in the Pink Sheets and on The OTC Bulletin Board®. Removal from the
Nasdaq Capital Market could have a material adverse effect on our ability
to
raise additional equity capital should that become necessary.
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 a restructuring plan, which included a workforce
reduction
of approximately 32 employees as part of a cost containment strategy.
The
workforce reduction was completed in June 2006. 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 and
reduced that
estimate approximately $9,000 during the third quarter of 2006, primarily
due to
forfeited benefits. We anticipate total cash paid for employee termination
benefits to be $229,000. The final cash payment to be recorded against
the 2006
restructuring reserve is expected to occur in November 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, obligated 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 included network related and administrative
support
services which were 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
was
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. The TSA terminated
on
September 12, 2006 and continued services after this date are recorded
as
revenues.
For
the
three and nine months ended September 30, 2006, we recorded reimbursed
transition expenses of $1.5 million and $7.2 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 consolidated statements of
operations
and comprehensive income (loss). Costs billed under the TSA were based
upon
estimated costs to us, and we estimate that no profit was recognized
on the
services performed under the TSA. The enterprise services were 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
could not be segregated based upon the services provided and therefore
the
estimated costs were primarily 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 nine
months
ended September 30, 2006 and 2005:
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
(Dollars
in thousands)
|
|
Total
revenue
|
|
$
|
26,171
|
|
$
|
22,383
|
|
$
|
72,827
|
|
$
|
72,383
|
|
Income
(loss) from operations
|
|
$
|
3,332
|
|
$
|
830
|
|
$
|
1,121
|
|
$
|
(1,306
|
)
|
Net
income (loss)
|
|
$
|
2,324
|
|
$
|
(126
|
)
|
$
|
(2,775
|
)
|
$
|
14,898
|
|
Income
(loss) per share diluted
|
|
$
|
0.06
|
|
$
|
(0.00
|
)
|
$
|
(0.07
|
)
|
$
|
0.38
|
|
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
47.1% and 44.9% of our total revenues for the nine months ended September
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 over $7.1 million to us. We received $7.1
million from
AT&T on July 31, 2006. During August 2006 we received an additional
$3.0
million from AT&T for similar traffic terminations that occurred subsequent
to our October 2004 complaint.
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 expansion
upon
completion and expect such 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 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, Pennsylvania, Maryland, Florida, Colorado, Alabama, North
Carolina,
South Carolina, New Jersey, Washington, D.C., Oregon, Washington,
Nevada,
Arizona, Utah, Idaho, and our 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 September 30, 2006 Compared to the Quarter Ended September
30,
2005
Our
significant revenue
components and operational metrics for the quarters ended September
30, 2006 and
2005 are as follows:
|
|
Three
Months Ended
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
compensation
|
|
$
|
8.9
|
|
$
|
12.0
|
|
|
(25.8
|
)%
|
Mature
Products
|
|
|
14.7
|
|
|
9.3
|
|
|
58.1
|
%
|
Growth
Products
|
|
|
2.6
|
|
|
1.1
|
|
|
136.4
|
%
|
Total
revenues
|
|
$
|
26.2
|
|
$
|
22.4
|
|
|
17.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Operational
metrics:
|
|
|
|
|
|
|
|
|
|
|
Minutes
of use (in billions)
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
|
|
|
6.38
|
|
|
12.01
|
|
|
(46.9
|
)%
|
Mature Products
|
|
|
-
|
|
|
0.07
|
|
|
(100.0
|
)%
|
Growth Products
|
|
|
0.23
|
|
|
0.09
|
|
|
155.6
|
%
|
Total minutes of use
|
|
|
6.61
|
|
|
12.17
|
|
|
(45.7
|
)%
|
Total
revenues, which is
composed of intercarrier, mature products and growth products, increased
17.0%
to $26.2 million in the quarter ended September 30, 2006 from $22.4
million
during the same period in 2005. This increase was primarily attributable
to
settlements of $9.5 million during the third quarter of 2006 compared
to $2.2
million in 2005, partially offset by lower revenues 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 decreased 25.8% to $8.9 million in the quarter ended
September 30, 2006
from $12.0 million during the same period in 2005 due primarily
to lower
revenues from a decrease in intercarrier minutes of use primarily
resulting from
a competitor, who is a customer, building out their own network,
and a more
rapid than expected decline in the Internet dial-up business.
The decline was
partially offset by an increase of third party transit traffic
of approximately
$0.7 million and settlements of $3.0 million in the third quarter
of 2006
compared to $2.2 million in 2005.
Mature
products revenues include
dial access services, collocation, and all enterprise products.
Revenues from
mature products increased $5.4 million, or 58.1% in the quarter
ended September
30, 2006 from $9.3 million during the same period in 2005. The
increase was
primarily due to a settlement and restructuring agreement with
an ISP of $6.5
million during the third quarter of 2006, partially offset by
lower revenues
from lower minutes of use in addition to Internet dial-up ISPs
reducing
services. The settlement and restructuring agreement with the
ISP, assuming no
increase in volume, is expected to result in an increase in revenues
of $5.4
million for 2006 and a decrease in revenues of $4.6 million and
$2.6 million for
2007 and 2008, respectively.
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 $1.5 million, or 136.4% in the quarter
ended September
30, 2006 from $1.1 million during the same period in 2005. The
increase was due
primarily to volume growth from products introduced in 2005.
This increase was
primarily in the western footprint and we expect gradual increases
in our
eastern footprint as we complete our expansion along with our
VeriSign, Inc.
alliance by the end of the year.
Total
minutes of use,
which is composed of intercarrier, mature products and growth
products declined
45.7% to 6.61 billion in the quarter ended September 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 6.38 billion in the
quarter ended
September 30, 2006 from 12.01 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 0.01 billion for the quarter ended
September 30,
2006 from 0.07 billion during the same period in 2005. Growth
products minutes
of use increased to 0.23 billion for the quarter ended September
30, 2006 from
0.09 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 September
30, 2006 and
2005 are as follows:
|
|
Three
Months Ended
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
$
|
9.9
|
|
$
|
9.6
|
|
|
3.1
|
%
|
Selling,
general and administrative
|
|
|
11.5
|
|
|
13.0
|
|
|
(11.5
|
)%
|
Reimbursed
transition expenses
|
|
|
(1.5
|
)
|
|
(4.5
|
)
|
|
(66.7
|
)%
|
Depreciation
and amortization
|
|
|
3.0
|
|
|
3.4
|
|
|
(11.8
|
)%
|
Total
costs and expenses
|
|
$
|
22.9
|
|
$
|
21.5
|
|
|
6.5
|
%
|
Consolidated
network expenses increased $0.3 million, or 3.1% during the three
months ended
September 30, 2006 compared to $9.6 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 in
addition to cost reduction efforts. During this transition period,
which ended
September 12, 2006, we were obligated under the TSA, among other
things, to
provide certain transition services to TelePacific at our estimated
cost. The
estimated costs reimbursed to us included network related services
and are
included under “Reimbursed transition expenses.”
Consolidated
selling, general and administrative expenses decreased 11.5%
to $11.5 million
for the quarter ended September 30, 2006 from $13.0 million during
the same
period in 2005. The decrease was primarily due to suspended compensation
associated with company and individual team performance goals,
reduced
professional costs and cost reduction activities.
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 $90,000
in selling,
general and administrative expense during the quarter ended September
30, 2006
as a result of this adoption. Total compensation expense recognized
for
stock-based awards for the three months ended September 30, 2006
and 2005 was
$118,000 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
September 30, 2006, we had unrecognized stock-based compensation
of $1.0 million
outstanding, which we expect to recognize over a weighted-average
period of 2.6
years.
Reimbursed
transition expenses were $1.5 million and $4.5 million for the
quarters ended
September 30, 2006 and 2005, respectively. The reimbursed transition
expenses
related to network and administrative services provided to TelePacific
in
accordance with the TSA. Costs billed under the TSA were based
upon estimated
costs to us, and as such no profit was recognized on the services
performed
under the TSA. The TSA ended on September 12, 2006 and reimbursement
of
transition expenses ended at that time. Continued services provided
after
September 12, 2006 are recorded under revenues. The enterprise
services were
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.
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 11.8% to $3.0
million in the
quarter ended September 30, 2006 from $3.4 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.
Consolidated
income from
operations was $3.3 million for the quarter ended September
30, 2006 compared to
$0.8 million during the same period in 2005 primarily due to
the factors
discussed in the preceding paragraphs.
Consolidated
interest
expense, net increased to $1.4 million for the quarter ended
September 30, 2006
compared to $1.1 million for the same period in 2005 due primarily
to higher
debt levels and increasing interest rates during 2006.
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
Interest
on Senior Notes
|
|
$
|
1,218
|
|
$
|
1,218
|
|
Amortization
of deferred financing costs
|
|
|
57
|
|
|
50
|
|
Other
interest expense
|
|
|
406
|
|
|
5
|
|
Less
interest income
|
|
|
(257
|
)
|
|
(182
|
)
|
|
|
$
|
1,424
|
|
$
|
1,091
|
|
For
the quarters ended
September 30, 2006 and 2005, our effective income tax rate was
5.3% and 40.0%,
respectively.
Consolidated
net income
was $2.3 million for the quarter ended September 30, 2006 compared
to a net loss
of $0.1 million during the same period in 2005 primarily due
to the factors
discussed in the preceding paragraphs.
Nine
Months Ended September 30, 2006 Compared to the Nine Months
Ended September 30,
2005
Our
significant revenue
components and operational metrics for the nine months ended
September 30, 2006
and 2005 are as follows:
|
|
Nine
Months Ended
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
compensation
|
|
$
|
34.3
|
|
$
|
32.5
|
|
|
5.5
|
%
|
Mature
Products
|
|
|
31.4
|
|
|
37.3
|
|
|
(15.8
|
)%
|
Growth
Products
|
|
|
7.1
|
|
|
2.6
|
|
|
173.1
|
%
|
Total
revenues
|
|
$
|
72.8
|
|
$
|
72.4
|
|
|
0.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Operational
metrics:
|
|
|
|
|
|
|
|
|
|
|
Minutes
of use (in billions)
|
|
|
|
|
|
|
|
|
|
|
Intercarrier
|
|
|
25.99
|
|
|
36.15
|
|
|
(28.1
|
)%
|
Mature Products
|
|
|
0.07
|
|
|
0.20
|
|
|
(65.0
|
)%
|
Growth Products
|
|
|
0.50
|
|
|
0.21
|
|
|
138.1
|
%
|
Total minutes of use
|
|
|
26.56
|
|
|
36.56
|
|
|
(27.4
|
)%
|
Total
revenues, which is composed of intercarrier, mature products
and growth
products, increased 0.6% to $72.8 million in the nine months
ended September 30,
2006 compared to $72.4 million for the same period in 2005.
This increase was
primarily attributable to revenue resulting from receipt
of administrative
orders to make disputed payments, settlements with carriers
for prior disputed
billings and a settlement and restructuring agreement with
an ISP of $19.8
million during 2006 compared to settlements of $2.2 million
in 2005, partially
offset by lower revenues 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 5.5% to $34.3 million in
the nine months ended
September 30, 2006 from $32.5 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 approximately
$13.2 million during
2006 compared to settlements of $2.2 million in 2005, 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 $5.9 million,
or 15.8% in the
nine months ended September 30, 2006 from $37.3 million during
the same period
in 2005. The decrease was primarily due to the sale of substantially
all of our
enterprise customer base to TelePacific on March 11, 2005,
lower revenues from
lower minutes of use and Internet dial-up ISPs reducing services,
partially
offset by a settlement and restructuring agreement with an
ISP of $6.5 million
during the third quarter of 2006. The settlement and restructuring
agreement
with the ISP, assuming no increase in volume, is expected
to result in an
increase in revenues of $5.4 million for 2006 and a decrease
in revenues of $4.6
million and $2.6 million for 2007 and 2008, respectively.
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 $4.5 million, or
173.1% in the nine
months ended September 30, 2006 from $2.6 million during
the same period in
2005. The increase was due primarily to volume growth from
products introduced
in 2005. This increase was primarily in the western footprint
and we expect
gradual increases in our eastern footprint as we complete
our expansion along
with our VeriSign, Inc. alliance by the end of the year.
Total
minutes of use, which is composed of intercarrier, mature
products and growth
products declined 27.4% to 26.56 billion in the nine months
ended September 30,
2006 from 36.56 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 28.1% to 25.99
billion during the
nine months ended September 30, 2006 from 36.15 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
nine months ended
September 30, 2006 from 0.20 billion for the same period
in 2005. Growth
products minutes of use increased to 0.50 billion for the
nine months ended
September 30, 2006 from 0.21 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 nine months ended
September 30, 2006 and
2005 are as follows:
|
|
Nine
Months Ended
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
%
Change
|
|
|
|
(unaudited)
|
|
|
|
|
|
(Dollars
in millions)
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
Network
expenses (exclusive of depreciation shown separately
below)
|
|
$
|
29.7
|
|
$
|
29.9
|
|
|
(0.7
|
)%
|
Selling,
general and administrative
|
|
|
40.0
|
|
|
40.1
|
|
|
(0.2
|
)%
|
Reimbursed
transition expenses
|
|
|
(7.1
|
)
|
|
(7.3
|
)
|
|
(2.7
|
)%
|
Depreciation
and amortization
|
|
|
8.9
|
|
|
10.3
|
|
|
(13.6
|
)%
|
Restructuring
charges
|
|
|
0.3
|
|
|
0.6
|
|
|
(50.0
|
)%
|
Total
costs and expenses
|
|
$
|
71.8
|
|
$
|
73.6
|
|
|
(2.4
|
)%
|
Consolidated
network expenses decreased $0.2 million, or 0.7% during
the nine months ended
September 30, 2006 compared to $29.9 million during the
same period in 2005 due
primarily to improved network efficiency 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
increased expenses associated with our national expansion.
During this
transition period, which ended September 12, 2006, we were
obligated under the
TSA, among other things, to provide certain transition
services to TelePacific
at our estimated cost. The estimated costs reimbursed to
us included network
related services and are included under “Reimbursed transition expenses.”
Consolidated
selling, general and administrative expenses decreased
0.2% to $40.0 million for
the nine months ended September 30, 2006 from $40.1 million
during the same
period in 2005 due primarily to suspended compensation
associated with company
and individual team performance goals.
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
$292,000 in selling,
general and administrative expense during the nine months
ended September 2006
as a result of this adoption. Total compensation expense
recognized for
stock-based awards for the nine months ended September
30, 2006 and 2005 was
$396,000 and $140,000, 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
September 30, 2006, we had unrecognized stock-based compensation
of $1.0 million
outstanding, which we expect to recognize over a weighted-average
period of 2.6
years.
Reimbursed
transition expenses were $7.1 million for the nine months
ended September 30,
2006 compared to $7.3 million during the same period in
2005. The reimbursed
transition expenses related to network and administrative
services provided to
TelePacific in accordance with the TSA. Costs billed under
the TSA were based
upon estimated costs to us, and as such no profit was recognized
on the services
performed under the TSA. The TSA ended on September 12,
2006 and reimbursement
of transition expenses ended at that time. Continued services
provided after
September 12, 2006 are recorded under revenues. The enterprise
services were
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.
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 13.6% to
$8.9 million in the
nine months ended September 30, 2006 from $10.3 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 nine months
ended September 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
income from operations was $1.1 million for the nine months
ended September 30,
2006 compared to a consolidated loss from operations of
$1.3 million during the
same period in 2005.
Consolidated
interest expense, net decreased to $4.3 million for the
nine months ended
September 30, 2006 compared to $5.2 million for the same
period in 2005 due
primarily from the extinguishment of the Senior Secured
Note during the first
quarter of 2005. The decrease was partially offset by higher
debt levels and
increasing interest rates during 2006. Our interest expense,
net was as
follows:
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(unaudited)
|
|
|
|
(Dollars
in thousands)
|
|
Interest
on Senior Notes
|
|
$
|
3,655
|
|
$
|
3,655
|
|
Accreted
discount on Senior Secured Note
|
|
|
-
|
|
|
1,262
|
|
Amortization
of deferred financing costs
|
|
|
171
|
|
|
255
|
|
Other
interest expense
|
|
|
1,131
|
|
|
524
|
|
Less
interest income
|
|
|
(629
|
)
|
|
(498
|
)
|
|
|
$
|
4,328
|
|
$
|
5,198
|
|
During
the nine months ended September 30, 2005, we recorded
a gain of $24.1 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
nine months ended September 30, 2006 and 2005, our effective
income tax rate was
4.1% and 2.9%, respectively.
Consolidated
net loss was $2.8 million for the nine months ended September
30, 2006 compared
to net income of $14.9 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 nine months ended September
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
|
|
Nine
Months Ended
|
|
|
|
September
30, 2006
|
|
September
30, 2006
|
|
|
|
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)
|
|
|
37.9
|
%
|
|
43.0
|
%
|
|
40.8
|
%
|
|
41.3
|
%
|
Selling,
general and administrative expenses
|
|
|
43.8
|
%
|
|
58.1
|
%
|
|
54.9
|
%
|
|
55.4
|
%
|
Reimbursed
transition expenses
|
|
|
(5.7
|
)%
|
|
(20.0
|
)%
|
|
(9.8
|
)%
|
|
(10.1
|
)%
|
Depreciation
and amortization expenses
|
|
|
11.4
|
%
|
|
15.0
|
%
|
|
12.3
|
%
|
|
14.3
|
%
|
Income
(loss) from operations
|
|
|
12.7
|
%
|
|
3.7
|
%
|
|
1.5
|
%
|
|
(1.8
|
)%
|
Net
income (loss)
|
|
|
8.9
|
%
|
|
(0.6
|
)%
|
|
(3.8
|
)%
|
|
20.6
|
%
|
The
following table sets forth unaudited statistical data
for each of the specified
quarters of 2006 and 2005. The operating and statistical
data for any quarter
are not necessarily indicative of results for any future
period.
|
|
Three
Months Ended
|
|
|
|
2006
|
|
2005
|
|
|
|
Sept.
30,
|
|
June
30,
|
|
March
31,
|
|
Dec.
31,
|
|
Sept.
30,
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Ports
equipped
|
|
|
1,288,704
|
|
|
1,288,704
|
|
|
1,151,616
|
|
|
1,151,616
|
|
|
1,054,848
|
|
Quarterly
minutes of use switched (in billions)
|
|
|
6.6
|
|
|
8.8
|
|
|
11.2
|
|
|
12.0
|
|
|
12.2
|
|
Capital
additions (in thousands)
|
|
|
$1,266
|
|
|
$557
|
|
|
$10,568
|
|
|
$5,797
|
|
|
$3,259
|
|
Employees
|
|
|
236
|
|
|
236
|
|
|
266
|
|
|
245
|
|
|
234
|
|
Liquidity
and Capital Resources:
Sources
and uses of cash. At
September 30, 2006, cash and short-term investments decreased $5.0 million
to
$21.7 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. Approximately $12.0 million of our
cash
and short-term investments was subject to a compensating balance arrangement
with Comerica. As a result of the restructuring described above, on November
15,
2006, the compensating balance arrangement was terminated.
Net
cash
provided by operating activities was $0.5 million for the nine months ended
September 30, 2006 compared to $5.0 million for the same period ended in
2005.
The cash provided for 2006 was primarily due to income from operations.
Net
cash
used in investing activities was $9.0 million for the nine months ended
September 30, 2006 due primarily to the purchase of property and equipment.
Net
cash provided by investing activities was $20.8 million during the nine months
ended September 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 of $3.5 million for the nine months ended
September 30, 2006 was primarily due to proceeds from borrowings under notes
payable. Net cash used in financing activities was $41.1 million during the
nine
months ended September 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 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 $6.8 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 September 30, 2006,
we did
not have any material future purchase commitments to purchase equipment from
any
of our vendors.
Debt
outstanding.
At
September 30, 2006 and December 31, 2005, long-term debt and capital lease
obligations consist of the following:
|
|
September
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars
in thousands)
|
|
Senior
Notes
|
|
$
|
36,102
|
|
$
|
36,102
|
|
Capital
lease obligations
|
|
|
548
|
|
|
651
|
|
Notes
payable
|
|
|
16,424
|
|
|
12,159
|
|
Less
current portion of notes payable and capital leases
|
|
|
(5,404
|
)
|
|
(5,392
|
)
|
|
|
$
|
47,670
|
|
$
|
43,520
|
|
The
Senior Notes of which there is $36.1 million in principal amount outstanding
at
September 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. As described above, we have received
a commitment from an investment advisor that has represented that it has
discretion over approximately $21.0 million of the $36.1 million of outstanding
principal amount of the Senior Notes to tender into an exchange offer made
to
all holders of Senior Notes for newly designated 13.5% Notes due 2009.
In
March
2006, we completed a 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 September
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 September 30, 2006 the principal balance of the note payable
was $0.1 and is included in the above table under Notes Payable. This obligation
was not restructured in connection with the restructuring discussed above.
In
November 2005, we entered into a Senior Secured Credit Facility with Comerica,
which provided for up to $5 million of revolving advances and up to $15 million
of term loans, subject to certain conditions. Any revolving advances were
not to
exceed 80% of eligible accounts receivables and were due and payable in full
on
November 9, 2007. There were no revolving advances as of September 30,
2006.
The
term
loan portion of the Senior Secured Credit Facility, which was to be used
within
certain limitations to finance capital equipment expenditures and acquisitions
or to refinance the Senior Notes, was structured into two tranches; the first
included all term loan borrowings through June 9, 2006, at which point it
expired, and was payable in thirty equal monthly installments commencing
July 1,
2006. The second tranche started June 10, 2006 and continued through January
9,
2007 at which point it expired, and was payable in twenty-three equal monthly
installments commencing February 1, 2007.
Rates
for
borrowings under the Senior Secured Credit Facility floated and were 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 Senior Secured Credit Facility was secured by all of
our
personal property and required us to maintain certain financial and restrictive
covenants. As of September 30, 2006 and December 31, 2005, the term loan
principal balance was $9.5 million and $2.5 million, respectively, and is
included in the above table under Notes Payable.
On
May
30, 2006, July 31, 2006 and September 25, 2006 we entered into amendments
to the
Senior Secured Credit Facility with Comerica that
provided, among other things, 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 Senior Secured Credit
Facility were amended such that we would not be required to comply with such
covenants as they were in effect prior to the amendments during the compliance
periods through and including November 30, 2006; provided that we remained
in
compliance with the minimum cash covenant, which, as amended, required the
minimum cash covenant specifies that we maintain a minimum balance of cash
at
Comerica equal to $2.5 million in excess of the outstanding indebtedness.
The
Amendments also provided that we could not request additional extensions
of
credit under the Senior Secured Credit Facility until we was in compliance
with
all of the financial covenants.
As
described above, as part of the restructuring, on November 15, 2006, an
affiliate of Columbia Ventures purchased our Senior Secured Credit Facility,
which had an outstanding balance at such time of approximately $8.8 million,
from our senior lender, Comerica. In connection with this purchase, Comerica
assigned its rights and obligations under the Senior Secured Credit Facility
to
the loan purchaser and, concurrently with such purchase and assignment, such
facility was amended and restated to provide, among other things, an increase
in
the maximum loan commitment to $24.0 million, consisting of an $8.0 million
revolving credit facility and a $16.0 million term loan in two tranches of
approximately $8.8 million and $7.2 million.
Under
revolving facility, as amended and restated, on and after February 1, 2007,
the
debt purchaser will make revolving loans to us of not less than $250,000,
not to
exceed the least of (i) $8,000,000, (ii) 85% of eligible accounts receivable,
and (iii) the amount necessary to replenish the aggregate amount of our
unrestricted cash and cash equivalents to $5,000,000 until December 31, 2008,
at
which time the revolving loans become due and payable. The revolving loans
will
accrue interest at 12% per annum. The interest accrued becomes due and payable
at maturity.
Under
the
term loan facility, as amended and restated, approximately $8.8 million,
the
maximum amount of the first tranche, was drawn on November 15, 2006 in order
to
fully refinance the aggregate obligations outstanding to Comerica under the
Senior Secured Credit Facility and reimburse Comerica for its legal expenses
in
connection with such transaction. We may borrow from the loan purchaser up
to an
aggregate of approximately $7.2 million under the second tranche upon the
latest
to occur of (i) February 1, 2007, (ii) the commercial availability of our
DIDOD
Release 1.1 and (iii) the effective date of long term binding agreements
between
us and VeriSign, Inc. acceptable to the loan purchaser. Any amounts borrowed
under the term loan facility are due and payable on December 31, 2008 and
will
accrue interest at 12% per annum, such interest to become due and payable
at
maturity. There can be no assurance that we will meet the conditions in order
to
draw upon these funds.
Obligations
under the Senior Secured Credit Facility, as amended and restated, are secured
by all of our personal property. Such facility contains usual and customary
events of default or facilities of this nature and provides that upon the
occurrence of an event of default, the loan purchaser may, among other things,
accelerate the payment of all amounts payable under the facility and cease
to
advance money or extend credit for our benefit. Under the terms of the Senior
Secured Credit Facility, as amended and restated, we are also required to
maintain certain financial and restrictive covenants which limit, among other
things, our ability to incur additional indebtedness, create liens, acquire,
sell or dispose of certain assets, engage in certain mergers and acquisitions,
pay dividends and make certain capital expenditures. Our ability to borrow
additional amounts under such facility is also subject to receipt of specified
regulatory approvals and the satisfaction of other customary
conditions.
In
addition, as described above, as part of the restructuring, we reached an
agreement with Merrill Lynch Capital to restructure approximately $5.7 million
of our obligations to them. Such agreement provides for, among other things,
deferral of payments of principal and interest due to them in January and
February of 2007, waiver of compliance with certain covenants and a commitment
to restructure the maturity date and payment terms on the remaining obligations
should certain conditions be met. In addition, under such agreement, we agreed
to pay Merrill Lynch Capital in respect of our obligations an amount equal
to
20% of any interest savings achieved as a result of the tender of more than
$21.0 million in principal amount of Senior Notes as part of the exchange
offer
we intend to conduct in respect of our Senior Notes.
Future
uses and sources of cash.
Our
principal sources of operating funds for the remainder of 2006 and the first
nine months of 2007 are anticipated to be current cash and short-term investment
balances, borrowing under our Senior Secured Credit Facility, as amended
an
restated, and cash flows from operating activities. However, there can be
no
assurance that the conditions to availability of borrowing under our Senior
Secured Credit Facility will be satisfied. If such conditions are not satisfied,
we will not be able to rely on our Senior Secured Credit Facility for operating
funds, which may materially and adversely impact our ability to pursue our
business plans and objectives. We currently expect to fund the following
expenditures during the next 12 months:
• interest
payments of approximately $2.5 million on notes (assumes tender of $21.0
million
of Senior Notes and the restructuring of our obligations to Merrill Lynch
Capital is completed);
• anticipated
capital expenditures of approximately $6.8 million;
• debt
principal payments of approximately $2.4 million (assumes the restructuring
of
our obligations to Merrill Lynch Capital is completed); and
• capital
lease
payments (including interest) of approximately $0.4 million.
On
September 25, 2006, the Company’s common stock was delisted from the Nasdaq
Capital Market due to noncompliance with Nasdaq’s minimum bid price requirement.
The Company’s stock is now quoted in the Pink Sheets and on The OTC Bulletin
Board®. Removal from the Nasdaq Capital Market could have a material adverse
effect on the Company’s ability to raise additional equity capital should that
become necessary.
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 September 30, 2006, we
had an
outstanding note payable of $9.5 million to Comerica Bank (Comerica). This
note
is at Comerica’s prime rate plus 0.5%, which was 8.75% as of September 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. As of September 30, 2006 all of our cash and investments
are in cash equivalents. A hypothetical 1% decrease in short-term interest
rates
would reduce the annualized pretax interest income on our $21.7 million cash
and
cash equivalents at September 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 September 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
Below
are material
changes from 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.
We
may not be able to satisfy the conditions to borrow and comply with certain
financial covenants and events of default under our Senior Secured Credit
Facility, as amended and restated.
Our
Senior Secured Credit
Facility, as amended and restated, is expected to be one of our principal
sources of operating funds. However, there can be no assurance that the
conditions to availability of borrowing under the Senior Secured Credit
Facility
will be satisfied. If such conditions are not satisfied, we will not be
able to
rely on our Senior Secured Credit Facility for operating funds, which may
materially and adversely impact our ability to pursue our business plans
and
objectives.
In
addition, we are
subject to certain financial and operational covenants and events of default
under the Senior Secured Credit Facility, including an event of default
based
upon our failure to obtain tenders for 51% of the Senior Notes in the planned
exchange offer. Failure to comply with such covenants and events of default
could result in certain remedies being exercised by the loan purchaser
that
could give the loan purchaser the right to accelerate, or declare due and
payable, all outstanding amounts under the Senior Secured Credit Facility,
as
amended and restated.
A
decline in liquidity and/or increase in volatility associated with the delisting
of our common stock from the Nasdaq Capital market.
We
have been delisted
from the Nasdaq Capital Market. Our common stock is currently traded in the
over-the-counter market. Trading in the over-the-counter market may adversely
impact our stock price and liquidity, and the ability of our stockholders
to
purchase and sell our shares in an orderly manner. Furthermore, the delisting
of
our shares could damage our general business reputation.
Exhibits
|
10.66
|
Fifth
Amendment to Loan and Security Agreement dated September 25, 2006,
by and
between
Comerica Bank and the Company.
|
|
10.67
|
Settlement
and Restructuring agreement dated September 29, 2006, by and between
Qwest
Communication
Corporation, Qwest Corporation and the
Company. Certain
confidential portions have been omitted and filed separately with
the
Securities and Exchange Commission pursuant to a request for confidential
treatment.)
|
|
10.68
|
Agreement
regarding compensation on change of control dated August 30, 2006,
made by
and
between the Company and Michael Hawn, Vice President of Customer
Network Services.
|
|
10.69
|
Agreement
regarding compensation on change of control dated August 30, 2006,
made by
and
between the Company and Eric Jacobs, Vice President of
Sales.
|
|
10.70
|
Agreement
regarding compensation on change of control dated August 30, 2006,
made by
and
between the Company and Ravi Brar, Chief Operating
Officer.
|
|
10.71
|
Agreement
regarding compensation on change of control dated August 30, 2006,
made by
and
between the Company and Todd Putnam, Chief Information
Officer.
|
|
10.72
|
Separation
Agreement with Wallace W. Griffin, dated October 25,
2006.
|
|
31.1
|
Certification
by Henry R. Carabelli, Chief Executive Officer pursuant to Section
302 of
the Sarbanes-Oxley Act of 2002.
|
|
31.2
|
Certification
by 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, 4 and 5 are not applicable and have been
omitted.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized on November 20, 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