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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Mark One FORM 10-K
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[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1999 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)
4210 Coronado Avenue, Stockton, California 95204
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (209) 926-3300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the common stock held by non-affiliates of the
Registrant, based upon the closing sale price of the common stock on March 1,
2000 as reported on the Nasdaq National Market System, was approximately
$556,450,000. Shares of common stock held by each executive officer and director
and by each person who owns 5% or more of the outstanding common stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 1, 2000 Registrant had outstanding 35,836,919 shares of common
stock.
Documents Incorporated by Reference
-----------------------------------
None
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
We have made statements in this Annual Report on Form 10-K that are not
historical facts. These "forward-looking statements" can be identified by the
use of terminology such as "believes," "expects," "may," "will," "should," or
"anticipates" or comparable terminology. These forward-looking statements
include, among others, statements concerning:
. our business strategy and competitive advantages;
. statements regarding the growth of the telecommunications industry and
our business;
. the markets for our services and products;
. forecasts of when we will enter particular markets or begin offering
particular services;
. our anticipated capital expenditures and funding requirements; and
. anticipated regulatory developments.
These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial, regulatory developments, industry growth and trend projections, that
could cause actual events or results to differ materially from those expressed
or implied by the statements. The most important factors that could affect these
statements or prevent us from achieving our stated goals include, but are not
limited to, our failure to:
. prevail in legal and regulatory proceedings regarding reciprocal
compensation for Internet-related calls or changes to regulations that
govern reciprocal compensation;
. successfully expand our operations into new geographic markets on a
timely and cost-effective basis;
. respond to competitors in our existing and planned markets;
. retain our key Internet service provider customers;
. execute and renew interconnection agreements with local incumbent
carriers on terms satisfactory to us;
. obtain sufficient leased transport capacity;
. maintain acceptance of our services by new and existing customers;
. replace or upgrade our technology and equipment that becomes obsolete;
. attract and retain talented employees and key executive officers;
. respond effectively to regulatory, legislative and judicial
developments;
. manage administrative, technical or operational issues presented by
our expansion plans;
. prevent interruption of services from system failures;
. generate sufficient cash to service our indebtedness; and
. have sufficient funds available to expand our business.
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PART I
ITEM 1. BUSINESS
The terms "the Company," "Pac-West," "we," "our," "us," and similar terms
as used in this Form 10-K, refer to Pac-West Telecomm, Inc. and, unless the
context otherwise requires, the telephone and answering service divisions of our
predecessor.
Our Company
Pac-West is a rapidly growing provider of integrated communications
services in the western United States. Our customers include Internet service
providers, small and medium businesses, and enhanced communications service
providers, many of which are communications-intensive users. We built our
network to capitalize on the significant growth in national Internet usage and
in the related demand for local telephone service by Internet service providers,
as well as the increasing demand of small and medium businesses for customized
and integrated communications services. We believe the structure of our network
and our presence in, or planned expansion into, each local access and transport
area in our target markets, provide us with significant competitive advantages
over incumbent local exchange carriers and other competitive local exchange
carriers, particularly for Internet service providers. Our network enables these
companies to provide their business and residential customers with access to
Internet, paging and other data and voice services from almost any point in a
state through a local call. We believe the breadth of our product offerings and
the structure of our network enable us to generate high network utilization,
substantial revenues, strong profit margins and positive cash flows.
The Company was incorporated in May 1996 in the state of California. Our
predecessor (also known as Pac-West Telecomm, Inc.), which transferred its
telephone division to our Company effective September 30, 1996, began offering
long distance service in 1982 and local service in 1996 in California.
Markets
We believe that the rapid opening of local markets to competition,
accelerated growth in local traffic related to increases in Internet access, and
the desire for one-stop integrated services by small and medium businesses
present significant opportunities for new entrants to achieve penetration of the
large, established local exchange services market. We also believe that the
primary determinants of success will be the construction of a network that meets
the needs of target customers, rapid deployment of network assets, building of a
direct local sales force to market to small and medium businesses and the
ability to provide competitively priced services.
We currently own and operate switches in Los Angeles (two switches),
Oakland and Stockton, California, Las Vegas, Nevada and Seattle, Washington,
with digital connections in most local access and transport areas in these
states. In addition, prior to the end of 2000, we plan to offer statewide
coverage throughout most of the local access and transport areas in Arizona,
Colorado, Texas, Utah, Idaho, New Mexico and Oregon. Initially, we intend to
serve Arizona, Colorado, Texas, Utah, Idaho, New Mexico and Oregon through our
existing switching sites and three planned additional high volume switching
sites. We expect that our network structure will allow virtually all callers in
these states to access our networks through a local call.
Network
We built our network to capitalize on the significant growth in demand for
switched data and voice communications and the increasing demands of small and
medium businesses for customized, integrated communications services. Since our
inception, we have used a "smart-build" strategy, building and owning
intelligent components of our network while leasing unbundled loops and
transport lines from other carriers. We believe that this strategy has provided
us with significant cost and time-to-market advantages over competitors that own
both their switches and fiber lines. By owning our switches, we can configure
our network to provide high performance, high reliability and cost-effective
solutions for our customers' needs. By leasing our transport lines, we can
reduce up-front capital expenditures, rapidly enter new markets, and provide
low-cost redundancy. In addition, we seek to maximize our operating profits by
carrying a high percentage of our customer-originated traffic on our network. As
traffic on our network increases, we intend to purchase rights of use in high
capacity dark fiber
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transport lines to interconnect certain of our markets with an owned backbone
network. This will provide us with greater flexibility in creating and managing
data and voice services and result in cost savings.
Our network enables our customers to provide their business and residential
customers with access to Internet, paging and other services from almost any
point in the state through a local call. In this way, our customers can achieve
statewide coverage with significantly lower capital and operating expenses. We
currently aggregate and concentrate all of our network traffic into our high
volume switching sites called Super POPs. Our switching sites offer Internet
service providers highly reliable, low cost tandem switching and the ability to
build lower cost networks by collocating equipment at our switching sites rather
than in each local access and transport area. In addition, our interconnection
arrangements and statewide leased transport network allow Internet service
providers to obtain statewide coverage at local calling rates, which reduces
switching and transmission costs.
As of December 31, 1999, we had an installed capacity of 460,800 ports in
California, Nevada and Washington. We expect to have nine switches with
operations in ten western states by the end of 2000, with statewide local
coverage in each of our target markets. We installed a second switch in Los
Angeles and built a switching site in Washington in late 1999, and we intend to
build switching sites in Colorado, Arizona and Texas in 2000.
Switching Platform. We have chosen Alcatel USA's digital tandem switches to
switch calls between originating locations and final destinations. Due to their
high call carrying capacity, multiple path call routing capabilities and ability
to switch multiple digital, voice and data applications of varying bandwidths,
tandem switches are ideally suited for handling the high volumes and long
holding times involved in serving Internet service provider customers. Tandem
switches, software and customer collocation facilities provide the scale,
switching capacity and standardization needed to efficiently and reliably serve
our target customers. Our uniform and advanced switching platform combined with
the structure of our computer network enable us to:
. deploy features and functions quickly throughout our entire network;
. expand switch and transport capacity in a cost-effective, demand-based
manner;
. lower maintenance costs through reduced training and spare parts
requirements; and
. achieve direct connectivity to wireless and other personal
communication system applications in the future.
Transmission Capacity. We currently lease our transmission facilities from
inter-exchange carriers, incumbent local exchange carriers and other competitive
local exchange carriers. We generally seek to lease fiber optic transmission
facilities from multiple sources in each of our current and target markets. In
addition, as discussed above, as traffic on our network increases, we intend to
purchase long-term rights of use in high capacity dark fiber transport lines or
IRU's. We believe that our broad market coverage results in:
(1) an increased number of buildings with multiple tenants that can be
directly connected to our switching network, which should maximize the
number of customers to which we can offer our services;
(2) a higher volume of communications traffic both originating and
terminating on our network, which should result in improved operating
margins;
(3) enhanced reliability at competitive prices;
(4) the ability to leverage our investment in high capacity switching
equipment and electronics; and
(5) the opportunity for our network to provide backhaul carriage for other
telecommunications service providers, such as long distance and
wireless carriers.
Interconnection. We presently have interconnection agreements with Pacific
Bell, GTE and Citizens Telephone Company in California, Central Telephone
Company (d/b/a Sprint of Nevada) and Nevada Bell in Nevada, US West and GTE in
Washington and Oregon, and US West in Arizona. Our interconnection agreement
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with GTE in California has expired and is currently being renegotiated. In
accordance with its terms, however, this agreement will remain in force during
renegotiation. We believe that interconnection arrangements between the
incumbent local exchange carriers and other competitive local exchange carriers
will be in place at appropriate times in other markets that we may enter.
Interconnection agreements between us and incumbent local exchange carriers are
subject to approval of the relevant state commission, and under the terms of the
Telecommunications Act of 1996, each incumbent local exchange carrier which is
subject to the Telecommunications Act of 1996 is required to negotiate an
interconnection agreement with us. Where an interconnection agreement cannot be
reached on terms and conditions satisfactory to us, we may pursue arbitration of
any disputes before the state utility commissions.
Strategy
We are focused on becoming the integrated communications provider of choice
for our customers. Our strategy to meet this objective is to:
Capitalize on growing demand in our current markets. The demand for data
and voice communication services in our current markets is large and growing
rapidly. Significant increases in dial-up access to the Internet have resulted
in the creation of over 5,000 Internet service providers in the United States,
which, in turn, has created strong demand for local access lines nationwide. We
intend to increase our market penetration and capitalize on this growth in our
current markets by adding more switches and transport lines to increase our
capacity, adding new and innovative products to our existing offerings, and
repackaging and repricing our offerings in response to the changing demands of
our customers. In addition, we believe that we are differentiated by the
architecture of our network, which offers the following benefits:
. switching systems which support high calling volumes and long holding
times for Internet service provider calls;
. statewide local calling capabilities through established physical
locations in each local access and transport area within a state,
which reduces Internet service providers' transmission costs; and
. the ability to collocate Internet modems and servers in fewer
locations, which enables Internet service providers to achieve broad
geographic coverage while minimizing capital expenditures.
Leverage existing customer base through geographic expansion. We are a
leading supplier of Internet access and other Internet infrastructure services
in California serving 78 Internet service providers, all of which have
operations in California, including Concentric Network Corp., EarthLink, Inc.
and Splitrock Services, Inc. We plan to leverage the expansion of these
customers into other western states by entering new markets where our current
customers have or are beginning operations. In addition, we refine our selection
of target markets based on a number of considerations, including the number of
potential customers and other competitors in those markets and the presence of
multiple transmission facility suppliers. We believe that our geographically
clustered network will enable us to take advantage of regional calling patterns
to transmit a large percentage of customer traffic on our network. We also
believe that by originating and terminating calls on our network, we can
continue to achieve significant cost savings and may develop some pricing
advantages over our competition.
Focus on the small and medium business market. We believe that small and
medium businesses have significant and increasing needs for advanced
communication services. Many of our target customers want technologically
advanced communications systems along with low cost bundled local, long
distance, data and other enhanced services but do not have the expertise to
design, purchase and maintain these kinds of systems and services themselves. We
also believe that these target customers are not adequately served by incumbent
local exchange carriers and other competitive local exchange carriers. We intend
to become a leading provider of integrated communications services to small and
medium businesses by providing a complete product offering of system design,
equipment installation and maintenance, voice, data and long distance services,
24/7 support, subscription services with multi-year contracts, and optional
upgrades to emerging state-of-the-art equipment. We believe that this product
mix will enable us to quickly penetrate target markets and build customer
loyalty.
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To support the small and medium business market, we have and will continue
to expand our sales, customer care and service delivery forces in selected
markets. From December 31, 1998 to December 31, 1999, our sales, customer care
and service delivery forces increased from 81 to 157 professionals. Of these
resources, the direct sales force increased from 34 to 61 in the same period.
Since the end of the first quarter of 1998, our sales, customer care and service
delivery forces, including direct sales agents, have approximately quadrupled.
We believe that employing a direct sales force and independent sales agents with
extensive local market and telecommunications sales experience enhances the
likelihood of success in new markets. Salespeople with experience in a
particular market provide us with extensive knowledge of our target customer
base through existing relationships with these customers. As a result, our
salespeople are able to pre-sell our products and services before we initiate
network operations in a particular market.
Expand portfolio of products and services. In order to achieve our growth
objectives, we expect to continue introducing new and innovative products and
services. We recently added several new products to our portfolio, including:
. managed modem, a packaged product that includes incoming call access
lines, modems, routers, and authentication services. This product
provides Internet service providers and business customers with a non-
capital intensive means of quickly establishing a local point of
presence or POP throughout our coverage area.
. remote access services, including mobile or remote office, virtual
office, distance learning and training, and telecommuting. These
services include Internet protocol fax, voice mail, paging, integrated
messaging, and local area network and virtual private network, or VPN,
services. This allows customers to access and interact with home or
branch office communications and information systems from anywhere in
our market area through a local call.
. high-speed data services. We currently offer high-speed private line
data services and digital subscriber line services to our customers.
We also intend to explore wireless and satellite technologies in order
to develop an array of high-speed alternatives for our customers.
Expand through potential strategic acquisitions. We may acquire other
competitive local exchange carriers or other communications providers to grow
our business. We believe that strategic acquisitions may enable us to accelerate
our market penetration, cross-sell additional services, diversify our customer
base and improve operating profitability.
Products and Services
Our products and services are designed to appeal to the sophisticated
telecommunications needs of our target customers.
Local Services. We provide local dial-tone services to customers, allowing
them to complete calls in a local calling area and to access long distance
carriers. Local services and long distance services can be bundled together
using the same transport facility. Our network is designed to allow a customer
to easily increase or decrease capacity and alter enhanced communications
services as the communications requirements of the business change. In addition
to our core local services, we also provide access to third party directory
assistance and operator services.
Long Distance Services. We provide domestic and international long distance
services. Long distance calls which do not terminate on our network are passed
to long distance carriers which route the remaining portion of the call. Our
ability to integrate local and long distance services allows us to aggregate
customers' monthly recurring, local usage and long distance charges on a single,
consolidated invoice.
Specialized Application Services. We tailor products and services for
target industries with special communications needs. These services typically
include rated local calling, expanded local calling area, discounted long
distance rates and tailored trunking configurations.
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Internet Service Provider Services. We provide Internet service providers
collocation services at each of our switch locations. Collocation enables an
Internet service provider to install its equipment in any or all of our switch
facilities and interconnect directly to our tandem switches to switch calls from
their originating locations to their final destinations. Collocated equipment is
protected by the same cooling, power back-up and security systems protecting our
switches. An Internet service provider's ability to collocate equipment at a
limited number of sites, rather than in each local access and transport area,
reduces its capital expenditures and maintenance requirements. We receive
monthly rental revenue from the Internet service provider for the space used.
Pac-West has recently introduced a managed modem service where we provide modem
pools and dedicated circuits into the worldwide web for our Internet service
provider customers.
Enhanced Services. In addition to providing typical enhanced services such
as voicemail, call transfer and conference calling, we offer additional
value-added enhanced services to complement our core local and long distance
services. These enhanced service offerings include:
. Internet Access Services, which enable customers to use their
available capacity for access to Internet service providers.
. Data Networking Services, which provide high-speed, broadband services
to use for data communications, such as private corporate networks.
. Digital Subscriber Line Services, which offer high-speed digital
subscriber line service to our Internet service provider and business
customers through a reseller relationship with one or more major
digital subscriber line supplier. We began to provide bundled
high-speed services through Covad Communications in the fourth quarter
of 1999.
Equipment Sales. System design and equipment sales and installation are
essential components of our strategy of marketing to medium and small
businesses. We offer our business customers technologically advanced systems
bundled together with local and long distance services.
Sales and Marketing
Sales. We are building an experienced direct sales force. Our direct sales
force was increased to 61 as of December 31, 1999, from 34 as of December 31,
1998. We recruit salespeople with strong sales backgrounds in our existing and
target markets, including salespeople from long distance companies,
telecommunications equipment manufacturers, network systems integrators and
incumbent local exchange carriers. We plan to continue to attract and retain
highly qualified salespeople by offering them an opportunity to work with an
experienced management team in an entrepreneurial environment and to participate
in the potential economic rewards made available through a results-oriented
compensation program that emphasizes sales commissions.
During the months prior to initiating service in a new market, our
salespeople will begin pre-selling our services to target customers. This
pre-selling effort is designed to shorten the period between the availability of
service and the receipt of customer orders and to generate customers in each
market who may enter into service agreements before the local Pac-West network
becomes operational.
Marketing. In our existing markets, we seek to position ourselves as a high
quality alternative to incumbent local exchange carriers for local
telecommunication services by offering network reliability and superior customer
support at competitive prices. We intend to build our reputation and brand
identity by working closely with our customers to develop services tailored to
their particular needs and by implementing targeted advertising and promotional
efforts, which will be gradually expanding to mass media.
Customer and Technical Service. We believe that our ability to provide
superior customer and technical service is a key factor in acquiring new
customers and reducing churn of existing customers. We have developed a customer
service strategy designed to effectively meet the service requirements of our
target customers. The principal salesperson for each customer will provide the
first line of customer service by identifying and resolving any customer
concerns. Customer service representatives will provide real time problem
identification and
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resolution and superior customer service. All of these services will be
supported by our experienced engineering and technical staff.
Customers
We focus on providing integrated communications services to Internet
service providers, small and medium businesses, enhanced communications service
providers, paging companies and call centers, many of which are
communications-intensive users. For the three month period ended December 31,
1999, eight of our top fifteen customers were Internet service providers. For
the years ended December 31, 1997, 1998 and 1999, Internet service providers
accounted for approximately 16.2%, 23.3% and 19.3%, respectively, of our
revenues, not including reciprocal compensation related to terminating calls to
Internet service providers.
In addition to Internet service providers, we have targeted enhanced
communications service providers as potential large volume users of our
services. Enhanced communications service providers offer unified messaging
platforms and fax mail services, in addition to recently introduced free fax and
voice mail services. The characteristics of this market segment not only offer
us the potential to sell more trunks and bill more minutes of use but also
allows us to improve the utilization of our resources.
Additional customer market segments we have targeted as potential large
volume users of our services include businesses with significant numbers of
telecommuters and businesses with substantial customer service call center
operations. Businesses with substantial numbers of telecommuters will be
targeted with our managed modem product, including our new 64k and 128k
integrated services digital network, or ISDN, service as well as our new digital
subscriber line service, to provide a secure, reliable, reasonably priced remote
access service to connect telecommuters with corporate local area networks or
LANs.
We have also targeted businesses with substantial customer service call
center operations, including the banking, public utilities, and cable television
industries. Companies within these industries often send bills or statements
with a toll-free telephone number. With our services, these companies can offer
a local telephone number on bills and statements, eliminating the need for the
company to pay for toll-free service to enable their customers to contact them.
Financial Information about Industry Segments
Pac-West operates in a single industry segment, telecommunication services.
Operations are managed and financial performance is evaluated based on the
delivery of multiple communication services to customers over common networks
and facilities. See our Financial Statements included in Item 8 of this Form
10-K for information related to revenues by service type.
Seasonality
There is no seasonality to any of the Company's services.
Significant Relationships
Reciprocal compensation payments from incumbent local exchange carriers
accounted for 37.4%, 37.1% and 57.9% of our revenues for the years ended
December 31, 1997, 1998 and 1999, respectively. Reciprocal compensation for 1999
includes amounts received in payment for settlements in connection with disputes
over previously withheld reciprocal compensation, which amounted to 27.5% of our
total 1999 revenue. The revenues from these carriers are the result of
interconnection agreements we have entered into with them that provide for the
transport and termination of local telecommunication traffic. Reciprocal
compensation payments are currently an important source of revenue for the
Company, and as a result, the failure, for any reason, of one or more incumbent
local exchange carrier from which we receive reciprocal compensation payments to
make such payments in the future could adversely affect our financial condition.
Further discussion regarding reciprocal compensation is located under
"Regulation - California and Nevada Regulatory Proceedings and Judicial
Appeals", and in Note 5 to the audited financial statements under "Revenue
Recognition and Legal Proceedings". Reciprocal compensation payments from
Pacific Bell accounted for approximately 35.7%, 32.8% and 45.6% of our total
revenues in 1997, 1998 and 1999, respectively. Reciprocal compensation payments
from GTE accounted for approximately 12.3% of our total revenues in 1999. No
other entities accounted for more than 10% of 1997, 1998 or 1999 revenues.
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Pacific Bell, from whom the Company is paid the largest amount of
reciprocal compensation, is also the Company's largest supplier, accounting for
44%, 50% and 49% of the Company's operating costs for the years ended December
31, 1997, 1998 and 1999, respectively.
Competition
The telecommunications industry is highly competitive. We believe that the
principal competitive factors affecting our business will be pricing levels and
pricing policies, customer service, accurate billing, and, to a lesser extent,
variety of services. Our ability to compete effectively will depend upon our
continued ability to maintain high quality, market-driven services at prices
generally equal to or below those charged by our competitors. To maintain our
competitive posture, we believe that we must be in a position to reduce our
prices in order to meet reductions in rates, if any, by others. Any such
reductions could adversely affect us. Many of our current and potential
competitors have financial, personnel, and other resources, including brand name
recognition, substantially greater than ours as well as other competitive
advantages over us.
Incumbent Local Exchange Carriers. In each of the markets we target, we
will compete principally with the incumbent local exchange carrier serving that
area, such as Pacific Bell and GTE in California. Some incumbent local exchange
carriers, including GTE, are offering long distance services to their local
telephone customers. The regional Bell operating companies, including Pacific
Bell, are actively seeking removal of federal regulatory restrictions that
prevent them from entering the long distance market. Many experts expect the
regional Bell operating companies to be successful in entering the long distance
market in a few states within the next two years and in most states within a
year or two thereafter. We believe the regional Bell operating companies expect
to offset market share losses in their local markets by capturing a significant
percentage of the long distance market, especially in the residential segment
where the regional Bell operating companies' strong regional brand names and
extensive advertising campaigns may be very successful. See "--Regulation."
As a relatively recent entrant in the integrated telecommunications
services industry, we have not achieved and do not expect to achieve a
significant market share for any of our services. In particular, the regional
Bell operating companies and other local telephone companies have long-standing
relationships with their customers, have financial, technical and marketing
resources substantially greater than ours, have the potential to subsidize
competitive services with revenues from a variety of businesses, have
long-standing relationships with regulatory authorities at the federal and state
levels, and currently benefit from certain existing regulations that favor the
incumbent local exchange carriers over us in certain respects. While recent
regulatory initiatives, which allow competitive local exchange carriers such as
ourselves to interconnect with incumbent local exchange carrier facilities,
provide us with increased business opportunities, such interconnection
opportunities have been, and likely will continue to be, accompanied by
increased pricing flexibility for and relaxation of regulatory oversight of the
incumbent local exchange carriers.
The FCC recently adopted an order that provides for increased incumbent
local exchange carrier pricing flexibility and deregulation of some access
services and provides a framework for increased pricing flexibility of other
services based on a showing by the incumbent local exchange carrier that there
is facilities-based competition in specified geographic areas. After meeting
these requirements, incumbent local exchange carriers will be allowed to offer
discounts to large customers through contract arrangements. The order also
permits incumbent local exchange carriers to offer new access services by filing
tariffs without prior approval and dispensing with the requirement for them to
provide cost supports for their pricing. The FCC also issued a Notice of
Proposed Rulemaking that would permit added pricing flexibility for local
exchange carriers for additional services conditioned on to be determined
competitive criteria and initiated an inquiry into whether competitive local
exchange carrier access rates should be regulated. Implementation of the FCC's
order could have a material adverse effect on us. As purchasers of access
services, we may see increased competition for those services which could lower
prices we have to pay for such services.
Competitive Access Carriers/Competitive Local Exchange Carriers/Other
Market Entrants. We also face, and expect to continue to face, competition from
other current and potential market entrants, including long distance carriers
seeking to enter, reenter or expand entry into the local exchange market such as
AT&T, MCI Worldcom, and Sprint, and from other competitive local exchange
carriers, out-of-region incumbent local exchange carriers,
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resellers of local exchange services, cable television companies, electric
utilities, microwave carriers, wireless telephone system operators and private
networks built by large end users. In addition, a continuing trend toward
mergers, acquisitions and strategic alliances in the telecommunications industry
could also increase the level of competition we face. Consolidation is also
occurring in the incumbent local exchange carrier industry, such as the proposed
plans for mergers between SBC and Ameritech, and between Bell Atlantic and GTE.
These types of consolidations and alliances could put us at a competitive
disadvantage.
The Telecommunications Act of 1996 imposes certain regulatory requirements
on all local exchange carriers, including competitors such as ourselves, while
granting the FCC expanded authority to reduce the level of regulation applicable
to any or all telecommunications carriers, including incumbent local exchange
carriers. The manner in which these provisions of the Telecommunications Act of
1996 are implemented and enforced could have a material adverse effect on our
ability to successfully compete against incumbent local exchange carriers and
other telecommunications service providers.
The changes in the Telecommunications Act of 1996 radically altered the
market opportunity for traditional competitive local exchange carriers. Because
many existing competitive local exchange carriers initially entered the market
providing dedicated access in the pre-1996 era, they had to build a fiber
infrastructure before offering services. Switches were added by most competitive
local exchange carriers since 1996 to take advantage of the opening of the local
market. With the Telecommunications Act of 1996 requiring unbundling of the
incumbent local exchange carrier networks, competitive local exchange carriers
are now able to enter the market more rapidly by installing switches and leasing
fiber transport capacity until traffic volume justifies building facilities. New
competitive local exchange carriers will not have to replicate existing
facilities and can be more opportunistic in designing and implementing networks.
Competition for Provision of Long Distance Services. The long distance
telecommunications industry has numerous entities competing for the same
customers and a high average churn rate, as customers frequently change long
distance providers in response to the offering of lower rates or promotional
incentives by competitors. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline.
Internet Service Providers. The competition for Internet service provider
customers in the telecommunications industry is high and we expect that
competition will intensify. In addition, alternative competing technologies
regarding this service may emerge. Our competitors in this market include other
telecommunications companies, including integrated online services providers
with their own communications networks. Many of these competitors have greater
financial, technological, marketing, personnel and other resources than ours.
Competition from International Telecommunications Providers. Under the
recent World Trade Organization agreement on basic telecommunications services,
the United States and 68 other members of the World Trade Organization committed
themselves to opening their respective telecommunications markets to foreign
ownership and/or to adopting regulatory measures to protect competitors against
anticompetitive behavior by dominant telecommunications companies, effective in
some cases as early as January 1998. Although we believe that the World Trade
Organization agreement could provide us with significant opportunities to
compete in markets that were not previously accessible and to provide more
reliable services at lower costs than we could have provided prior to
implementation of the World Trade Organization agreement, it could also provide
similar opportunities to our competitors. There can be no assurance that the
pro-competitive effects of the World Trade Organization agreement will not have
a material adverse effect on our business, financial condition and results of
operations or that members of the World Trade Organization will implement the
terms of the World Trade Organization agreement.
10
Regulation
Our telecommunications services business is subject to varying degrees of
federal, state and local regulation.
Federal Regulation
The FCC regulates interstate and international telecommunications services.
We provide service on a common carrier basis. The FCC imposes certain
regulations on common carriers such as the regional Bell operating companies
that have some degree of market power. The FCC imposes less regulation on common
carriers without market power including, to date, competitive local exchange
carriers. Among other obligations, common carriers are generally subject to
nondiscrimination and tariff filing requirements, as well as certain service
reporting requirements. The FCC also requires common carriers to receive an
authorization to construct and operate telecommunications facilities, and to
provide or resell telecommunications services, between the United States and
international points.
In August 1996, the FCC released an interconnection decision establishing
rules implementing the Telecommunications Act of 1996 requirements that
incumbent local exchange carriers negotiate interconnection agreements and
providing guidelines for review of such agreements by state public utilities
commissions. On July 18, 1997, the Eighth Circuit vacated certain portions of
the interconnection decision, including provisions establishing a pricing
methodology and a procedure permitting new entrants to pick and choose among
various provisions of existing interconnection agreements between incumbent
local exchange carriers and their competitors. On October 14, 1997, the Eighth
Circuit issued a decision vacating additional FCC rules affecting the use of
combinations of an incumbent local exchange carrier's unbundled network
elements. On January 25, 1999, the Supreme Court reversed most aspects of the
Eighth Circuit's holdings with respect to FCC jurisdiction and, among other
things, declared that the FCC has general authority under the Telecommunications
Act of 1996 to promulgate regulations governing local interconnection pricing,
including regulations governing reciprocal compensation. The Supreme Court also
found that the FCC had the authority to promulgate a pick and choose rule, and
upheld most of the FCC's rules governing access to unbundled network elements.
The Court, however, remanded to the FCC its designation of unbundled network
elements based on the FCC's use of an improper standard to determine whether an
unbundled element must be made available. On November 5, 1999, the FCC released
an order largely retaining its list of unbundled network elements, but
eliminating the requirement that ILECs provide unbundled access to operator and
directory assistance service and determining that in the most dense areas of the
top 50 metropolitan areas in certain circumstances local switching need not be
unbundled. The FCC at the same time added dark fiber to the list of unbundled
network elements.
The Eighth Circuit decisions and their recent reversal by the Supreme Court
perpetuate continuing uncertainty about the rules governing the pricing, terms
and conditions of interconnection agreements. The Supreme Court's action in
particular may require or trigger the renegotiation of existing agreements.
Although state public utilities commissions have continued to conduct
arbitrations, and to implement and enforce interconnection agreements during the
pendency of the Eighth Circuit proceedings, the Supreme Court's recent ruling
and further proceedings on remand at the Eighth Circuit or the FCC may affect
the scope of state commissions' authority to conduct such proceedings or to
implement or enforce interconnection agreements. They could also result in new
or additional rules being promulgated by the FCC. Given the general uncertainty
surrounding the effect of the Eighth Circuit decisions and the recent decision
of the Supreme Court reversing them, there can be no assurance that we will be
able to continue to obtain or enforce interconnection terms that are acceptable
to us or that are consistent with our business plans.
The Telecommunications Act of 1996 is intended to increase competition. The
act opens the local services market by requiring incumbent local exchange
carriers to permit interconnection to their networks and establishing incumbent
local exchange carrier obligations with respect to:
Reciprocal Compensation. Requires all incumbent local exchange
carriers and competitive local exchange carriers to complete calls
originated by competing carriers under reciprocal arrangements at prices
based on a reasonable approximation of incremental cost or through mutual
exchange of traffic without explicit payment.
11
Resale. Requires all incumbent local exchange carriers and competitive
local exchange carriers to permit resale of their telecommunications
services without unreasonable restrictions or conditions. In addition,
incumbent local exchange carriers are required to offer wholesale versions
of all retail services to other telecommunications carriers for resale at
discounted rates, based on the costs avoided by the incumbent local
exchange carrier in the wholesale offering.
Interconnection. Requires all incumbent local exchange carriers and
competitive local exchange carriers to permit their competitors to
interconnect with their facilities. Requires all incumbent local exchange
carriers to permit interconnection at any technically feasible point within
their networks, on nondiscriminatory terms, at prices based on cost, which
may include a reasonable profit. At the option of the carrier seeking
interconnection, collocation of the requesting carrier's equipment in the
incumbent local exchange carriers' premises must be offered, except where
an incumbent local exchange carrier can demonstrate space limitations or
other technical impediments to collocation.
Unbundled Access. Requires all incumbent local exchange carriers to
provide nondiscriminatory access to unbundled network elements, including
certain network facilities, equipment, features, functions, and
capabilities, at any technically feasible point within their networks. Such
access must be on nondiscriminatory terms, at prices based on cost, which
may include a reasonable profit.
Number Portability. Requires all incumbent local exchange carriers and
competitive local exchange carriers to permit users of telecommunications
services to retain existing telephone numbers without impairment of
quality, reliability or convenience when switching from one
telecommunications carrier to another.
Dialing Parity. Requires all incumbent local exchange carriers and
competitive local exchange carriers to provide "1+" equal access to
competing providers of telephone exchange service and toll service, and to
provide nondiscriminatory access to telephone numbers, operator services,
directory assistance, and directory listing, with no unreasonable dialing
delays.
Access to Rights-of-Way. Requires all incumbent local exchange
carriers and competitive local exchange carriers to permit competing
carriers access to poles, ducts, conduits and rights-of-way at regulated
prices.
Incumbent local exchange carriers are required to negotiate in good faith
with carriers requesting any or all of the above arrangements. If the
negotiating carriers cannot reach agreement within a prescribed time, either
carrier may request arbitration of the disputed issues by the state regulatory
commission. Where an agreement has not been reached, incumbent local exchange
carriers remain subject to interconnection obligations established by the FCC
and state telecommunication regulatory commissions.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new subsidies for telecommunications and information services
provided to qualifying schools and libraries with an annual cap of $2.3 billion
and for services provided to rural health care providers with an annual cap of
$400.0 million. The FCC also expanded the federal subsidies for local exchange
telephone service provided to low-income consumers. Providers of interstate
telecommunications service, such as ourselves, as well as certain other
entities, must pay for these programs. Our share of these federal subsidy funds
will be based on our share of certain defined telecommunications end-user
revenues. We are paying approximately $8,452 per month in subsidy payments
during the first half of 2000. To offset this expense, we currently charge our
customers a surcharge on all interstate usage, subject to periodic adjustment.
The FCC is currently in the process of revising its rules for subsidizing
service provided to consumers in high cost areas, which may result in further
substantial increases in the overall cost of the subsidy program. Several
parties appealed the May 8th order. Such appeals were consolidated and
transferred to the United States Court of Appeals for the Fifth Circuit. On July
30, 1999, the Fifth Circuit affirmed most portions of the May 8th order, but
remanded certain aspects of the order to the FCC to conduct further proceedings.
The FCC and a federal-state joint board also are continuing to examine and
revise various aspects of universal service. We cannot predict the effect that
further regulatory or judicial revision of the universal service regime will
have on our business, financial condition or results of operations.
12
The Telecommunications Act of 1996 codifies the incumbent local exchange
carriers' equal access and nondiscrimination obligations and preempts
inconsistent state regulation. The Telecommunications Act of 1996 also contains
special provisions that eliminate the AT&T Antitrust Consent Decree and similar
antitrust restrictions on the regional Bell operating companies restricting the
regional Bell operating companies from providing long distance services and
engaging in telecommunications equipment manufacturing. The Telecommunications
Act of 1996 permitted the regional Bell operating companies to enter the
out-of-region long distance market immediately upon its enactment. Further,
provisions of the Telecommunications Act of 1996 permit a regional Bell
operating company to enter the long distance market in its traditional service
area if it satisfies several procedural and substantive requirements in those
states in which it seeks long distance relief. These requirements include
obtaining FCC approval upon a showing that the regional Bell operating company
has entered into interconnection agreements or, under some circumstances, has
offered to do so. The interconnection agreements must satisfy a 14-point
checklist of competitive requirements and the FCC must be satisfied that the
regional Bell operating companies' entry into long distance markets is in the
public interest. To date, several petitions by regional Bell operating companies
for such entry have been denied by the FCC and only Bell Atlantic's application
for New York has been granted. A petition for such authority by SEC for Texas is
currently pending before the FCC.
Under the Telecommunications Act of 1996, any entity, including cable
television companies and electric and gas utilities, may enter any
telecommunications market, subject to reasonable state regulation of safety,
quality and consumer protection. Because implementation of the
Telecommunications Act of 1996 is subject to numerous federal and state policy
rulemaking proceedings and judicial review there is still uncertainty as to what
impact such legislation will have on us, but it is likely to encourage
additional competitive entry in markets we serve.
In accordance with authority granted by the FCC, we resell the
international telecommunications services of other common carriers between the
United States and international points. In connection with such authority, we
have filed tariffs with the FCC stating the rates, terms and conditions for our
international services.
With respect to our domestic service offerings, we have filed tariffs with
the FCC stating the rates, terms and conditions for our interstate services. Our
tariffs are generally not subject to pre-effective review by the FCC, and can be
amended on one day's notice. Our interstate services are provided in competition
with interexchange carriers and, with respect to access services, the incumbent
local exchange carriers.
In October 1996, the FCC adopted an order eliminating the requirement that
non-dominant interstate carriers such as ourselves maintain tariffs on file with
the FCC for domestic interstate services. This order applies to all non-dominant
interstate carriers, including AT&T. The order does not apply to the switched
and special access services of the regional Bell operating companies or other
local exchange providers. On February 13, 1997, the United States Court of
Appeals for the District of Columbia Circuit stayed the implementation of the
FCC order pending its review of the order on the merits. Currently, that
temporary stay remains in effect. If the stay is lifted and the FCC order
becomes effective, telecommunications carriers such as ourselves will no longer
be able to rely on the filing of tariffs with the FCC as a means of providing
notice to customers of prices, terms and conditions on which they offer their
interstate services. In June 1997, the FCC issued another order which allows
non-dominant carriers, such as ourselves, to offer interstate access services
without the filing of tariffs. The obligation to provide non-discriminatory,
just and reasonable prices remains unchanged under the Communications Act of
1934. While tariffs provided a means of providing notice of prices, terms and
conditions, we intend to rely primarily on our sales force and direct marketing
to provide such information to our customers.
To the extent we provide interexchange telecommunications service, we are
required to pay access charges to incumbent local exchange carriers and other
competitive local exchange carriers when we use the facilities of those
companies to originate or terminate interexchange calls. Also, as a competitive
local exchange carrier, we provide access services to other interexchange
service providers. The interstate access charges of incumbent local exchange
carriers are subject to extensive regulation by the FCC, while those of
competitive local exchange carriers are subject to a lesser degree of FCC
regulation but remain subject to the requirement that all charges be just,
reasonable, and not unreasonably discriminatory. In two orders released on
December 24, 1996, and May 16, 1997, the FCC made major changes to the
interstate access charge structure. In the December 24th order, the FCC removed
restrictions on incumbent local exchange carriers' ability to lower access
prices and relaxed the regulation of new switched access services in those
markets where there are other providers of access services. If this increased
13
pricing flexibility is not effectively monitored by federal regulators, it could
have a material adverse effect on our ability to compete in providing interstate
access services. The May 16th order substantially increased the costs that price
cap incumbent local exchange carriers subject to the FCC's price cap rules,
recover through monthly, non-traffic-sensitive access charges and substantially
decreased the costs that price cap incumbent local exchange carriers recover
through traffic-sensitive access charges. In the May 16th order, which was
upheld on appeal by the United States Court of Appeals for the Eighth Circuit,
the FCC also announced its plan to bring interstate access rate levels more in
line with costs. On August 5, 1999, the FCC adopted an order granting price cap
local exchange carriers additional pricing flexibility, implementing certain
access charge reforms, and seeking comment on others. The order provides certain
immediate regulatory relief to price cap carriers and sets a framework of
"triggers" to provide these companies with greater flexibility to set interstate
access rates as competition increases. The order also initiated rulemaking to
determine whether the FCC should regulate competitive local exchange carriers
access charges. The manner in which the FCC continues to implement its approach
to lowering access charge levels and a decision to regulate competitive local
exchange carrier access rates could have a material effect on our ability to
compete in providing interstate access services.
On February 26, 1999, the FCC issued a declaratory ruling on the issue of
inter-carrier compensation for calls bound to Internet service providers. The
FCC ruled that the calls are jurisdictionally mixed, but largely interstate
calls. The FCC, however, determined that this issue did not resolve the question
of whether inter-carrier reciprocal compensation is owed for such calls under
existing interconnection agreements. The FCC noted a number of factors that
would allow the state public utilities commissions to continue to require the
payment of reciprocal compensation. Since the issuance of the FCC decision,
twenty-eight states have issued decisions either initially or on reconsideration
of existing decisions. In twenty-four states, the commission determined
compensation is owed. In Massachusetts, however, the commission vacated its
earlier decision because, in its view, its decision was based solely on a ground
rejected by the FCC and in Missouri the commission determined that the parties
payments would be subject to a reconciliation once the FCC determines the issue
of the amount of compensation owed. Until then, compensation should be tracked
but it does not have to be paid. New Jersey and South Carolina are the only
states to find reciprocal compensation does not apply. On March 24, 2000, the
U.S. Court of Appeals for The District of Columbia vacated the FCC's declatory
ruling and remanded the matter to the FCC. The Court determined that the FCC has
not provided a reasoned basis for treating calls to Internet service providers
differently from other local calls and, therefore, reciprocal compensation
should apply. We cannot predict the impact of the FCC's and the Court's ruling
on existing state decisions, the outcome of pending appeals or future litigation
on this issue.
In February 2000, the FCC also initiated a rulemaking to establish a
federal rate for calls to Internet service providers. To date, the FCC has not
issued any rule establishing such a rate.
The FCC recently adopted new rules designed to make it easier and less
expensive for CLECs to obtain colocation in central offices, by among other
things, restricting the ILEC's ability to prevent certain types of equipment
from being colocated and requiring ILECs to offer alternative colocation
arrangements which will be less costly. On March 17, 2000 the U.S. Court of
Appeals for the D.C. Circuit vacated those portions of the FCC's expanded
colocation risks that permitted CLECs to colocate equipment that contained
functions in addition to those necessary for interconnection or access to
unbundled network elements. The Court, while upholding the FCC's authority to
require less costly forms of colocation rejected the FCC's effort to leave the
choices of space in the ILEC central offices to the CLEC. The Court vacated the
rules in part and remanded to the FCC, the issue of what equipment is necessary
for interconnection and access to unbundled network elements.
On November 18, 1999 the FCC also adopted a new order requiring ILECs to
provide line sharing, which would allow CLECs to offer data services over the
same lines that a consumer uses for voice services without the CLEC having to
offer voice services. While we expect these new rules will be beneficial to
CLEC's, we cannot be certain that these new rules will be implemented by the
ILEC's in a favorable manner. Moreover, these rules have been appealed. We
cannot predict that the outcome of these rules on our business.
State Regulation: General Framework
State regulatory agencies have regulatory jurisdiction when Pac-West
facilities and services are used to provide intrastate services. A significant
portion of our current traffic is classified as intrastate and therefore subject
to state regulation. To provide intrastate services, we generally must obtain a
certificate of public convenience and necessity from the state regulatory agency
and comply with state requirements for telecommunications utilities, including
state tariffing requirements. We have obtained such certificates to provide
local exchange and intrastate toll service in California, Nevada, Washington,
Oregon, Arizona and Colorado, and applications are pending in Texas, Idaho, Utah
and New Mexico. There can be no assurance that such state authorizations will be
granted. Most states in which we operate or propose to operate also requires us
to seek approval for any transfers of control.
In addition, the implementation of the Telecommunications Act of 1996 is
subject to numerous state rulemaking proceedings on these issues, it is
currently difficult to predict how quickly full competition for local services,
including local dial tone, will be introduced. Furthermore, the
Telecommunications Act of 1996 provides that state public utilities commissions
have significant roles in determining the content of interconnection agreements,
including the responsibility to conduct the mandatory arbitration proceedings
called for by the Telecommunications Act of 1996. The actions of the state
public utilities commissions are subject to the Telecommunications Act of 1996
and, in several respects, the FCC's interpretations thereof. For example, the
FCC has determined that the state public utilities commissions will continue to
determine whether reciprocal compensation will be included in arbitrated
interconnection agreements at least until the FCC adopts a federal rule.
California Regulatory Proceedings and Judicial Appeals
Reciprocal Compensation Proceedings. On October 22, 1998, the California
Public Utilities Commission issued a decision holding that local telephone calls
placed to Internet service providers are local calls entitled to reciprocal
compensation. On November 30, 1998, Pacific Bell and GTE filed applications for
rehearing of the October 22, 1998 decision, which were denied on July 22, 1999.
On August 25, 1999, we, along with the
14
commissioners of the California Public Utilities Commission and others, were
named as a defendant in an action filed by GTE California. The action challenges
the legality of the California Public Utilities Commission's decisions regarding
reciprocal compensation as discussed above. We and the other defendants filed
motions to dismiss on a variety of grounds, and defendant MCI Worldcom filed a
motion for judgment on the pleadings. The district court heard argument on the
motions on January 21, 2000 and took the motions under submission on that day.
If the district court denies the motions, we expect all parties to move for
summary judgment and for the district court to resolve the case by summary
judgment. On October 6, 1999, Pacific Bell sued the California Public Utilities
Commission and its members in the U.S. District Court for the Northern District
of California. Pacific Bell's lawsuit, like GTE's, challenges the legality of
the California Public Utilities Commission's October 22, 1998 decision. We and
other competitive local exchange carriers moved to intervene in this case as
defendants, and the parties did not oppose those motions. The district court has
taken the motions to intervene under submission. The California Public Utilities
Commission has moved to dismiss the case. The district court heard arguments on
that motion on January 21, 2000 and has taken the motion under submission.
On November 16, 1998, Pacific Bell filed a Petition for Arbitration of an
interconnection agreement in accordance with Section 252(b) of the
Telecommunications Act of 1996. This agreement would replace the interconnection
agreement which was executed in 1996. On June 24, 1999, the California Public
Utilities Commission adopted a decision (D.99-06-088) which adopted the terms of
the interconnection agreement between us and Pacific Bell resulting from the
arbitration process commenced by the petition. The decision provides that until
such time as the October 1998 decision regarding reciprocal compensation is
modified, reciprocal compensation is payable by Pacific Bell for calls to
Internet service provider customers of Pac-West. The decision also adopts per
minute rate levels for reciprocal compensation based on Pacific Bell's approved
costs, and these rate levels are substantially lower than the rates under the
1996 interconnection agreement. The parties were ordered to sign an
interconnection agreement incorporating these and other results of the
arbitration process, and the new interconnection agreement became effective on
June 29, 1999. Pacific Bell has requested a rehearing of this matter and on
October 6, 1999, filed an appeal in federal district court in San Francisco with
respect to this decision although they have paid the full amount of our billings
for calls after the effective date of the new agreement. Other competitive local
exchange carriers have moved to intervene in this case as defendants. The
parties did not oppose these motions. The district court has taken the motions
to intervene under submission. The California Public Utilities Commission has
moved to dismiss this case. The district court heard arguments on that motion on
January 21, 2000 and has taken the motion under submission.
In February 2000, the California Public Utilities Commission commenced a
separate generic proceeding to develop its prospective policy regarding
reciprocal compensation. We cannot predict the outcome of the California Public
Utilities Commission or GTE proceedings, future appeals or additional pending
cases involving related issues, or of the applicability of such proceedings to
our interconnection agreement with Pacific Bell or GTE. As a result, no
assurance can be given that we will continue to collect the reciprocal
compensation or whether we will be entitled to reciprocal compensation for these
types of calls in the future. Internet service providers currently form a
significant part of our customer base in California and adverse decisions in
these proceedings could limit our ability to serve this group of customers
profitably and have a material adverse effect on us.
We expect that reciprocal compensation will continue to represent a
significant portion of our revenues in the future although the per minute
reciprocal compensation rate may decline significantly in the future. We and GTE
of California are currently in the process of renegotiating our interconnection
agreement and the terms of our reciprocal negotiations or any arbitration under
Section 252 which may occur in the absence of successful negotiations.
Rating and Routing of Calls. On September 3, 1999, the California Public
Utilities Commission released a decision finding that carriers can provide
customers with local telephone numbers for rate centers in which the customer is
not located and where a carrier has no physical facilities. The decision
deferred the resolution of intercarrier compensation issues in such
circumstances to further evidentiary proceedings. In February 2000 the
Commission combined this proceeding with the generic rulemaking it commenced to
explore its future policy with respect to reciprocal compensation described
above. While the ultimate results of this proceeding are unknown, we expect that
we will not be prohibited from providing service using this method although the
reciprocal compensation rate may be lessened.
15
Nevada Regulatory Proceedings and Judicial Appeals
On October 12, 1998, we filed a petition for arbitration of an
interconnection agreement with Nevada Bell and the Public Utilities Commission
of Nevada in accordance with Section 252(b) of the Telecommunications Act of
1996. The issues in this arbitration generally concerned whether reciprocal
compensation is payable for calls placed to Internet service providers and
whether reciprocal compensation is payable for a local-rated call placed by a
dialing party in one local calling area that is routed to a second local calling
area for completion. On April 8, 1999, the Public Utilities Commission of Nevada
held that calls placed to Internet service providers are subject to reciprocal
compensation in the same manner as other calls. The Public Utilities Commission
of Nevada also held that, under current Nevada regulatory policy, calls routed
from one local calling area to another local calling area for completion should
not be deemed local calls.
Due to the geographic centralization of Nevada populations within large
local calling areas, we do not believe that the Public Utilities Commission of
Nevada's ruling on the classification of local calls will have a material effect
on our planned operations in Nevada.
On September 2, 1999, Nevada Bell sued in U.S. District Court in Reno,
Nevada to reverse the decision of the Public Utilities Commission of Nevada. The
defendants in that case are Pac-West, the Public Utilities Commission of Nevada
and two of its three members, and Advance Telcom Group, Inc., another
competitive local exchange carrier. The Court has accepted a stipulation of the
parties to resolve the case by summary judgment or by other dispositive motion.
On March 1, 2000, Pac-West, Advanced Telcom Group, Inc., and the Public
Utilities Commission of Nevada filed motions for summary judgment to affirm the
decision. On the same date, Nevada Bell filed a motion for summary judgment to
reverse the decision. Briefing will be complete on April 20, 2000 and the Court
will rule sometime after that date. No assurances can be given concerning the
outcome in this case or in any resulting appeal. Because we expect that Internet
service providers will form a significant part of our customer base in Nevada,
an adverse decision in this case, or in any resulting appeal, could have a
material adverse effect on us.
Local Regulation
Our network is subject to numerous local regulations such as building codes
and licensing requirements. Such regulations vary on a city by city and county
by county basis. To the extent we decide in the future to install our own fiber
optic transmission facilities, we will need to obtain rights-of-way over private
and publicly owned land and pole attachment authorizations. There can be no
assurance that such rights-of-way or authorizations will be available to us on
economically reasonable or advantageous terms. We could also be subject to
unexpected franchise requirements and be required to pay license or franchise
fees based on a percentage of gross revenues or some other formula.
Employees
As of December 31, 1999, we had 271 full time employees. We believe that
our future success will depend on our continued ability to attract and retain
highly skilled and qualified employees. None of our employees are currently
represented by a collective bargaining agreement. We also believe that we enjoy
good relationships with our employees.
16
ITEM 2. PROPERTIES
We are headquartered in Stockton, California and lease offices and space in
a number of locations primarily for sales offices and network equipment
installations. As of December 31, 1999, we had 26 premise leases. The table
below lists our material facilities:
Approximate
Location Use Lease Expiration Square Footage
- -------- --- ---------------- --------------
Stockton, CA Corporate headquarters and switching facility June 2002 33,000
Oakland, CA Switching facility November 2003 9,971
Los Angeles, CA Switching facilities September 2006 14,520
Las Vegas, NV Switching facility August 2009 12,065
Tukwila (Seattle), WA Switching facility December 2009 16,851
Since December 31, 1999, we entered into leases for 24,316 square feet of
space in Thornton, Colorado and 12,321 square feet in Phoenix, Arizona. Both of
these locations are for establishing new switching facilities, which we expect
to be operational during the second quarter of 2000. Each such lease has an
initial term of ten years, with two five-year renewal options.
We believe that our leased facilities are suitable and adequate to meet our
current needs in the markets in which we currently operate. Additional
facilities will be required as our business in existing markets grows and we
expand into new markets. Each of our material leases is extendable at our
option. Our Stockton, California lease is extendable for five two-year periods,
and each of our Oakland, Los Angeles, Las Vegas and Tukwila leases are
extendable for two five-year periods.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various legal proceedings, including the Pacific
Bell and California Public Utility Commission, and the Nevada Bell and Public
Utilities Commission of Nevada proceedings related to reciprocal compensation
payment and other interconnection agreement issues. See "Business - Regulation."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 5, 1999, the board of directors of Pac-West initiated a consent
solicitation for the purpose of obtaining the approval of the holders of our
common stock and then outstanding preferred stock in connection with: (a) a
proposed increase in the total number of authorized shares to 50,000,000 common
shares and 1,750,000 preferred shares; (b) a proposed stock split of each of our
common shares and then outstanding preferred shares in a ratio of 1.4 shares to
1 share; and (c) a proposed amendment of the definition of "Original Cost" of
preferred stock in our Articles of Incorporation to mean $25.72 per share.
On October 5, 1999, the board of directors of Pac-West also initiated a
consent solicitation for the purpose of obtaining the approval of the holders of
our common stock and then outstanding preferred stock in connection with a
proposed amendment to our bylaws that, among other changes, would:
. eliminate cumulative voting for election of directors;
. change the expiration of the directors' terms so that the term of
only three directors expire at each annual meeting; and
. amend the section covering board resignations and vacancies.
On October 7, 1999, each such proposal was approved by the unanimous
written consent of the holders of our common stock and the preferred stock then
outstanding.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In connection with the Company's initial public offering of its common
stock, trading of our common stock began on the Nasdaq National Market System
under the symbol "PACW" on November 4, 1999. The following table represents the
quarterly high and low closing sale prices of the Company's common stock for the
year ended December 31, 1999 as reported by the Nasdaq stock market.
1999 High Low
---- ---- ---
Fourth quarter (since November 4, 1999) $29.375 $18.4375
As of March 1, 2000 the number of shareholders of record of the Company's common stock was 521.
We have never paid any cash dividends on our common stock and do not
anticipate declaring or paying any cash dividends in the foreseeable future. We
currently intend to retain future earnings, if any, to fund the development and
growth of our business. Declaration or payment of future dividends, if any, will
be at the discretion of our board of directors after taking into account various
factors, including our financial condition, operating results, current and
anticipated cash needs and plans for expansion. In addition, our ability to pay
dividends on the common stock is restricted by the provisions of our senior
credit facility and our senior notes indenture.
On September 22, 1999, all of our unregistered Series A senior notes due
2009 were exchanged for Series B senior notes due 2009, which were registered
under the Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
This section presents selected historical financial data of the Company.
You should read carefully the financial statements, related notes thereto, and
the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this Form 10-K. The
selected data in this section is not intended to replace the financial
statements.
On October 1, 1996, we began operations when our predecessor company
transferred its telephone and answering service divisions to Pac-West. As a
result, this Form 10-K includes our audited financial statements for the period
from our commencement on October 1, 1996 to December 31, 1996, and for the years
ended December 31, 1997, 1998 and 1999. Due to the significant changes in our
operations since September 30, 1996, we believe that the financial information
of our predecessor's telephone and answering service divisions is not directly
comparable to our current results of operations.
Except as discussed below, we recognize revenues for telecommunications
services when service is provided. Reciprocal compensation is recognized as
revenue only to the extent received in cash. See Note 5 to the audited financial
statements under Revenue Recognition and Legal Proceedings, and "Regulation -
California and Nevada Regulatory Proceedings and Judicial Appeals."
Adjusted EBITDA represents earnings before interest, net; income taxes;
depreciation and amortization; further adjusted for the costs of merger and
recapitalization; transaction bonuses and consultant's costs; and extraordinary
item. Included in other (income) expense, net, is interest income of $20,000,
$15,000, $5,000, $90,000, $327,000, and $3,690,000 for the predecessor telephone
and answering service divisions for the year ended December 31, 1995 and for the
nine month period ended September 30, 1996, and for Pac-West for the period from
commencement on October 1, 1996 to December 31, 1996 and for the years ended
December 31, 1997, 1998 and 1999, respectively. Although EBITDA is not a measure
of financial performance under generally accepted accounting principles, we
believe it is a common measure used by analysts and investors in comparing a
company's results with those of similar companies as well as to evaluate the
capacity of a company to service its obligations.
18
Predecessor Telephone and
Answering Service Divisions Pac-West Telecomm, Inc.
--------------------------- -------------------------------------------------------
Period from
Commencement
Nine Month on October 1,
Year Ended Period Ended 1996 to Year Ended
December 31, September 30, December 31, December 31,
----------------------------------------
1995 1996 1996 1997 1998 1999
----------- ------------ ------------ ------- ------- -------
(in thousands) (in thousands, except per share data)
Statements of Operations Data:
Revenues.................................... $ 8,900 $ 8,737 $ 4,232 $29,551 $ 42,211 $ 95,505
Costs and expenses:
Operating costs........................... 3,498 4,202 2,064 12,060 15,344 20,510
Selling, general and administrative:
Selling, general and administrative..... 3,011 3,123 1,519 7,367 10,779 22,855
Transaction bonuses and consultant's
costs (1)............................... -- -- -- -- 3,798 --
Depreciation and amortization............. 512 549 299 2,204 4,106 8,689
------- ------- ------- ------- -------- ---------
Income from operations.................. 1,879 863 350 7,920 8,184 43,451
Interest expense............................ 93 33 105 932 4,199 18,124
(Gain) on disposal of answering service
division.................................... -- -- -- (385) -- --
Costs of merger and recapitalization (1).... -- -- -- -- 3,004 --
Other (income) expense, net................. (17) (34) 11 (119) (330) (3,690)
------- ------- ------- ------- -------- ---------
Income before provision for income
taxes and extraordinary item............ 1,803 864 234 7,492 1,311 29,017
Provision for income taxes.................. 722 345 94 2,997 1,561 13,111
------- ------- ------- ------- -------- ---------
Income (loss) before extraordinary item. 1,081 519 140 4,495 (250) 15,906
Extraordinary item--loss on early
extinguishments of debt, net of income tax
benefit of $278 (1)......................... (417)
------- ------- ------- ------- -------- ---------
Net income (loss)........................... $ 1,081 $ 519 $ 140 $ 4,495 $ (667) $ 15,906
======= ======= ======= ======= ======== =========
Income (loss) before extraordinary items
per share:
Basic..................................... $ 1.00 $ 32.11 $ (0.30) $ 0.59
Diluted................................... $ 1.00 $ 32.11 $ (0.30) $ 0.56
Net Income (loss) per share:
Basic..................................... $ 1.00 $ 32.11 $ (0.38) $ 0.59
Diluted................................... $ 1.00 $ 32.11 $ (0.38) $ 0.56
Weighted average shares outstanding:
Basic..................................... 140 140 5,244 20,173
Diluted................................... 140 140 5,244 21,294
Other Financial Data:
Adjusted EBITDA............................. $ 2,388 $ 1,431 $ 633 $10,538 $ 16,091 $ 52,140
Adjusted EBITDA margin %.................... 26.8% 16.4% 15.0% 35.7% 38.1% 54.6%
Cash provided by (used in):
Operating activities...................... $ 1,758 $ 1,092 $ 75 $ 5,876 $ 12,033 $ 41,439
Investing activities...................... (1,266) (2,523) (1,682) (6,619) (42,031) (135,966)
Financing activities...................... (350) 1,778 1,549 3,658 41,631 161,979
Balance Sheet Data (as of period end):
Cash and cash equivalents................... $ 399 $ 746 $ 688 $ 3,603 $ 15,236 $ 82,688
Short-term investments -- -- -- -- -- 70,138
Restricted cash ............................ -- -- -- -- -- 10,087
Working capital (deficit)................... (219) 626 398 2,598 15,532 151,492
Equipment, vehicles and leasehold 3,065 5,883 9,483 19,079 57,294 105,189
improvements, net...........................
Total assets................................ 5,141 8,641 12,966 27,528 82,493 290,100
Total long-term debt........................ 149 2,536 5,690 12,206 100,116 150,017
Convertible redeemable preferred stock,
including accrued cumulative dividends of
$1,324 at December 31, 1998............... -- -- -- -- 46,324 --
Stockholders' equity (deficit).............. 2,526 4,037 4,177 8,672 (74,113) 106,250
(1) Transaction bonuses and consultant's costs, costs of merger and
recapitalization, and the extraordinary item all relate to our
recapitalization described in Note 1 to the audited financial statements.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Pac-West is a rapidly-growing provider of integrated communications
services in the western United States. Our customers include Internet service
providers, small and medium businesses and enhanced communications service
providers, many of which are communications intensive users. Our predecessor,
also known as Pac-West Telecomm, Inc., began selling office phone systems in
1980 and reselling long distance service to small and medium businesses and
residential customers in 1982. Beginning in 1986, our predecessor began offering
paging and telephone answering services to its customers. Effective September
30, 1996, our predecessor transferred its telephone and answering service
divisions to us. Prior to September 30, 1996, we did not conduct any operations
and, since that time, we have disposed of the answering service division and
have focused our business strategy on operating as a provider of integrated
communications services.
For the years ended December 31, 1998 and 1999, recognizing compensation
from other communications companies for completing their customers' calls only
to the extent such compensation was actually received in cash, we had net
revenues of approximately $42.2 million and $95.5 million, respectively, and
adjusted EBITDA of approximately $16.1 million and $52.1 million, respectively.
As of December 31, 1999, we had 105,147 lines in service, a 117% increase
from December 31, 1998. For the year ended December 31, 1999 our minutes of use
were 15.2 billion, an increase of 97% over 1998.
Factors Affecting Operations
Revenues. We derive our revenues from monthly recurring charges, usage
charges and initial non-recurring charges and telephone equipment sales and
service. 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 incumbent local exchange carriers as reciprocal
compensation for completion of their customers' calls through Pac-West, and
access charges paid by carriers for long distance traffic terminated by
Pac-West. Initial non-recurring charges are paid by end users, if applicable,
for the initiation of our service.
We derive a substantial portion of our revenues from reciprocal
compensation paid by incumbent local exchange carriers with which we have
interconnection agreements. Reciprocal compensation revenues increased
significantly in recent fiscal quarters as a result of increasing inbound call
volume from our Internet service provider and other customers. For the years
ended December 31, 1997, 1998 and 1999, recorded reciprocal compensation
accounted for approximately 37.4%, 37.1% and 57.9%, respectively, of our
revenues. Until recently, two incumbent local exchange carriers with which we
have interconnection agreements, Pacific Bell and GTE, refused to pay that
portion of reciprocal compensation due under their prior agreement that they
estimated was the result of inbound calls terminating to Internet service
providers. These incumbent local exchange carriers contended that such Internet
service provider calls are not local calls within the meaning of their
respective interconnection agreements and claimed that no reciprocal
compensation was therefore payable. The total reciprocal compensation withheld
by Pacific Bell and GTE and not included in revenues was $3.8 million for the
year ended December 31, 1997 and $32.6 million for the year ended December 31,
1998. Pacific Bell discontinued withholding amounts as of June 29, 1999 and GTE
discontinued withholdings as of October 1, 1999. The amounts withheld in 1999
prior to these dates aggregated $29.9 million. On September 9, 1999, Pac-West
entered into a settlement agreement with Pacific Bell regarding all of our
outstanding claims for unpaid reciprocal compensation under our prior
interconnection agreement. Under the terms of the settlement agreement, Pacific
Bell agreed to pay $20.0 million to Pac-West and $20.0 million to certain
stockholders of Pac-West as of the date of the recapitalization in settlement of
those claims. As a result of these payments, the terms of our September 1998
recapitalization requiring additional distributions to certain of our
shareholders have been satisfied. See "Certain Relationships and Related
Transactions - Recapitalization." In October 1999, GTE paid all amounts withheld
totaling $6,308,000.
On June 24, 1999, the California Public Utilities Commission adopted a
decision in an arbitration proceeding between us and Pacific Bell which held
that reciprocal compensation would be payable for Internet service provider
calls under our new interconnection agreement with Pacific Bell which became
effective on June 29, 1999. Pacific
20
Bell has paid the full amount of our billings for calls since the effective date
of the new agreement. On August 25, 1999, we, along with the commissioners of
the California Public Utility Commission and others, were named as a defendant
in an action filed by GTE California. The action challenges the legality of the
California Public Utility Commission's decisions regarding reciprocal
compensation as discussed above. We intend to seek dismissal of the action or
otherwise contest the claims of GTE California. The obligation of GTE or other
local exchange carriers to pay this reciprocal compensation under its current
agreement is currently under review by both state and federal regulators.
We expect that reciprocal compensation will continue to represent a
significant portion of our revenues in the future. We are currently negotiating
and implementing new interconnection agreements and the terms of the related
reciprocal compensation. The per minute reciprocal compensation rate we receive
from Pacific Bell under our new agreement is significantly lower than it was
under our previous agreement. Based on current market conditions, we also expect
that the per minute reciprocal compensation rate will similarly decline from
historic rates under any other future interconnection agreements.
Operating Costs. Operating costs are comprised primarily of leased
transport charges, usage charges for long distance and intrastate calls and, to
a lesser extent, reciprocal compensation related to calls that originate with a
Pac-West customer and terminate on the network of an incumbent local exchange
carrier or other competitive local exchange carrier. Our leased transport
charges are the lease payments we incur for the transmission facilities used to
connect our customers to our switch and to connect to the incumbent local
exchange carrier and other competitive local exchange carrier networks. Our
strategy of leasing rather than building our own transport facilities results in
our operating costs being a significant component of total costs.
Selling, General and Administrative Expenses. Our recurring selling,
general and administrative expenses include network development, administration
and maintenance costs, selling and marketing, customer service, information
technology, billing, corporate administration and personnel. We expect to incur
significant selling and marketing costs as we continue to expand our operations,
a significant amount of which will be incurred in a particular market before the
switch becomes operational and begins to generate revenue. Consequently, selling
and marketing expenses are expected to increase until implementation of our
expansion plan is substantially complete. We will incur other costs and
expenses, including the costs associated with the development and maintenance of
our networks, administrative overhead, premises leases and bad debts. We expect
that these costs will grow significantly as we expand our operations and that
sales and marketing and administrative overhead will be a large portion of these
expenses during the start-up phase in each of our new markets.
Results of Operations
The following table summarizes the results of operations as a percentage of
revenues for Pac-West for the years ended December 31, 1997, 1998 and 1999.
Selling, general and administrative expenses and income from operations for
the year ended December 31, 1998 include $3.8 million of one-time transaction
bonuses and consultant's costs. Excluding these transaction bonuses and
consultant's costs, selling, general and administrative expenses were 25.5% of
revenues and income from operations was 28.4% of revenues for that period. The
net loss for 1998 includes the costs of the recapitalization of $3.0 million,
transaction bonuses and consultant's costs of $3.8 million and the extraordinary
loss on early extinguishment of debt of $0.7 million before income tax benefit.
21
Pac-West Telecomm, Inc.
-----------------------
Year Ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
Statements of Operations Data:
Revenues..................................... 100.0% 100.0% 100.0%
Operating costs.............................. 40.8 36.4 21.5
Selling, general and administrative expenses. 24.9 34.5 23.9
Depreciation and amortization expense........ 7.5 9.7 9.1
Income from operations....................... 26.8 19.4 45.5
Net income (loss)............................ 15.2 (1.6) 16.7
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenues for the year ended December 31, 1999 increased $53.3 million to
$95.5 million from $42.2 million for 1998. The increase in revenues was
primarily attributed to an increase of $39.6 million in paid local
interconnection revenues, which included settlement payments totaling $26.3
million received in connection with previously withheld reciprocal compensation,
an increase of $8.5 million in recurring charges and installation charges billed
directly to Internet service providers, an increase of $0.2 million in local and
long distance usage revenues, and an increase of $1.0 million in dedicated
transport revenues.
In the third quarter of 1998, we installed new higher capacity switches at
our Stockton and Los Angeles switching sites. During the fourth quarter of 1998,
we expanded switch capacity to existing and new customers. In the second quarter
of 1999, we activated a new higher capacity switch in Oakland and continued to
expand our switching capacity in Los Angeles. Our revenues for 1999 also
increased from 1998 as a result of additional switch capacities, and increased
utilization of our expanded switch capacities, primarily attributable to
Internet service provider customers. In addition, new service orders from small
and medium businesses have continued to accelerate in 1999 as we have built our
sales force, with a 393% increase from 1998 in lines sold to small and medium
businesses during 1999.
The number of access lines in service increased 117% to 105,147 as of
December 31, 1999 from 48,517 as of December 31, 1998. Billable minutes of use
were 15.2 billion in 1999, up 97% from 7.7 billion for 1998.
The number of inbound local calls and the minutes subject to reciprocal
compensation revenues in accordance with interconnection agreements increased
57% and 97%, respectively, for the year ended December 31, 1999 over 1998. The
effect of the significant increases in inbound local calls and minutes, together
with the payments of previously withheld reciprocal compensation, resulted in a
$39.6 million or 253% increase in paid interconnection revenues for the year
ended December 31, 1999 over 1998.
The $8.5 million increase in 1999 over 1998 in direct billings to Internet
service providers represented an 87% year to year increase. Lines used by our
Internet service providers significantly increased in 1999 over 1998 to 76,596
lines in service by Internet service providers at December 31, 1999, from 41,135
lines in service at December 31, 1998.
Lines in service by our small and medium business customers also increased
significantly in 1999 to 17,163 lines in service at December 31, 1999, from
3,730 lines in service at December 31, 1998, an increase of 360%.
The $0.2 million increase in outbound local and long distance revenues,
including 800 number and travel card calls, represented a 3% increase in 1999
over 1998. This increase is directly related to our focus on providing services
to high-volume, telecommunication intensive users and to small and medium
businesses, offset by lower rates.
The $1.0 million or 24% increase in dedicated transport revenues primarily
related to increased data networking services for private corporate networks.
22
Our operating costs for 1999 increased $5.2 million to $20.5 million from
$15.3 million for 1998. Our operating costs as a percentage of revenues
decreased to 21.5% for the year ended December 31, 1999 from 36.4% for 1998. The
increase in operating costs was primarily due to an increase in network
operations associated with a higher level of telecommunications activity. In
addition, we made significant investments in our telephone infrastructure during
the second half of 1998 and 1999 to accommodate future growth of our
communications services. As a result of increased utilization of our newly
installed switching equipment and the use of higher capacity transmission
facilities, plus the revenue from the payment of previously withheld reciprocal
compensation, our operating costs decreased as a percentage of revenues.
Our selling, general and administrative expenses for the year ended
December 31, 1999 increased $12.1 million to $22.9 million from $10.8 million
for 1998, (which excludes the $3.8 million of bonuses paid in 1998 to certain
key executives in connection with their assistance with our recapitalization and
consulting payments made in 1998 to our current President in connection with
services provided by him prior to his joining Pac-West). As a percentage of
revenues, our selling, general and administrative expenses decreased to 23.9%
for the year ended December 31, 1999 from 25.5% in 1998, (which excludes the
previously described $3.8 million of bonuses and consulting payments paid in
1998). The increase in selling, general and administrative expenses was
primarily due to the addition of 40 employees in sales and marketing; an
increase in network operational, development and administration costs, including
26 additional network employees; an increase of 22 service technicians; and 43
additional employees in other administration, customer service and information
technology functions. Our total number of employees increased from 140 at
December 31, 1998 to 271 at December 31, 1999.
Our depreciation and amortization expense for the year ended December 31,
1999 increased $4.6 million to $8.7 million from $4.1 million for 1998.
Depreciation and amortization as a percentage of revenues decreased to 9.1% for
the year ended December 31, 1999 from 9.7% in 1998. The increase in depreciation
and amortization expense was primarily due to the additional depreciation on the
portion of the $42.5 million of equipment acquired during 1998, which has been
placed in service and the $56.4 million of equipment acquired in 1999 as it is
placed in service.
Our interest expense for the year ended December 31, 1999 increased $13.9
million to $18.1 million from $4.2 million in 1998. The increase in interest
expense was primarily due to the interest on the $150 million senior notes
issued on January 29, 1999, including amortization over 10 years of the related
deferred financing costs associated with that offering. In addition, the
interest rate on the senior notes since January 29, 1999 is a higher interest
rate than the rates paid on outstanding financing in 1998. Interest expense is
net of amounts capitalized of $2.3 million and $0.3 million in 1998 and 1999
respectively.
Our income tax provision for 1999 reflects the tax impact of the receipt in
1999 of previously withheld reciprocal compensation. The income tax provision
for 1998 reflects the nondeductible impact of a substantial portion of the costs
associated with the recapitalization.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Our revenues for the year ended December 31, 1998 increased $12.6 million
to $42.2 million from $29.6 million for 1997. The increase in revenues was
primarily attributed to an increase of $4.6 million in paid interconnection
revenues, an increase of $5.1 million in recurring charges and installation
charges billed directly to Internet service providers, an increase of $1.2
million in local and long distance usage revenues, and an increase of $0.8
million in dedicated transport revenues.
The number of access lines in service increased 117% to 48,517 as of
December 31, 1998 from 22,400 as of December 31, 1997. Billable minutes of use
were approximately 7.7 billion in 1998, up 221% from 2.4 billion in 1997.
The number of inbound local calls and the minutes subject to reciprocal
compensation revenues in accordance with interconnection agreements increased
128% and 232%, respectively, 1998 over 1997. However, for reasons discussed
elsewhere in this Form 10-K, the incumbent local exchange carriers paid only 32%
of the reciprocal compensation billings in 1998 as compared to paying 74% in
1997. The net effect of the significant increases in
23
inbound local calls and minutes, partially offset by the significantly lower
payment percentage, resulted in a $4.6 million or 42% increase in paid
interconnection revenues in 1998 over 1997.
The $5.1 million increase in 1998 over 1997 in direct billings to Internet
service providers represented a 106% year over year increase. Lines used by our
Internet service providers significantly increased from 1997 to 1998, from
18,430 lines in service by Internet service providers at December 31, 1997 to
41,135 lines in service at December 31, 1998.
Lines in service by our small and medium business customers increased in
1998 to 3,730 lines in service at December 31, 1998, from 500 lines in service
at December 31, 1997, an increase of 646%.
The $1.2 million increase in outbound local and long distance revenues,
including 800 number and travel card calls, represented a 23% increase in 1998
over 1997. This increase is directly related to our focus on providing services
to high-volume, telecommunication intensive users and to small and medium
businesses.
The $0.8 million or 25% increase in dedicated transport revenues primarily
related to increased data networking services for private corporate networks.
Our operating costs for the year ended December 31, 1998 increased $3.2
million to $15.3 million from $12.1 million for 1997. Our operating costs as a
percentage of revenues decreased to 36.4% for the year ended December 31, 1998
from 40.8% for 1997. The increase in operating costs was primarily due to an
increase in network operations associated with the higher level of revenues. In
addition, we made significant investments in our telephone infrastructure
beginning in the second half of 1996 through 1998 to accommodate future growth
of competitive local exchange carrier services. As a result of increased
utilization of our newly installed switching equipment and the use of higher
capacity transmission facilities, our operating costs decreased as a percentage
of revenues.
Excluding $3.8 million of bonuses paid in 1998 to certain key executives in
connection with their assistance with our recapitalization and consulting
payments made in 1998 to our current President in connection with services
provided by him in 1998 prior to his joining Pac-West, our selling, general and
administrative expenses for the year ended December 31, 1998 increased $3.4
million to $10.8 million from $7.4 million for 1997. Excluding the $3.8 million
of transaction bonuses and consultant's costs, our selling, general and
administrative expenses as a percentage of revenues increased to 25.5% for the
year ended December 31, 1998 from 24.9% in 1997. Selling, general and
administrative expense in 1998 reflects a 79% increase in the number of
employees, a $0.6 million increase in facility costs and a $1.6 million increase
in payroll costs related to the increased hiring of technology, sales,
administrative and support personnel.
Our depreciation and amortization expense for the year ended December 31,
1998 increased $1.9 million to $4.1 million from $2.2 million for 1997.
Depreciation and amortization as a percentage of revenues increased to 9.7% for
the year ended December 31, 1998 from 7.5% in 1997. The increase in depreciation
and amortization expense was primarily due to the additional depreciation on the
$7.7 million of equipment acquired during the second half of 1997 and the $20.1
million of equipment acquired during the first nine months of 1998.
Our interest expense for the year ended December 31, 1998 increased $3.3
million to $4.2 million from $0.9 million in 1997. The increase in interest
expense was primarily due to an increase in long-term debt during 1998. The
increase in long-term debt in 1998 was primarily due to $10.5 million of new
borrowings during the year to finance the purchase of network equipment, and due
to incremental borrowings of approximately $53.0 million in connection with the
merger and recapitalization.
Our income tax provision for 1998 reflects the impact of the
nondeductibility of a substantial portion of the costs associated with the
recapitalization. Excluding the impact of these one-time costs, our combined
effective federal and state tax rate for 1998 was 40%, consistent with 1997's
effective tax rate.
24
Quarterly Operating and Statistical Data
The following table sets forth unaudited operating and statistical data for
each of the specified quarters of 1998 and 1999. The operating and statistical
data for any quarter are not necessarily indicative of results for any future
period.
Quarter Ended
-----------------------------------------------------------------------------
1998 1999
----- ----
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- -------- ------- ------- ------- -------- -------
Ports equipped............................ 90,000 90,000 174,000 220,800 251,520 309,120 309,120 460,800
Lines sold to date........................ 29,930 34,176 39,641 62,088 74,026 80,984 97,117 116,391
Lines in service to date.................. 27,930 32,176 35,141 48,517 67,691 76,263 88,009 105,147
Estimated data lines (% of installed
lines).................................... 93% 92% 89% 88% 85% 82% 76% 73%
Lines on switch %......................... 95% 95% 95% 96% 96% 96% 96% 96%
Internet service provider and enhanced
communications service provider
customer lines collocated %............... 89% 90% 90% 89% 83% 81% 83% 83%
Quarterly minutes of use switched
(in millions)............................. 1,488 1,745 2,002 2,494 3,116 3,523 4,020 4,552
Metropolitan statistical areas served..... 25 25 25 25 25 25 25 25
Capital expenditures (in thousands)....... $1,275 $6,588 $13,031 $21,572 $3,633 $18,275 $11,371 $23,091
Employees................................. 84 99 112 140 168 187 216 271
Liquidity and Capital Resources
Net cash provided by operating activities was $41.4 million for the year
ended December 31, 1999 compared to $12.0 million for 1998. This increase
primarily reflects an increase in earnings before taxes, depreciation and
amortization plus $8.5 million of accrued interest on our senior notes. Net cash
provided by operating activities was $12.0 million for the year ended December
31, 1998 compared to $5.9 million for the year ended December 31, 1997. This
increase primarily reflects increased accounts payable and accrued liabilities
of $5.9 million.
Net cash used in investing activities was $136.0 million for the year ended
December 31, 1999 compared to $42.0 million for 1998. During 1999, we invested
$56.4 million in new switching and related equipment as compared to $42.2
million 1998. Further, as of December 31, 1999, $70.1 million of cash was
invested in short-term investments and $9.5 million, net of redemptions, had
been used to purchase short-term investments to fund the interest reserve trust
account for the February 2, 2000 semi-annual interest payment on the senior
notes. Net cash used in investing activities was $42.0 million for the year
ended December 31, 1998 compared to $6.6 million for the year ended December 31,
1997. During 1998, we invested approximately $41.0 million in new switching and
related equipment and leasehold improvements to expand switching capacity in Los
Angeles, Oakland and Stockton, California. During 1997, our investment of
approximately $6.7 million in new switching and related equipment and leasehold
improvements was partially offset by $0.5 million of proceeds from the
disposition of assets.
Net cash provided by financing activities was $162.0 million for the year
ended December 31, 1999 compared to $41.6 million for 1998. The net cash
provided in 1999 was primarily attributable to proceeds from the issuance of
$150 million of our senior notes reduced by the payoff of $100 million of senior
secured borrowings, plus the $118.1 million net proceeds from the initial public
offering of our common stock. Net cash provided by financing activities was
$41.6 million for the year ended December 31, 1998 compared to $3.7 million for
1997. The net cash provided in 1998 was primarily attributable to $37.8 million
of proceeds from the sale of our common and convertible redeemable preferred
stock, $75.4 million of proceeds from senior secured borrowings in connection
with the recapitalization, less $74.0 million of payments to existing
stockholders.
The local telecommunications services business is capital intensive. Our
operations have required and will continue to require substantial capital
investment for the design, acquisition, construction and implementation of our
network. Capital expenditures, including amounts financed under capital leases,
were $11.9 million, $42.5 million, and $56.4 million for the years ending
December 31, 1997, 1998 and 1999, respectively. Of the $56.4 million of capital
expenditures during 1999, $32.4 million was included in projects in progress as
of December 31, 1999 and therefore will not being depreciated until placed in
service in 2000. Our business plan, as currently contemplated,
25
anticipates capital expenditures, excluding acquisitions, of over $100 million
annually through 2001. The actual cost of our planned expansion will depend on a
variety of factors, including the cost of the development of our network in each
of our new markets, the extent of competition and pricing of the
telecommunications services in such markets, and the acceptance of our services.
Accordingly, our actual capital requirements may exceed the amounts described
above.
Our senior credit facility provides for maximum borrowings of $40.0 million
for working capital and other general corporate purposes, and bears interest, at
our option, at:
(1) the base rate, as defined in the senior credit facility; or
(2) the LIBOR rate, as defined in the senior credit facility, plus between
2.25% and 3.5%.
As of December 31, 1999, there were no amounts outstanding under this
facility and the borrowing rate would have been approximately 9.25%. Our
borrowings under the senior credit facility will be secured by all of our
assets. The senior credit facility has a three year term expiring June 2002.
Our principal sources of funds for 2000 and 2001 are anticipated to be
current unrestricted cash balances, cash flows from operating activities,
borrowings under the senior credit facility and restricted cash. We believe that
these funds will provide us with sufficient liquidity to fund our business plan
through 2001. No assurance can be given, however, that this will be the case.
The foregoing statements do not take into account acquisitions which, if made,
are expected to be funded through a combination of cash and equity - see Note 11
to the financial statements included in this Form 10-K. Depending upon our rate
of growth and profitability, especially if we pursue any significant
acquisitions, we may require additional equity or debt financing to meet our
working capital requirements or capital equipment needs. There can be no
assurance that additional financing will be available when required or, if
available, will be on terms satisfactory to us.
Instruments governing our indebtedness, including the senior credit
facility and the senior notes indenture, contain financial and other covenants
that restrict, among other things, our ability to incur additional indebtedness,
incur liens, pay dividends or make certain other restricted payments, consummate
certain asset sales, enter into certain transactions with affiliates, merge or
consolidate with any other person or sell, assign, transfer, lease, convey or
otherwise dispose of substantially all of our assets. Such limitations could
limit corporate and operating activities, including our ability to respond to
market conditions to provide for unanticipated capital investments or to take
advantage of business opportunities. We have pledged to the trustee for the
benefit of the holders of the notes approximately $19.7 million in principal
amount of U.S. government securities plus any interest thereon to provide for
the payment of the first two scheduled interest payments on our senior notes.
The first scheduled interest payment of $10.2 million was paid on August 2,
1999, and the second scheduled interest payment of $10.1 million was paid on
February 2, 2000. These outstanding U.S. government securities are classified as
restricted cash on our financial statements for the year ended December 31,
1999.
Inflation
We do not believe that inflation has had any material effect on our
business over the past three years.
Year 2000 Issues
During 1999, management completed the process of preparing for the Year
2000 date changes. This process involved identifying and remediating date
recognition problems in computer systems, software and other operating
equipment, working with third parties to address their Year 2000 issues, and
developing contingency plans to address potential risks in the event of Year
2000 failures. To date, we have successfully managed the transition. Although
considered unlikely, unanticipated problems in our core business processes,
including problems associated with non-compliant third parties and disruptions
to the economy in general, could still occur despite efforts to date to
remediate affected systems and develop contingency plans. Management will
continue to monitor all business processes, including interaction with our
customers, vendors and other third parties, throughout 2000 to address any
issues and ensure all processes continue to function properly.
26
Through December 31, 1999, the cost of the Year 2000 project totaled
approximately $150,000. At this time, we do not anticipate additional costs
associated with remediating date recognition problems in computer systems,
software and other operating equipment. The cost of addressing Year 2000 issues
were reported as a general and administrative expense. We did not defer any
material information technology projects due to our Year 2000 efforts. Since we
had been working on a Year 2000 resolution for over one year, all major
decisions during this period regarding replacement of equipment and software
were done with Year 2000 compliance as a major purchase criteria. Costs of
software upgrades and additions, as well as hardware upgrades which were
required for compatibility, enhancement, capability/capacity, or efficiency were
not considered as a Year 2000 cost.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The SEC's rule related to market risk disclosure requires that we describe
and quantify our potential losses from market risk sensitive instruments
attributable to reasonably possible market changes. Market risk sensitive
instruments include all financial or commodity instruments and other financial
instruments that are sensitive to future changes in interest rates, currency
exchange rates, commodity prices or other market factors. We are not exposed to
market risks from changes in foreign currency exchange rates or commodity
prices. We do not hold derivative financial instruments nor do we hold
securities for trading or speculative purposes. At December 31, 1999, we had
$150 million of fixed rate notes outstanding, and consequently we currently have
no risk exposure associated with increasing interest rates on our debt. In
addition, we have a line of credit with a variable interest rate tied to LIBOR;
however, there were no amounts outstanding at December 31, 1999. We are,
however, exposed to changes in interest rates on our investments in cash
equivalents and short-term investments. Substantially all of our investments in
cash equivalents and short-term investments are in money market funds that hold
short-term investment grade commercial paper, treasury bills or other U.S.
government obligations. Currently this reduces our exposure to long-term
interest rate changes. We do not use interest rate derivative instruments to
manage our exposure to interest rate changes. A hypothetical 100 basis point
decline in short-term interest rates would reduce the annualized earnings on our
$152.8 million of cash equivalent and short-term investments at December 31,
1999 by approximately $1,528,000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Financial Statements required by Item 8, together with
the notes thereto and the report thereon of the independent public accountants
dated February 10, 2000, are set forth on pages F-1 through F-20 of this Form
10-K. The financial statement schedule listed under Item 14(a)2, together with
the report thereon of the independent public accountants dated February 10,
2000, are set forth on pages F-21 and F-22 of this Form 10-K and should be read
in conjunction with our Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE RESIGTRANT
The table below sets forth certain information as of December 31, 1999 with
respect to Pac-West's current directors, executive officers, and key employees:
Name Age Position(s)
---- --- -----------
Executive Officers:
Wallace W. Griffin................................ 61 President, Chief Executive Officer and Director
John K. La Rue.................................... 50 Executive Vice President--Technology and
Network Operations and Director
Richard E. Bryson................................. 46 Chief Financial Officer
Brian K. Johnson.................................. 38 Senior Vice President and General
Manager--Business Segment
Joel A. Effron.................................... 55 Senior Vice President--Sales and Marketing
Dennis V. Meyer................................... 61 Vice President--Finance and Treasurer
Jason R. Mills.................................... 27 Vice President--Network Operations
Gregory Joksch.................................... 43 Vice President--Information Technologies
Jeff M. Webster................................... 35 Vice President--Business Operations
John F. Sumpter................................... 51 Vice President--Regulatory
H. Ravi Brar...................................... 31 Vice President--Business Development
Directors:
Jerry L. Johnson.................................. 52 Chairman of the Board of Directors
David G. Chandler................................. 41 Director
Mark S. Fowler.................................... 58 Director
Samuel A. Plum.................................... 55 Director
Dr. Jagdish N. Sheth.............................. 61 Director
The present principal occupations and recent employment history of each of
our executive officers, key employees and directors listed above are set forth
below.
Wallace W. Griffin has served as the President, Chief Executive Officer and
a Director of Pac-West since September 1998. From 1994 to 1997, Mr. Griffin
served as a Group President for a number of Jones International companies,
including Jones Lightwave, Ltd., a competitive local exchange carrier, and Jones
Education Company, a leader in using technology to deliver education.
Concurrently, he was co-owner of a consulting and business development company,
Griffin Enterprises, Inc. From 1987 through 1992, Mr. Griffin served as the
President and Chief Executive Officer of U S West Marketing Resources Group,
where he managed the $1 billion publishing, media software and advertising
services division. Mr. Griffin has over thirty-five years experience in
telecommunications, cable television, publishing and advertising. Mr. Griffin is
also a director of DDx Incorporated.
John K. La Rue founded Pac-West's predecessor, also known as Pac-West
Telecomm, Inc., in 1980 and served as its President from 1980 until September
30, 1996 and as our President from our incorporation in 1996 until September
1998. Since September 1998, Mr. La Rue has served as our Executive Vice
President of Technology and Network Operations and as a Director.
Richard E. Bryson has served as our Chief Financial Officer since November
1998. From 1992 to 1998, Mr. Bryson worked at Bank of America as a Managing
Director in the Telecommunications Group providing emerging telecommunications
companies with corporate finance and capital markets services. From 1989 to
1992, he was President and founder of MBIC, a fund investing in growth
companies. From 1980 to 1989, he worked at Citibank in Mezzanine Investments and
Capital Markets.
28
Brian K. Johnson has served as our Senior Vice President and General
Manager--Business Segment since August 1999 and prior to that served as our Vice
President of Sales since September 1998. Mr. Johnson has over 15 years of sales
and sales management experience. Most recently, Mr. Johnson served for two years
as Vice President and General Manager of WinStar Telecommunications, overseeing
competitive local exchange carrier operations in the San Francisco Bay Area.
Prior to joining WinStar, Mr. Johnson was employed by Metrocall for two years as
Vice President and General Manager for the California and Nevada markets. His
telecommunications sales management experience includes positions at Comverse
Technology, LA Cellular and Harris Corporation.
Joel A. Effron has served as our Senior Vice President of Sales and
Marketing since April 1997. From 1994 through 1997, Mr. Effron ran his own
management consulting company called J. Effron & Associates. Prior to that, Mr.
Effron served as President of three corporations, including Compath, a $35
million marketing, installation and service company for business telephone
systems, Codart, a communication and entertainment start-up, and Zendex, a
computer manufacturer. Mr. Effron has over 25 years of experience in the
telecommunications industry with extensive senior management experience in
marketing, planning, policies and procedures and manpower development.
Dennis V. Meyer served as our and our predecessor's Chief Financial Officer
and Treasurer from 1994 until November 1998. In November 1998, Mr. Meyer was
appointed Vice President--Finance and Treasurer. Prior to 1994, Mr. Meyer spent
12 years in public accounting at Ernst & Ernst, now Ernst & Young, a national
accounting firm. Mr. Meyer is a certified public accountant with over twenty
years of experience as a senior financial officer of several manufacturing and
regulated transportation companies. Mr. Meyer also served as an officer in the
Air Artillery Branch of the U.S. Army.
Jason R. Mills has served as Vice President of Network Operations since
1997. Mr. Mills joined our predecessor in 1986 and has been serving as our
Director of Network Operations for the past five years. Mr. Mills also serves as
a director of Utility Telephone, Inc.
Gregory Joksch has served as our Vice President of Information Technologies
since September 1998. From 1992 to 1998, he served as Director of Information
Technologies and was responsible for our information technology systems.
Jeff M. Webster has served as Vice President-Business Operations since
September 1998 and before that served as Vice President of Operations since
1991. His current areas of responsibility include human resource management. Mr.
Webster began with Pac-West as an Account Executive in 1987 and was later
promoted to general management of business operations, human resources,
administration and customer service management.
John F. Sumpter has served as our Vice President of Regulatory since July,
1999. He has over 28 years of experience in the telecommunications industry.
Prior to joining us, he was employed with AT&T from 1984 to 1999, where he held
several executive legal regulatory positions, including Division Manager of Law
and Government Affairs, District Manager of Switched Services Product
Management, and District Manager of Marketing. Mr. Sumpter is responsible for
our relations with government regulatory agencies, regulatory compliance and
intercarrier relations.
H. Ravi Brar has served as our Vice President of Business Development since
July, 1999. In addition, Mr. Brar serves as President and is a director of
Installnet Inc., DBD Consulting, Inc. and US Net Solutions, Inc., each a
recently acquired, wholly-owned subsidiary of Pac-West. Prior to joining us, Mr.
Brar was employed with Xerox Corporation from 1991 to 1999, where he held
several senior level business development and financial management positions,
including Business Development Manager of Xerox's developing markets operations
in China and Russia, and Area General Manager and Controller of Xerox's business
services division in Pittsburgh, PA. Mr. Brar is responsible for oversight of
Pac-West's business development and strategic planning activities, including
mergers and acquisitions, growth markets, and strategic alliances.
29
Jerry L. Johnson has served as our Chairman of the Board since September
1998. Since 1995, Mr. Johnson has been employed by Safeguard Scientifics, where
he is the Executive Vice President overseeing the partner companies in the
network infrastructure group. From 1985 to 1995, he worked at U S West in
various positions, including Vice President, Network and Technology Services,
which included managing U S West's largest division, supervising 21,000
management, engineering, technical and clerical employees. From 1983 to 1985,
Mr. Johnson was President and CEO of Northwestern Bell Information Technologies.
Mr. Johnson also serves as a Chairman of the Board of QuestOne Decision Sciences
Corporation and Sotas Inc., and as a director of Extant, Inc., Vitts Networks,
Inc., Intellisource Group, Inc., and NexTone Communications, Inc..
David G. Chandler has served as one of our Directors since September 1998.
Mr. Chandler is a Managing Director of William Blair Capital Partners, L.L.C., a
Chicago-based private equity firm. In addition, Mr. Chandler is a Principal of
William Blair & Company where he has been employed since 1987. Prior to joining
William Blair & Company, he was an investment banker with Morgan Stanley & Co.
Incorporated from 1984 to 1987. Mr. Chandler serves as a director of the
following companies: Electronic Manufacturing Systems, Inc., Encore Paper
Company, Gibraltar Packaging Group, Harmonic Systems Incorporated, Morton Grove
Pharmaceuticals, Inc., Pharma Research Corporation, Engineering Materials Corp.,
Pre Delivery Services Corp, DJ Pharma and Sweetwater Sound, Inc.
Mark S. Fowler has served as one of our Directors since August 1999. Mr.
Fowler is a founder and current Chairman of Assure Sat, Inc., a business formed
for the purpose of operating telecommunications satellites that provide "backup"
protection to satellite operators. In addition, Mr. Fowler founded and served as
CEO of Power Fone, a business sold to Nextel Communications in 1994 for $400
million. He also was a co-founder and Chairman from 1996 to January 2000 of
Unisite, Inc., a provider of leased tower space to wireless service operating
companies. From 1981 to 1987, Mr. Fowler served as Chairman of the Federal
Communications Commission and practiced communications law with the law firm of
Latham & Watkins from 1987 to 1994 as Senior Communications Counsel, and, from
1994 to present, as of counsel to the firm. Mr. Fowler serves as a director of
Talk.com Inc. and Beasley Broadcast Group, Inc.
Samuel A. Plum has served as one of our Directors since September 1998. Mr.
Plum has been a Managing General Partner of the general partner of SCP Private
Equity Partners, L.P. since its commencement in August 1996 and was employed by
Safeguard from 1993 to 1996. From February 1989 to January 1993, Mr. Plum served
as President of Charterhouse, Inc. and Charterhouse North American Securities,
Inc., the U.S. investment banking and broker-dealer divisions of Charterhouse
PLC, a merchant bank located in the United Kingdom. From 1973 to 1989, Mr. Plum
served in various capacities in the investment banking divisions of Paine Webber
Inc. and Blyth Eastman Dillon & Co., Inc. Mr. Plum has 22 years of investment
banking, mergers and acquisitions and private equity investment experience. Mr.
Plum also serves as a director of Index Stock Photography, Inc. and Metallurg
Holdings, Inc.
Dr. Jagdish N. Sheth has served as one of our Directors since July 1999.
Dr. Sheth has also been the Charles H. Kellstadt Professor of Marketing in the
Goizueta Business School since 1991 and is the founder of the Center for
Relationship Marketing at Emory University. From 1984 to 1991, Dr. Sheth was the
Robert E. Brookner Professor of Marketing at the University of Southern
California and is the founder of its Center for Telecommunications Management.
Dr. Sheth also serves as a director of Norstan, Inc.
Mark J. DeNino and Bruce A. Westphal resigned their positions as directors
at Pac-West effective as of March 1, 2000 and March 16, 2000, respectively. The
board of directors has not yet identified and nominated any person to fill the
vacant Class II directorship of Mr. DeNino or the vacant Class I directorship of
Mr. Westphal. When the board of directors identifies a person to fill each of
the vacant Class II directorship and the vacant Class I directorship, if will
appoint each such person to serve on the board of directors until the end of the
term of the appropriate class of directorship. See "Management - Classes of the
Board."
All members of the board of directors set forth in this report have been
elected in accordance with a shareholders agreement that was entered into in
connection with our recapitalization in September 1998. There are no other
family relationships between any of our directors or executive officers. Our
executive officers are elected by and serve at the discretion of the board of
directors.
30
Classes of the Board
Following the closing of our initial public offering, our Board of
Directors were divided into three classes of directors, with each class serving
staggered three-year terms. As a result, approximately one-third of our Board of
Directors will be elected each year. Class I consists of Messrs. Plum and
Chandler, and one vacant directorship whose terms expire at the 2002 annual
meeting. Class II consists of Messrs. Sheth and Fowler, and one vacant
directorship whose terms expire at the 2001 annual meeting. Class III consists
of Messrs. Johnson, Griffin and La Rue whose terms expire at the 2000 annual
meeting.
Committees of the Board of Directors
Our board has standing executive, compensation and audit committees. The
executive committee currently consists of Jerry L. Johnson, Wallace W. Griffin,
David G. Chandler and Samuel A. Plum. The compensation committee consists of
Samuel A. Plum and Mark S. Fowler. The audit committee consists of David G.
Chandler, Dr. Jagdish N. Sheth and Mark S. Fowler.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Exchange Act requires the Company's executive officers
and directors, and persons who own more than ten percent of a registered class
of the Company's equity securities, to file reports of ownership and changes in
ownership with the Securities and Exchange Commission (the "Commission") and the
Stock Market, as required. These persons are required by regulation of the
Commission to furnish the Company with copies of all Section 16(a) forms they
file.
Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons that no Forms 5 were
required for those persons, the Company believes that during the fiscal year
ended December 31, 1999, except for Richard E. Bryson, Bay Alarm Company and
Samuel A. Plum, each of whom filed a Form 4 late, the Company's executive
officers, directors and greater than ten percent beneficial owners complied with
all applicable Section 16(a) filing requirements.
ITEM 11. EXECUTIVE COMPENSATION
The following table summarizes the compensation we paid to our named
executive officers, consisting of our chief executive officer and four most
highly compensated executive officers for the fiscal year ended December 31,
1999. None of the perquisites and other benefits paid to each named executive
officer exceeded the lesser of $50,000 or 10% of the total annual salary and
bonus received by that officer. "All Other Compensation" reflects matching
contributions we made under our 401(k) plan plus group life and disability
insurance premiums paid by the Company on behalf of such officer. The amount
listed under "All Other Compensation" includes $18,419 of life insurance and
long-term disability insurance premiums we paid on behalf of Mr. Griffin and
includes $2,539 of long-term disability insurance premiums we paid on behalf of
Mr. LaRue.
1999 Summary Compensation Table
Name and Principal Regular All Other
Position Held Salary Bonus Compensation
-------------- ------ ----- ------------
Wallace W. Griffin....................... $350,000 $350,000 $23,845
President, Chief Executive Officer and
Director John K. La Rue.................. 350,000 140,000 7,746
Executive Vice President and Director
Richard E. Bryson........................ 225,000 90,000 3,783
Chief Financial Officer
Brian K. Johnson......................... 150,370 56,000 3,648
Senior Vice President and General
Manager - Business Segment
Jason R. Mills........................... 185,000 50,000 5,341
Vice President--Network Operations
31
Stock Incentive Plan
We have established the Pac-West Telecomm, Inc. 1999 Stock Incentive Plan,
which authorizes the granting of stock options, including restricted stock,
SARS, dividend equivalent rights, performance units, performance shares or other
similar rights or benefits to our or our subsidiaries' current or future
employees, directors, consultants, advisors. Under the 1999 Stock Incentive
Plan, the board of directors is authorized to issue options to purchase shares
of common stock in such quantity, at such exercise prices, on such terms and
subject to such conditions as established by the board. An aggregate of
3,150,000 shares of common stock have been reserved for option grants under the
1999 Stock Incentive Plan and the employment agreements of Messrs. Griffin and
Bryson, subject to adjustment upon the occurrence of certain events to prevent
any dilution or expansion of the rights of participants that might otherwise
result from the occurrence of such events. As of December 31, 1999, we had
granted options outstanding with respect to 2,224,650 shares of common stock,
including those granted under the employment agreements. No options have been
exercised through December 31, 1999.
The amounts shown for realizable potential value are calculated assuming
that the market value of the common stock was equal to the exercise price per
share as of the date of grant of the options. This value is the approximate
price per share at which shares of the common stock would have been sold in
private transactions on or about the date on which the options were granted. The
dollar amounts under these columns assume a compounded annual market price
increase for the underlying shares of the common stock from the date of grant to
the end of the option term of 5% and 10%. This format is prescribed by the SEC
and is not intended to forecast future appreciation of shares of the common
stock. The actual value, if any, a named officer may realize will depend on the
excess of the market price for shares of the common stock on the date the option
is exercised over the exercise price. Accordingly, there is no assurance that
the value realized by a named officer will be at or near the value estimated
above.
Option Grants in 1999
The table below provides information regarding stock options granted to the
named executive officers during 1999. None of the named executive officers
received SAR's. All options referred to below are exercisable to purchase shares
of our common stock.
% of Total Potential Realizable
Number of Options Value at Assumed
Securities Granted to Annual Rates of Stock
Underlying Employees Exercise or Price Appreciation for
Name Options in Fiscal Base Price Expiration Option Term
---- -----------
Granted (#) Year ($/Sh) Date 5% ($) 10% ($)
----------- ---- ------ ---- ------ -------
Wallace W. Griffin................. 137,847 8.3% $10.00 11/03/2009 $867,000 $2,197,000
John K. LaRue ..................... 224,000 13.5 2.14 02/28/2009 301,000 764,000
Richard E. Bryson.................. 86,153 5.2 10.00 11/03/2009 542,000 1,373,000
Brian K. Johnson................... 70,000 4.2 2.14 04/01/2009 94,000 239,000
Brian K. Johnson................... 35,000 2.1 2.14 07/01/2009 47,000 119,000
Jason R. Mills..................... 105,000 6.3 2.14 02/28/2009 141,000 358,000
Outstanding Stock Options and Year-End Values
The following table sets forth information regarding the number and value
of unexercised stock options held by each of the named executive officers as of
December 31, 1999. None of the named executive officers exercised stock options
in 1999.
Name Number of Unexercised Options Value of Unexercised In-the-Money
----
at Year End Options at Year End
Exercisable Non-Exercisable Exercisable Non-Exercisable
----------- --------------- ----------- ---------------
Wallace W. Griffin..................... 487,847 0 $11,381,000 $0
John K. LaRue ......................... 0 224,000 0 5,457,000
Richard E. Bryson...................... 159,070 145,833 3,293,000 3,821,000
Brian K. Johnson....................... 0 105,000 0 2,558,000
Jason R. Mills......................... 0 105,000 0 2,558,000
32
Qualified 401(k) and Profit Sharing Plan
We maintain a tax-qualified 401(k) plan. Employees who are 18 years of age
may elect to participate in the plan after completing six months of service with
us. We match 50% of employee contributions up to 6% of compensation deferred.
Our matching contributions vest at a rate 20% per year starting with the
employee's second year of service. Although we have not historically done so, we
may also make discretionary profit-sharing contributions to all employees who
satisfy plan participation requirements.
Pension Plans
We do not maintain a pension plan.
Director Compensation
Directors who are employed by our company, including Mr. Griffin and Mr. La
Rue, and directors who are affiliated with our principal shareholders, including
Messrs. Chandler, Johnson and Plum are not currently entitled to receive any
compensation for serving on our board of directors. Our outside directors, Dr.
Sheth and Mr. Fowler, receive $5,000 per quarter as compensation for serving on
our board of directors. In 1999, we granted each of Dr. Sheth and Mr. Fowler
stock options to purchase 35,000 shares of our common stock at a strike price of
$2.14. The stock options will vest over a three-year period with 33 1/3% vesting
at the end of each year. We pay for the reasonable out-of-pocket expenses
incurred by each director in connection with attending board and committee
meetings.
Employment Agreements
Messrs. Wallace W. Griffin, John K. La Rue, Richard E. Bryson and Jason R.
Mills have each entered into employment agreements with us. The employment
agreements provide for initial base salaries and bonuses upon our achievement of
certain objective and subjective criteria and contain terms as follows:
Initial
Employee Effective Date Term Base Salary Bonus
-------- -------------- ---- ----------- -----
Wallace W. Griffin................. September 16, 1998 3 years $350,000 40%
John K. La Rue..................... September 16, 1998 2 years $350,000 40%
Richard E. Bryson.................. October 30, 1998 2 years $225,000 40%
Jason R. Mills..................... September 16, 1998 2 years $180,000 25%
The employment agreements also provide for participation in all benefit
plans made available to Pac-West executives.
Each of the employment agreements may be terminated earlier by us or the
respective executive under certain conditions.
In connection with their respective employment agreements, Mr. Griffin
purchased 525,000 shares of common stock for an aggregate purchase price of
$250,000 and Mr. Bryson purchased 87,458 shares of common stock for an aggregate
purchase price of $41,667. In each case, the executives purchased said shares
through a combination of cash and promissory notes, the payments of which notes
were secured by pledge agreements pledging all of stock so purchased. We have a
right to repurchase such shares in the event of the termination of such
executive's employment with us for any reason. In addition, their respective
employment agreements granted to Mr. Griffin and Mr. Bryson options to purchase
350,000 shares and 218,750 shares, respectively, of common stock at a purchase
price of $0.48 per share.
33
Upon termination by us without cause, as defined in the respective
employment agreement, that executive will be entitled to receive severance
payments which, subject to certain conditions, equal:
. in the case of Mr. La Rue, base salary for the remainder of the term of
employment under the employment agreement plus the one-year period
thereafter;
. in the case of Mr. Griffin, base salary for the greater of the remainder
of the term of employment under the employment agreement or the six-
month period thereafter;
. in the case of Mr. Bryson, base salary for one year following
termination plus our payment of all health insurance premiums with
respect to Mr. Bryson's continuation coverage rights under the
Consolidated Omnibus Budget Reconciliation Act of 1985, as amended, or
any similar statute or regulation then in effect, for a maximum of the
one-year period after such termination; and
. in the case of Mr. Mills base salary for the remainder of the term of
employment under the employment agreement.
If the employment period is terminated as a result of the executive's
disability, then the executive and/or his estate or beneficiaries, as the case
may be, will be entitled to receive benefits under our employee benefit programs
as in effect on the date of such termination to the extent permitted under such
programs and, in addition, will be entitled to receive:
(1) an amount equal to that executive's base salary for the one-year
period after the termination of the employment period; and
(2) the amount of any annual bonus otherwise payable to the executive for
the fiscal year in which executive's employment is terminated, except
that the amount of any such annual bonus otherwise payable will be
allocated on the basis of the number of days during such fiscal year
that executive was employed by us.
If the employment period is terminated as a result of the executive's
death, then the executive and/or his estate or beneficiaries, as the case may
be, will be entitled to receive benefits under our employee benefit programs as
in effect on the date of such termination to the extent permitted under such
programs and, in addition, will be entitled to receive the amount of any annual
bonus otherwise payable to the executive for the fiscal year in which the
executive's employment is terminated, except that the amount of any such annual
bonus otherwise payable will be allocated on the basis of the number of days
during such fiscal year that the executive was employed by us. If we terminate
the employment period for cause or if the executive resigns for any reason,
other than a termination without cause under the respective employment
agreement, then the executive will be entitled to receive his base salary
through the date of termination and we will have no further liability whatsoever
to executive.
Each of the executives have agreed to forfeit any severance obligations
owing to such executives in the event they breach certain noncompetition
provisions. See "Certain Relationships and Related Transactions--Non-
Competition; Non-Solicitation; Confidentiality Agreements."
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board of Directors currently consists of
three directors, none of which are executive officers or employees of the
Company. There are no director interlocking relationships.
34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding ownership of
our common stock as of March 1, 2000 for: (1) each person who we know owns
beneficially more than 5% of our outstanding common stock; (2) each of our
current directors and named executive officers; and (3) all of our current
directors and executive officers as a group.
Number of Shares Percent Beneficially
Beneficial Owner Beneficially Owned (1) Owned (2)
---------------- ---------------------- ---------
Significant Stockholders:
Bay Alarm Securities LLC...................................... 4,890,930(3) 13.7%
925 Ygnacio Valley Road
Walnut Creek, CA 94596
SCP Private Equity Partners, L.P.............................. 3,652,649(4) 10.2
435 Devon Park Drive, Building 300
Wayne, PA 19087
William Blair Capital Partners VI, L.P........................ 3,652,649(5) 10.2
222 West Adams Street
Chicago, IL 60606
TL Ventures III L.P. and related entities..................... 3,258,826(6) 9.1
700 Building
435 Devon Park Drive
Wayne, PA 19087-1990
Safeguard Scientifics, Inc. .................................. 2,375,223(7) 6.6
800 The Safeguard Building
435 Devon Park Drive
Wayne, PA 19087
Directors and Named Executive Officers:
Richard E. Bryson............................................. 246,528(8) *
David G. Chandler............................................. 3,652,649(9) 10.2
Mark S. Fowler................................................ 1,000(10)
Wallace W. Griffin............................................ 1,012,847(11) 2.8
Brian K. Johnson.............................................. 17,500(12) *
Jerry L. Johnson.............................................. 30,043(13) *
John K. La Rue................................................ 914,888(14) 2.6
Jason R. Mills................................................ 37,250(15) *
Samuel A. Plum................................................ 3,667,649(16) 10.2
Jagdish N. Sheth.............................................. 2,000(17) *
All of Pac-West's directors and executive officers as a group
(18 persons)....................................................... 9,607,054(18) 26.4
(1) The number of shares includes shares of common stock subject to options
exercisable within sixty (60) days of March 1, 2000.
(2) Shares of common stock exercisable within sixty (60) days of March 1, 2000
are considered outstanding for the purpose of determining the percent of
the class held by the holder of such option, but not for the purpose of
computing the percentage held by others. Percentages of less than one (1)
percent are denoted by an asterisk.
35
(3) Based solely upon information provided on March 13, 2000 by Bay Alarm
Company, the sole member of Bay Alarm Securities LLC ("Bay Alarm"), Bay
Alarm is the direct beneficial owner of 4,890,930 shares of common stock.
(4) Based solely upon a Schedule 13G, dated March 10, 2000, filed jointly by
SCP Private Equity Partners, L.P. ("Equity Partners"), SCP Private Equity
Management, L.P. ("Equity Management"), Winston Churchill ("Churchill"),
Samuel A. Plum ("Plum"), and Safeguard Capital Management, Inc. ("Capital
Management"), Equity Partners is the direct beneficial owner of 3,652,649
shares of common stock. Equity Management, by virtue of it being the
general partner of Equity Partners, may be deemed to be the beneficial
owner of the shares of common stock owned by Equity Partners. In addition,
Churchill, Plum and Capital Management, by virtue of their being general
partners of Equity Management, may also be deemed to be the beneficial
owner of the shares of common stock owned by Equity Partners. Each of
Equity Management, Churchill, Plum and Capital Management disclaims any
direct or indirect beneficial ownership of the 3,652,649 shares of common
stock owned by Equity Partners.
(5) Based solely upon a Schedule 13G, dated February 14, 2000, filed jointly by
William Blair Capital Partners VI, L.P. ("WB Partnership") and William
Blair Capital Partners VI, L.L.C. ("WB LLC"), WB Partnership is the direct
beneficial owner of 3,652,649 shares of common stock. WB LLC, by virtue of
it being the general partner of WB Partnership, may be deemed to be the
beneficial owner of the shares of common stock owned by WB Partnership. WB
LLC disclaims beneficial ownership of the 3,652,649 shares of common stock
owned by WB Partnership.
(6) Based solely upon a Schedule 13G, dated February 10, 2000, filed jointly by
TL III, TL Offshore, TL Interfund, TL Ventures III, LLC, TL Ventures III
Management, LP, TL Ventures III Offshore and TL Ventures Offshore Partners,
LP, TLIII, TL Offshore and TL Interfund are the direct beneficial owners of
2,623,878, 549,264 and 85,684 shares of common stock, respectively. TL
Ventures III Management, LP, by virtue of it being the general partner of
TL III and TL III Interfund and TL Ventures III, LLC, by virtue of it being
the general partner of TL Ventures III Management, LP, may be deemed to be
the beneficial owner of the 2,623,878 and 85,684 shares of common stock
owned by TL III and TL Interfund, respectively. TL Ventures Offshore
Partners, LP, by virtue of it being the general partner of TL Offshore, and
TL Ventures III Offshore, Ltd., by virtue of it being the general partner
of TL Ventures Offshore Partners, LP, may be deemed to be the beneficial
owner of the 549,264 shares of common stock owned by TL Offshore.
(7) Based solely upon information provided by Safeguard Scientifics, Inc.
("Safeguard"), shares are owned of record by Safeguard 98 Capital L.P.
Safeguard Delaware, Inc., a wholly owned subsidiary of Safeguard, is the
sole general partner of Safeguard 98 Capital L.P. and has sole authority
and responsibility for all acquisition, voting and disposition decisions
regarding such shares. The shares exclude the following shares of common
stock held by other entities in which Safeguard has a pecuniary interest:
393,824 shares held by Enertech Capital Partners L.P., 3,652,649 shares
held by SCP Private Equity Partners, L.P., 2,623,878 shares held by TL
Ventures III L.P., 85,684 shares held by TL Ventures III Interfund, and
549,264 shares held by TL Ventures III Offshore L.P. Safeguard Scientifics
(Delaware), Inc. ("Safeguard Delaware"), a wholly owned subsidiary of
Safeguard, is a member of Enertech Management L.L.C., the general partner
of Enertech Management L.P., which is the general partner of Enertech
Capital Partners L.P., and holds a limited partnership interest in the
fund. Safeguard Capital Management, Inc., a wholly owned subsidiary of
Safeguard Delaware, is a general partner of SCP Private Equity Management
L.P., the general partner of SCP Private Equity Partners L.P., and holds a
limited partnership interest in the fund. Safeguard Delaware is a member of
TL Ventures III LLC, the general partner of TL Ventures III Management
L.P., which is the general partner of TL Ventures III L.P. and TL Ventures
III Interfund, and holds a limited partnership interest in TL Ventures III
Management L.P. Safeguard Delaware is also a shareholder of TL Ventures III
Offshore Ltd., the general partner of TL Ventures III Offshore Partners
L.P., which is the general partner of TL Ventures III Offshore L.P., and
holds a limited partnership interest in TL Ventures III Offshore Partners
L.P. Safeguard disclaims beneficial ownership of the shares owned by these
entities.
36
(8) The shares of common stock shown as beneficially owned by Mr. Bryson
include 159,070 shares subject to options. In addition, Mr. Bryson is the
direct beneficial owner of 21,458 shares of common stock. Mr. Bryson, by
virtue of his being a co-trustee for each of the Lauren E. Bryson
Irrevocable Trust, dated December 29, 1999 (the "Lauren Bryson Trust"), the
Anna C. Bryson Irrevocable Trust, dated December 29, 1999 (the "Anna Bryson
Trust") and the William H. Bryson Irrevocable Trust, dated December 29,
1999 (the "William Bryson Trust"), may be deemed to be the beneficial owner
of the 22,000 shares of common stock owned by each of the Lauren Bryson
Trust, the Anna Bryson Trust and the William Bryson Trust. Mr. Bryson
disclaims beneficial ownership of the 66,000 shares of common stock held by
the Lauren Bryson Trust, the Anna Bryson Trust and the William Bryson
Trust.
(9) Mr. Chandler, by virtue of his being a managing director of WB LLC, may be
deemed to be the beneficial owner of 3,652,649 shares of common stock owned
by WB Partnership. Mr. Chandler expressly disclaims beneficial ownership of
any shares owned by WB Partnership.
(10) The shares of common stock shown as beneficially owned by Mr. Fowler
include 1,000 shares of common stock owned directly by Mr. Fowler.
(11) The shares of common stock shown as beneficially owned by Mr. Griffin
include 487,847 shares subject to options and 245,000 shares of common
stock owned directly by Mr. Griffin. In addition, Mr. Griffin, by virtue of
his being a general partner of Griffin Family Limited Liability
Partnership, L.L.P. ("Griffin LLP"), may be deemed to be the beneficial
owner of 280,000 shares of common stock owned by Griffin LLP.
(12) The shares of common stock shown as beneficially owned by Mr. Johnson
include 17,500 shares subject to options.
(13) The shares of common stock shown as beneficially owned by Mr. Johnson
include 29,929 shares of common stock owned directly by Mr. Johnson. In
addition, Mr. Johnson, by virtue of his participation in a 401(K) plan, may
be deemed to be the beneficial owner of 114 shares of common stock owned
directly by such 401(K) plan.
(14) The shares of common stock shown as beneficially owned by Mr. La Rue
include 56,000 subject to options and 680,668 shares of common stock owned
directly by Mr. La Rue. In addition, Mr. La Rue, by virtue of his being the
trustee of the Jason R. Mills and Jennifer L. Mills Irrevocable Trust,
dated September 14, 1998 (the "Mills Trust"), may be deemed to be the
beneficial owner of 178,220 shares of common stock owned by the Mills
Trust. Mr. La Rue expressly disclaims beneficial ownership of the shares of
common stock owned by the Mills Trust.
(15) The shares of common stock shown as beneficially owned by Mr. Mills include
26,250 shares of common stock subject to options and 11,000 shares of
common stock owned directly by Mr. Mills.
(16) The shares of common stock shown as beneficially owned by Mr. Plum include
15,000 shares of common stock owned directly by Mr. Plum. In addition, Mr.
Plum, by virtue of his being the managing general partner of Equity
Partners, may be deemed to be the beneficial owner of 3,652,649 shares
owned by Equity Partners. Mr. Plum expressly disclaims beneficial ownership
of the shares of common stock owned by Equity Partners.
(17) The shares of common stock shown as beneficially owned by Dr. Sheth include
2,000 shares of common stock owned directly by Dr. Sheth.
(18) The shares of common stock shown as beneficially owned by all of Pac-West's
directors and executive officers as a group include the shares of common
stock beneficially owned by the directors and the named executive officers
described in footnotes 8 to 16 as well as 84,700 shares of common stock
beneficially owned by executive officers other than the named executive
officers.
37
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Recapitalization
Our recapitalization was completed on September 16, 1998 in accordance with
the merger agreement between us, Bay Alarm Company and John K. La Rue, the
preexisting investors, and PWT Acquisition Corp. a corporation newly formed by
an equity investment group led by Safeguard 98 Capital, L.P. and William Blair
Capital Partners L.L.P. to effect the recapitalization.
Under the merger agreement, Mr. La Rue and Bay Alarm Company were entitled
to receive additional consideration of up to $20 million in the event that
certain billings under dispute were received subject to the recapitalization.
On September 9, 1999, Pac-West entered into a settlement agreement with
Pacific Bell regarding claims for unpaid reciprocal compensation under our prior
interconnection agreement. Under the terms of the settlement agreement, Pacific
Bell agreed to pay $20.0 million to Pac-West and $20.0 million in the aggregate
to Mr. La Rue and Bay Alarm Company in settlement of those claims. As a result
of these payments, the terms of our September 1998 merger agreement requiring
additional distributions to these shareholders have been satisfied.
In accordance with the merger agreement, Mr. La Rue and Bay Alarm Company
have agreed to indemnify us and certain of our related parties for all
liabilities and other losses arising from, among other things:
(1) any breach by Pac-West of any representation, warranty, covenant or
agreement we made in the merger agreement or in any schedule, exhibit,
or other related document;
(2) any claims of any brokers, finders, our employees or consultants
relating to the transactions contemplated by the merger agreement not
specifically set forth in or contemplated by the merger agreement; or
(3) any claim by any person other than PWT Acquisition Corp. or its
affiliates with respect to, or arising as a result of, any
reorganization, liquidation, dissolution, recapitalization, non due
course borrowing, merger, consolidation, sale or purchase of assets or
similar transactions proposed prior to closing of the merger; provided
that Mr. La Rue and Bay Alarm Company receive notice of such loss
within the applicable time periods set forth in the merger agreement.
Subject to certain exceptions, Mr. La Rue and Bay Alarm Company do not have
any obligation to indemnify any of the indemnified parties from any losses
caused by the breach or alleged breach of any representation or warranty
contained in the merger agreement until the indemnified parties collectively
suffer related aggregate losses in excess of $500,000, which acts as a
deductible. Mr. La Rue and Bay Alarm Company have an obligation to indemnify the
indemnified parties for all losses suffered by any of the indemnified parties in
excess of the deductible, provided that Mr. La Rue and Bay Alarm Company do not
have any obligation to indemnify the indemnified parties from such aggregate
losses in excess of an indemnity cap of $15.0 million. Despite the above,
breaches or alleged breaches of certain post-closing covenants or agreements
contained in the merger agreement will not be subject to the deductible or the
indemnity cap.
The merger agreement contains representations and warranties typical of
those kinds of agreements, including, for example, those relating to corporate
organization and capitalization, the valid authorization, execution, delivery
and enforceability of all transaction documents, the financial statements, the
absence of material adverse changes in the business, assets, financial condition
and results of operations, the absence of material undisclosed liabilities, tax
matters, the quality and title of personal and real property, material
contracts, intellectual property, employee benefits plans, environmental
matters, compliance with laws, governmental authorizations, permits and licenses
and insurance matters. Generally, our representations and warranties expire
thirty days after receipt of the audited financial statements for fiscal 1999
except that those relating to tax matters survive until the expiration of the
applicable statute of limitations and certain other representations and
warranties which survive indefinitely.
38
The foregoing summary of the material terms of the merger agreement and
related matters does not purport to be complete and is subject to, and is
qualified in its entirety by reference to, all of the provisions of the merger
agreement, including the definitions of certain terms therein and the exhibits
and schedules hereto.
Registration Agreement
In connection with the recapitalization, all of our shareholders entered
into a registration agreement. In accordance with the registration agreement, at
any time after May 7, 2000 each of the four equity investors in the
recapitalization may request one registration at our expense under the
Securities Act of 1933 of all or any portion of their Pac-West common stock on
Form S-1 or other similar long-form registration and an unlimited number of Form
S-2 or S-3 or other similar short-form registrations, provided that the
aggregate offering value of the registrable securities requested to be
registered in any long-form registration must equal at least $5 million in all
long-form registrations and at least $1 million in all short-form registrations.
In the event that any one of the four equity investors in the recapitalization
makes such a demand registration request, all other parties to the registration
agreement will be entitled to participate in such registration. The registration
agreement will also grant to the parties thereto piggyback registration rights
with respect to all other registrations of our common stock and we, subject to
limited exceptions, will pay all expenses related to the piggyback
registrations.
Non-Competition; Non-Solicitation; Confidentiality Agreements
In connection with the recapitalization and in accordance with the terms of
the merger agreement, Mr. La Rue and Bay Alarm Company each have entered into a
covenant not to compete with Pac-West, not to engage, and not to permit any
affiliate to engage, for a noncompete period of two years after the closing date
of the recapitalization in any business which:
(1) provides telecommunication services of the type provided as of the
closing date by Pac-West; or
(2) provides services of the type which we have taken significant actions
as of the closing date to begin providing or of the type we have
indicated that we plan to begin providing in any business plan or
similar document delivered to PWT Acquisition Corp. or our
shareholders prior to the closing date, in each case within Arizona,
California, Colorado, Idaho, Nevada, New Mexico, Oregon, Texas, Utah
and Washington, the province of British Columbia, Canada and the
territories and jurisdictions of Mexico.
The noncompete restrictions do not prohibit any party from being a passive
owner of not more than 5% of the outstanding stock of any class of a corporation
which is publicly traded; and provided further that the noncompete restrictions
do not restrict the activities of any party to the extent such party has
received the consent of our board of directors to such activities.
In accordance with their respective employment agreements, Messrs. La Rue,
Griffin, Bryson and Mills have agreed to forfeit any severance obligations owing
to such executives in the event of their breach of similar noncompetition
provisions. For purposes of Mr. Mills' agreement, the restricted territories
include Arizona, California, Colorado, Idaho, Nevada, New Mexico, Oregon, Texas,
Utah and Washington, the province of British Columbia, Canada and the
territories and jurisdictions of Mexico. For purposes of Mr. Griffin's and Mr.
Bryson's respective agreements, the restricted territories include the United
States of America, Canada and the territories and jurisdictions of Mexico.
Messrs. La Rue, Griffin, Bryson, Mills and Bay Alarm have also agreed to
maintain the confidentiality of our information and not to solicit our employees
and customers as provided in the merger agreement or their respective employment
agreements, as the case may be.
Other Transactions with Significant Stockholders
Mr. Bruce A. Westphal, who served as our chairman of the board until the
recapitalization and as a director of the Company until March 16, 2000, is the
chairman of the board of both Bay Alarm Company and InReach Internet. As of
March 1, 2000, an affiliate of Bay Alarm Company held approximately 13.7% of our
outstanding common stock. Sales to Bay Alarm accounted for approximately
$987,000, $1,211,000 and $912,000, or 3.3%, 2.9% and
39
1.0%, of our revenues for the years ended December 31, 1997, 1998 and 1999,
respectively. In addition, Bay Alarm Company provides us with security
monitoring services at its normal commercial rates. Bay Alarm Company purchased
the real property at which our Oakland switch facility is located. In connection
with that purchase, we negotiated a lease with Bay Alarm Company for our
continued use of that commercial space. The monthly lease payments under the
lease are approximately $13,000 effective December 1998. Sales to InReach
Internet LLC accounted for approximately $1,122,000, $1,469,000 and $1,755,000,
or 3.8%, 3.5% and 1.8%, of our revenue for the years ended December 31, 1997,
1998 and 1999, respectively.
40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The financial statements of Pac-West Telecomm, Inc. for the year
ended December 31, 1999, together with the Report of Independent
Public Accountants, are set forth on Pages F-1 through F-19 of
this Form 10-K. The supplemental financial information listed and
appearing hereafter should be read in conjunction with the
financial statements included in the Form 10-K.
(2) Financial Statement Schedules
The following are included in Part IV of this Form 10-K for each
of the years ended December 31, 1997, 1998 and 1999 as applicable:
Report of Independent Public Accountants on Supplemental
Schedule F-21
Schedule II -Valuation and Qualifying Accounts F-22
Financial statement schedules not included in this Form 10-K have
been omitted either because they are not applicable or because the
required information is shown in the financial statements or notes
thereto, included in this Form 10-K.
(3) Exhibits
The exhibits are filed herewith pursuant to Item 601 of Regulation
S-K.
Exhibit
Number Description
- ------ -----------
2.1 Agreement of Merger, dated September 16, 1998, between PWT Acquisition
Corp. and Pac-West Telecomm, Inc., as amended (Incorporated by
reference to Exhibit 2.1 to the Registrant's Registration Statement
(No. 333-76779)).
2.2 Agreement and Plan of Merger, dated June 30, 1998, between PWT
Acquisition Corp., Pac-West Telecomm, Inc., Bay Alarm Company and John
K. La Rue, as amended (Incorporated by reference to Exhibit 2.2 to the
Registrant's Registration Statement (No. 333-76779))
3.1(a) Amended and Restated Articles of Incorporation of Pac-West Telecomm,
Inc. (Incorporated by reference to Exhibit 3.1(a) to the Registrant's
Registration Statement (No. 333-86607)).
3.1(b) Certificate of Amendment of Articles of Incorporation (Incorporated by
reference to Exhibit 3.1(b) to the Registrant's Registration Statement
(No. 333-86607)).
3.2 Bylaws of the Company (Incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (Reg. No. 333-86607)).
4.1 Form of certificate representing common stock of Pac-West Telecomm,
Inc. (Incorporated by reference to Exhibit 4.1 to the Registrant's
Registration Statement (No. 333-86607)).
10.1 Shareholders Agreement, dated September 16, 1998, between Pac-West,
John K. La Rue, Bay Alarm Company, certain named investors and certain
named executives (Incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement (No. 333-76779)).
41
10.2 Registration Rights Agreement, dated September 16, 1998, between Pac-
West, John K. LaRue, Bay Alarm Company, certain investors and certain
executives (Incorporated by reference to Exhibit 10.2 to the
Registrant's Registration Statement (No. 333-86607)).
10.3 Stock Purchase Agreement, dated September 16, 1998, between PWT
Acquisition Corp. and certain named investors (Incorporated by
reference to Exhibit 10.3 to the Registrant's Registration Statement
(No. 333-76779)).
10.4 Stock Purchase Agreement, dated September 16, 1998, between Pac-West
and certain named investors (Incorporated by reference to Exhibit 10.4
to the Registrant's Registration Statement (No. 333-76779)).
10.5 Pledge and Security Agreement, dated January 29, 1999, between Pac-
West and Norwest Bank Minnesota, N.A. (Incorporated by reference to
Exhibit 10.5 to the Registrant's Registration Statement (No. 333-
76779)).
**10.6(a) Pac-West Telecomm, Inc. 1999 Stock Incentive Plan (Incorporated by
reference to Exhibit 10.6(a) to the Registrant's Registration
Statement (No. 333-76779)).
**10.6(b) Pac-West Telecomm, Inc. 1999 Stock Incentive Plan form of notice of
Stock Option Award and Stock Option Award Agreement between Pac-West
and its grantees as designated (Incorporated by reference to Exhibit
10.6(b) to the Registrant's Registration Statement (No. 333-76779)).
**10.7 Employment Agreement, dated June 30, 1998, between Pac-West and John
K. La Rue (Incorporated by reference to Exhibit 10.7 to the
Registrant's Registration Statement (No. 333-76779)).
**10.8 Executive Agreement, dated September 16, 1998, between Pac-West and
Wallace W. Griffin (Incorporated by reference to Exhibit 10.8 to the
Registrant's Registration Statement (No. 333-76779)).
**10.9 Executive Agreement, dated October 30, 1998, between Pac-West and
Richard E. Bryson (Incorporated by reference to Exhibit 10.9 to the
Registrant's Registration Statement (No. 333-76779)).
**10.10 Employment Agreement, dated October 21, 1998, between Pac-West and
Dennis V. Meyer (Incorporated by reference to Exhibit 10.10 to the
Registrant's Registration Statement (No. 333-76779)).
**10.11 Employment Agreement, dated September 14, 1998, between Pac-West and
Jason R. Mills (Incorporated by reference to Exhibit 10.11 to the
Registrant's Registration Statement (No. 333-76779)).
**10.12 Confidentiality Agreement, dated September 16, 1998, between Pac-West
and John K. La Rue (Incorporated by reference to Exhibit 10.12 to the
Registrant's Registration Statement (No. 333-76779)).
**10.13 Confidentiality Agreement, dated September 16, 1998, between Pac-West
and Wallace W. Griffin (Incorporated by reference to Exhibit 10.13 to
the Registrant's Registration Statement (No. 333-76779)).
**10.14 Confidentiality Agreement, dated September 16, 1998, between Pac-West
and Richard E. Bryson (Incorporated by reference to Exhibit 10.14 to
the Registrant's Registration Statement (No. 333-76779)).
**10.15 Confidentiality Agreement, dated October 22, 1998, between Pac-West
and Dennis V. Meyer (Incorporated by reference to Exhibit 10.15 to the
Registrant's Registration Statement (No. 333-76779)).
42
**10.16 Confidentiality Agreement, dated September 16, 1998, between Pac-West
and Jason R. Mills (Incorporated by reference to Exhibit 10.16 to the
Registrant's Registration Statement (No. 333-76779)).
10.17 Lease Agreement, dated as of June 23, 1995, as amended, by and between
Geremia Brothers and Pac-West for 4202 and 4210 Coronado Avenue,
Stockton, California (Incorporated by reference to Exhibit 10.17 to
the Registrant's Registration Statement (No. 333-76779)).
10.18 Lease Agreement, dated as of July 3, 1996, as amended, by and between
One Wilshire Arcade Imperial, Ltd., Paramount Group, Inc. and Pac-West
for 624 South Grand Avenue, Los Angeles, California (Incorporated by
reference to Exhibit 10.18 to the Registrant's Registration Statement
(No. 333-76779)).
10.19 Balco Properties Office Lease, dated as of November 10, 1998, by and
between BalcoProperties and Pac-West for Franklin Building, 1624
Franklin Street, Suites 40, 100, Mezzanine, 201, 203, 210, 214 and
222, Oakland, California (Incorporated by reference to Exhibit 10.19
to the Registrant's Registration Statement (No. 333-76779)).
10.20 Lease Agreement, dated as of December 17, 1998, by and between Wing
Fong & Associates LLC and Pac-West for 302 and 304 East Carson Street,
Las Vegas, Nevada (Incorporated by reference to Exhibit 10.20 to the
Registrant's Registration Statement (No. 333-76779)).
**10.21 Promissory Note, dated September 16, 1998, between Pac-West and
Wallace W, Griffin, and related Executive Stock Pledge Agreement
between same parties of even date (Incorporated by reference to
Exhibit 10.21 to the Registrant's Registration Statement (No. 333-
75779)).
**10.22 Promissory Note, dated October 30, 1998, between Pac-West and Richard
Bryson, and related Executive Stock Pledge Agreement between same
parties of even date (Incorporated by reference to Exhibit 10.22 to
the Registrant's Registration Statement (No. 333-76779)).
10.23(a) Loan and Security Agreement dated June 15, 1999, between Pac-West,
Union Bank of California and other lenders as designated (Incorporated
by reference to Exhibit 10.23(a) to the Registrant's Registration
Statement (No. 333-86607)).
10.23(b) Form of Addition of Lender and Consent and Amendment to Loan and
Security Agreement (Incorporated by reference to Exhibit 10.23(b) to
the Registrant's Registration Statement (No. 333-86607)).
10.24 Interconnection Agreement under Sections 251 and 252 of the
Telecommunications Act of 1996, dated June 29, 1999, between Pac-West
and Pacific Bell, and related Errata to Approved Interconnection
Agreement dated June 30, 1999 (Incorporated by reference to Exhibit
10.24 to the Registrant's Registration Statement (No. 333-76779)).
10.25 Telecommunication Facility Interconnection Agreement, dated June 21,
1996, between Pac-West and GTE California Inc. (Incorporated by
reference to Exhibit 10.25 to the Registrant's Registration Statement
(No. 333-76779)).
10.26 Master Interconnection and Resale Agreement for the State of Nevada,
dated January 15,1999, between Pac-West and The Nevada Division of
Central Telephone Company d/b/a Sprint of Nevada (Incorporated by
reference to Exhibit 10.26 to the Registrant's Registration Statement
(No. 333-76779)).
10.27 Indenture, dated January 29, 1999 between Pac-West Telecomm, Inc. and
Norwest Bank Minnesota, N.A., pursuant to which the Series B 131/2%
Notes due 2009 will be issued (Incorporated by reference to Exhibit
10.27 to the Registrant's Registration Statement (No. 333-76779)).
43
10.28 Registration Rights Agreement, dated January 29, 1999 between Pac-West
Telecomm, Inc. and Nations Banc Montgomery Securities LLC, CIBC
Oppenheimer Corp. and First Union Capital Markets, as initial
purchasers of notes (Incorporated by reference to Exhibit 10.28 to the
Registrant's Registration Statement (No. 333-76779)).
**10.29 Employment Agreement, dated September 11, 1998, between Pac-West and
Gregory Joksch (Incorporated by reference to Exhibit 10.29 to the
Registrant's Registration Statement (No. 333-86607)).
**10.30 Confidentiality Agreement, dated September 11, 1998 between Pac-West
and Gregory Joksch (Incorporated by reference to Exhibit 10.30 to the
Registrant's Registration Statement (No. 333-86607)).
*10.31 Agreement for Local Wireline Network Interconnection and Service
Resale between Pac-West Telecomm, Inc. and U.S. West Communiations,
Inc. for the State of Washington executed September 2, 1999.
*10.32 Agreement for Local Wireline Network Interconnection Between Citizens
Telecommunication Company of California, Inc. and Pac-West Telecomm,
Inc. dated November 1, 1999.
*10.33 Agreement for Local Wireline Network Interconnection and Service
Resale Between Pac-West Telecomm, Inc. and US West Communications,
Inc. for the State of Arizona dated September 2, 1999.
*10.34 Lease Agreement, dated as of September 10, 1999, by and between David
A. and Sandra L. Sabey and Pac-West Telecomm, Inc. for 12201 Tukwila
International Blvd., Building B, Second Floor, Tukwila, Washington.
*23.1 Consent of Arthur Andersen LLP
*27.1 Financial Data Schedule
* Newly Filed
** Management contract or compensatory plan or arrangement
(b) Reports on Form 8-K
None
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Form 10-K to be signed
on its behalf by the undersigned thereunto duly authorized on March 24, 2000.
PAC-WEST TELECOMM, INC.
Registrant
By: /s/ WALLACE W. GRIFFIN
-----------------------
Wallace W. Griffin
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Form 10-K has been signed by the following persons on behalf of the Registrant
in the capacities indicated.
/s/ Wallace W. Griffin President, Chief Executive Officer and Director
- ---------------------------
Wallace W. Griffin (Principal Executive Officer)
/s/ Richard E. Bryson Chief Financial Officer
- ---------------------------
Richard E. Bryson (Principal Financial Officer)
/s/ Dennis V. Meyer Vice President--Finance and Treasurer
- ---------------------------
Dennis V. Meyer (Principal Accounting Officer)
/s/ Jerry L. Johnson Chairman of the Board of Directors
- ---------------------------
Jerry L. Johnson
/s/ John K. La Rue Director and Executive Vice President--
- ---------------------------
John K. La Rue Technology and Network Operations
/s/ David G. Chandler Director
- ---------------------------
David G. Chandler
/s/ Mark S. Fowler Director
- ---------------------------
Mark S. Fowler
/s/ Samuel A. Plum Director
- ---------------------------
Samuel A. Plum
/s/ Dr. Jagdish N. Sheth Director
- ---------------------------
Dr. Jagdish N. Sheth
45
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Arthur Andersen LLP, Independent Public Accountants.............. F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-5
Statements of Changes in Stockholders' Equity (Deficit).................... F-6
Statements of Cash Flows................................................... F-7
Notes to Financial Statements.............................................. F-8
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Pac-West Telecomm, Inc.:
We have audited the accompanying balance sheets of Pac-West Telecomm, Inc. (a
California corporation) as of December 31, 1998 and 1999, and the related
statements of operations, changes in stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pac-West Telecomm, Inc. as of
December 31, 1998 and 1999, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1999, in conformity
with accounting principles generally accepted in the United States.
San Francisco, California,
February 10, 2000
F-2
PAC-WEST TELECOMM, INC.
BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
ASSETS
1998 1999
-----------------------------------
CURRENT ASSETS:
Cash and cash equivalents $ 15,236,000 $ 82,688,000
Restricted cash -- 10,087,000
Short-term investments -- 70,138,000
Trade accounts receivable, net of allowances of $400,000 and $675,000 in
1998 and 1999, respectively 4,623,000 8,339,000
Accounts receivable from related parties 64,000 63,000
Income tax receivable 1,971,000 195,000
Inventories 447,000 952,000
Prepaid expenses and other current assets 861,000 2,786,000
Deferred financing costs, net 457,000 864,000
Deferred tax assets 151,000 580,000
-----------------------------------
Total current assets 23,810,000 176,692,000
-----------------------------------
EQUIPMENT, VEHICLES AND LEASEHOLD IMPROVEMENTS:
Network and other communication equipment 29,817,000 71,142,000
Office furniture and equipment 1,965,000 3,640,000
Vehicles 717,000 1,199,000
Leasehold improvements 5,581,000 11,661,000
Projects in progress (Note 2) 25,597,000 32,405,000
-----------------------------------
63,677,000 120,047,000
Less: Accumulated depreciation and amortization (6,383,000) (14,858,000)
-----------------------------------
Equipment, vehicles and leasehold improvements, net 57,294,000 105,189,000
-----------------------------------
OTHER ASSETS, net 1,389,000 8,219,000
-----------------------------------
Total assets $ 82,493,000 $ 290,100,000
===================================
The accompanying notes are an integral part of these financial statements.
F-3
PAC-WEST TELECOMM, INC.
BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
1998 1999
---------------------------------
CURRENT LIABILITIES:
Current portion of notes payable $ 132,000 $ 99,000
Accounts payable 5,147,000 13,158,000
Accrued payroll and related expenses 846,000 1,719,000
Accrued interest on Senior Notes -- 8,435,000
Other accrued liabilities 2,153,000 1,269,000
Income taxes payable -- 520,000
---------------------------------
Total current liabilities 8,278,000 25,200,000
---------------------------------
SENIOR NOTES -- 150,000,000
SENIOR SECURED BORROWINGS AND OTHER LONG-TERM 100,000,000 --
OBLIGATIONS (Note 3)
NOTES PAYABLE, less current portion 116,000 17,000
---------------------------------
Total long-term debt 100,116,000 150,017,000
---------------------------------
DEFERRED INCOME TAXES 1,888,000 8,633,000
---------------------------------
Total liabilities 110,282,000 183,850,000
---------------------------------
COMMITMENTS AND CONTINGENCIES (Note 5)
CONVERTIBLE REDEEMABLE PREFERRED STOCK, $0.001 par value;
1,750,000 shares authorized; 1,750,000 and 0 issued and outstanding at
December 31, 1998 and 1999 (preference in liquidation of $45,000,000,
plus accrued cumulative dividends of $1,324,000 at December 31, 1998) 46,324,000 --
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $0.001 par value:
Authorized shares--50,000,000
Issued and outstanding shares--17,587,458 and 35,393,326 at
December 31, 1998 and 1999, respectively 18,000 35,000
Additional paid-in capital 8,905,000 173,345,000
Notes receivable from stockholders (233,000) (233,000)
Retained earnings (deficit) (82,803,000) (66,897,000)
---------------------------------
Total stockholders' equity (deficit) (74,113,000) 106,250,000
---------------------------------
Total liabilities and stockholders' equity (deficit) $ 82,493,000 $ 290,100,000
=================================
The accompanying notes are an integral part of these financial statements.
F-4
PAC-WEST TELECOMM, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
1997 1998 1999
-----------------------------------------------
REVENUES (Note 5) $ 29,551,000 $ 42,211,000 $ 95,505,000
------------------------------------------------
COSTS AND EXPENSES:
Operating 12,060,000 15,344,000 20,510,000
Selling, general and administrative:
Selling, general and administrative 7,367,000 10,779,000 22,855,000
Transaction bonuses and consultant's costs (Note 1) -- 3,798,000 --
Depreciation and amortization 2,204,000 4,106,000 8,689,000
------------------------------------------------
Total costs and expenses 21,631,000 34,027,000 52,054,000
------------------------------------------------
Income from operations 7,920,000 8,184,000 43,451,000
------------------------------------------------
OTHER EXPENSE (INCOME):
Interest expense 932,000 4,199,000 18,124,000
Gain on disposal of answering service division (385,000) -- --
Costs of merger with PWT Acquisition Corp. and recapitalization -- 3,004,000 --
Other income, net (119,000) (330,000) (3,690,000)
------------------------------------------------
Total other expense, net 428,000 6,873,000 14,434,000
------------------------------------------------
Income before provision for income taxes and extraordinary item 7,492,000 1,311,000 29,017,000
PROVISION FOR INCOME TAXES 2,997,000 1,561,000 13,111,000
------------------------------------------------
Income (loss) before extraordinary item 4,495,000 (250,000) 15,906,000
EXTRAORDINARY ITEM: Loss on early extinguishment of debt, net of income
tax benefit of $278,000 -- (417,000) --
------------------------------------------------
Net income (loss) 4,495,000 (667,000) 15,906,000
ACCRUED PREFERRED STOCK DIVIDENDS -- (1,324,000) (4,085,000)
------------------------------------------------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCKHOLDERS $ 4,495,000 $ (1,991,000) $ 11,821,000
================================================
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM PER SHARE:
Basic $ 32.11 $ (0.30) $ 0.59
Diluted $ 32.11 $ (0.30) $ 0.56
NET INCOME (LOSS) PER SHARE:
Basic $ 32.11 $ (0.38) $ 0.59
Diluted $ 32.11 $ (0.38) $ 0.56
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 140,000 5,244,191 20,172,968
Diluted 140,000 5,244,191 21,293,828
The accompanying notes are an integral part of these financial statements.
F-5
PAC-WEST TELECOMM, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Notes Total
Additional Receivable Retained Stockholders'
Common Stock Paid-in from Earnings Equity
---------------------------
Shares Amount Capital Stockholders (Deficit) (Deficit)
------------ ----------- ------------ ------------ ------------ -------------
BALANCE, December 31, 1996 140,000 $ 4,037,000 $ -- $ -- $ 140,000 $ 4,177,000
Net income -- -- -- -- 4,495,000 4,495,000
--------------------------------------------------------------------------------------------------
BALANCE, December 31, 1997 140,000 4,037,000 -- -- 4,635,000 8,672,000
Conversion to $0.001 par value
stock -- (4,037,000) 4,037,000 -- -- --
Effect of merger with PWT
Acquisition Corp. and
recapitalization (Note 1) 7,176,988 7,000 1,193,000 -- (86,771,000) (85,571,000)
Issuance of common stock 9,658,012 10,000 4,708,000 -- -- 4,718,000
Accrued cumulative
dividends - preferred
stock -- -- (1,324,000) -- -- (1,324,000)
Issuances of common stock
for cash and notes
receivable 612,458 1,000 291,000 (233,000) -- 59,000
Net loss -- -- -- -- (667,000) (667,000)
---------------------------------------------------------------------------------------------------
BALANCE, December 31, 1998 17,587,458 18,000 8,905,000 (233,000) (82,803,000) (74,113,000)
Net proceeds from
initial public offering
of common stock 12,765,000 12,000 118,121,000 -- -- 118,133,000
Conversion of preferred stock 5,040,868 5,000 50,404,000 -- -- 50,409,000
Accrued cumulative dividends -
preferred stock -- -- (4,085,000) -- -- (4,085,000)
Net income -- -- -- -- 15,906,000 15,906,000
--------------------------------------------------------------------------------------------------
BALANCE, December 31, 1999 35,393,326 $ 35,000 $173,345,000 $(233,000) $(66,897,000) $106,250,000
==================================================================================================
The accompanying notes are an integral part of these financial statements.
F-6
PAC-WEST TELECOMM, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
1997 1998 1999
--------------------------------------------------
OPERATING ACTIVITIES:
Net income (loss) $ 4,495,000 $ (667,000) $ 15,906,000
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Extraordinary item--loss on early extinguishment of debt, net of income tax
benefit -- 417,000 --
Costs of merger with PWT Acquisition Corp. and recapitalization -- 3,004,000 --
Depreciation and amortization 2,204,000 4,106,000 8,689,000
Amortization of deferred financing costs -- 1,438,000 1,162,000
Gain on disposal of answering service division (385,000) -- --
Gain on disposal of equipment (15,000) -- --
Interest earned on restricted cash -- -- (629,000)
Provision for doubtful accounts 216,000 100,000 275,000
Deferred income tax provision 711,000 963,000 6,316,000
Changes in operating assets and liabilities:
Increase in trade accounts receivable (2,034,000) (1,061,000) (3,991,000)
Decrease (increase) in accounts receivable from related parties (67,000) 97,000 1,000
Decrease (increase) in income tax receivable 0 (1,971,000) 1,776,000
(Increase) decrease in inventories 195,000 (117,000) (505,000)
Increase in prepaid expenses and other current assets (175,000) (263,000) (1,975,000)
Decrease (increase) in other assets (56,000) 91,000 (2,541,000)
Increase in accounts payable 654,000 3,988,000 8,011,000
Increase in accrued interest on Senior Notes -- -- 8,435,000
Increase in income taxes payable -- -- 520,000
Increase (decrease) in accrued payroll and related expenses and other
liabilities 133,000 1,908,000 (11,000)
--------------------------------------------------
Net cash provided by operating activities 5,876,000 12,033,000 41,439,000
--------------------------------------------------
INVESTING ACTIVITIES:
Purchases of equipment, vehicles and leasehold improvements (7,103,000) (42,176,000) (56,370,000)
Purchases of short-term investments -- -- (70,138,000)
Purchase of restricted cash investments, net of redemptions of $10,238,000 -- -- (9,458,000)
Proceeds from disposal of answering service division 402,000 -- --
Proceeds from disposal of equipment 82,000 145,000 --
--------------------------------------------------
Net cash used in investing activities (6,619,000) (42,031,000) (135,966,000)
--------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from issuance of Senior Notes -- -- 150,000,000
Net proceeds from initial public offering of common stock -- -- 118,133,000
Repayment of senior secured borrowings -- -- (100,000,000)
Proceeds from notes payable 5,931,000 10,514,000 --
Repayments on notes payable (1,332,000) (2,658,000) (132,000)
Principal payments on capital leases (730,000) (828,000) --
Payment for deferred financing costs -- (1,195,000) (6,022,000)
Proceeds from senior secured borrowings -- 15,587,000 --
Increase in other long-term obligations -- 9,000,000 --
Proceeds from the issuance of common stock -- 9,000 --
Merger with PWT Acquisition Corp. and recapitalization:
Proceeds from the issuance of preferred stock -- 31,844,000 --
Proceeds from the issuances of common stock -- 5,968,000 --
Proceeds from senior secured borrowings -- 75,413,000 --
Payments to existing stockholders -- (74,015,000) --
Extinguishments of notes payable and capital leases -- (23,159,000) --
Payment for deferred financing costs -- (1,895,000) --
Costs of merger with PWT Acquisition Corp. and recapitalization -- (2,954,000) --
Repayment of loans payable to officers and stockholder (211,000) -- --
--------------------------------------------------
Net cash provided by financing activities 3,658,000 41,631,000 161,979,000
--------------------------------------------------
Net increase in cash and cash equivalents 2,915,000 11,633,000 67,452,000
CASH AND CASH EQUIVALENTS:
Beginning of year 688,000 3,603,000 15,236,000
--------------------------------------------------
End of year $ 3,603,000 $ 15,236,000 $ 82,688,000
==================================================
The accompanying notes are an integral part of these financial statements.
F-7
PAC-WEST TELECOMM, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. ORGANIZATION:
Pac-West Telecomm, Inc. (the Company) is a rapidly-growing provider of
integrated communications services in the western United States. The Company's
customers include Internet Service Providers (ISPs), small and medium businesses
and enhanced communications service providers, many of which are communications
intensive users.
The Company was incorporated in May 1996 in the state of California as a wholly
owned subsidiary of CalPage (a telephone, answering and paging services
company), also formerly named Pac-West Telecomm, Inc. CalPage transferred its
telephone and answering service divisions to the Company effective September 30,
1996 (the Initial Transfer).
During 1997, the Company sold the customer base and other assets of its
answering service division (see Note 10).
The success of the Company is dependent upon several factors. These factors
include the Company's ability to penetrate additional markets and to manage
network growth and technological change within the telecommunications industry,
the successful implementation of local and enhanced services to its customers
and ISPs, and competition from preexisting and new providers of local and long-
distance services, as well as positive and timely responses regarding
governmental regulations.
On September 16, 1998, the Company completed a merger with PWT Acquisition Corp.
(PWT) and a recapitalization of the Company (the Transaction). PWT was formed
by a group of investors (the New Stockholders) for the purpose of injecting
additional equity into the Company and effecting the recapitalization. In
connection with the Transaction, PWT was merged into the Company, with the
Company being the surviving corporation. In connection with the Transaction,
the existing stockholders of the Company, received cash payments of
approximately $74 million, as well as shares of newly issued preferred and
common stock of the Company in exchange for a substantial portion of their
ownership interests. Additionally, at the consummation of the Transaction, the
Company paid transaction bonuses and consultant's costs totaling approximately
$3.8 million, which are included in the accompanying statements of operations.
Under the terms of the Transaction, the existing stockholders of the Company
were entitled to receive additional consideration up to $20 million in the event
that certain billings under dispute were received subsequent to the
recapitalization (see Note 5). After consummation of the Transaction, the
existing stockholders continue to hold approximately 28 percent of the issued
and outstanding common stock of the Company. As a result of the continued
significant ownership interests of the existing stockholders, no adjustments
have been made to the historical carrying amounts of the Company's assets and
liabilities as a result of the Transaction.
On November 9, 1999, the Company consummated an initial public offering of its
common stock. A total of 12,765,000 shares were issued in connection with the
offering resulting in net proceeds after underwriters' discount and expenses of
approximately $118.1 million. In addition, concurrent with the offering, all
outstanding preferred stock and related accrued cumulative dividends were
converted into 5,040,868 shares of the Company's common stock.
F-8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Concentration of Customers and Suppliers
The relative concentrations of customers and suppliers of the Company are:
1997 1998 1999
---------------------------
Revenues (percent of revenues): Incumbent Local Exchange
Carriers (ILECs, see Note 5) 37% 37% 58%
Suppliers (percent of operating costs): largest supplier 44% 50% 49%
In 1997, 1998 and 1999, the Company's largest supplier was also the largest
ILEC.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and the accompanying
notes. Actual results could differ from those estimates.
Regulation and Competition
Rates charged by the Company for certain telephone services are subject to the
approval of various regulatory authorities. Trends in the telecommunications
industry point toward increased competition in virtually all markets and the
continued deregulation or alternative regulation of telecommunications services
in many jurisdictions.
Revenue Recognition
Revenues from the sale of telecommunications products are recognized in the
month in which the service is provided, except for reciprocal compensation
generated by calls placed to ISPs connected through the Company's network. The
rights of competitive local exchange carriers, such as the Company, to receive
this type of compensation is the subject of numerous regulatory and legal
challenges (see Note 5). Until this issue is ultimately resolved, the Company
will continue to recognize this revenue on a cash-received basis.
Revenues from the sale of telecommunications products are recognized upon
installation, or if no installation is required, upon shipment. Initial
non-recurring revenues from the installation of telecommunication products are
recognized upon completion of installation to the extent of direct costs
incurred. Any initial non-recurring installation revenue in excess of direct
costs is deferred and amortized over the expected service contract period,
generally two years or less.
Cash Equivalents
For purposes of reporting cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less from the date of
acquisition to be cash equivalents.
Restricted Cash
Restricted cash represents short-term investments deposited in an interest
reserve trust account to fund the initial interest payments through February 1,
2000 under the $150,000,000 Senior Notes. All such interest payments have been
made.
Short-Term Investments
All investments with an original maturity of greater than three months from the
date of acquisition are accounted for under Financial Accounting Standards Board
(FASB) Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The Company determines the appropriate classification at the time
of purchase. All investments as of December 31, 1999 were classified as
available-for-sale and appropriately carried at fair value. Realized gains and
losses are included in other income, net in the accompanying statements of
operations. Differences between cost and fair value are recorded as unrealized
gains and losses in a separate component of stockholders' equity. As of
December 31, 1999, the cost of these investments approximated market.
Inventories
Inventories consist of telephone equipment, parts and installation materials,
which are valued at the lower of cost or market. Cost is determined by the
average-cost method. Provision is made to reduce slow moving inventory to
reflect its estimated net realizable value.
F-9
Equipment, Vehicles and Leasehold Improvements
Equipment, vehicles and leasehold improvements are stated at cost and include
network and other communication equipment, office furniture and equipment,
vehicles, leasehold improvements, projects -in progress and equipment deposits.
Equipment includes assets acquired under capital leases. Expenditures for
maintenance are charged to expense as incurred. Upon retirement, the asset cost
and related accumulated depreciation are relieved from the financial statements.
Gains and losses associated with dispositions of equipment, vehicles and
leasehold improvements are reflected as a component of other income, net in the
accompanying statements of operations. Depreciation and amortization is
computed using the straight-line method based on the following estimated useful
lives:
Equipment 3 to 7 years
Vehicles 5 years
Leasehold improvements 10 years or life of lease,
whichever is shorter
The Company capitalizes interest on capital projects when the project involves
considerable time and major expenditures. Such interest is capitalized as part
of the cost of the equipment and leasehold improvement and is amortized over the
remaining life of the assets. Interest is capitalized based on rates for
borrowings that are outstanding over the period required to complete the asset.
In 1998 and 1999, the Company capitalized $303,000 and $2,346,000, respectively,
of interest related to capital projects. Capitalizable interest in 1997 was
insignificant.
Depreciation and amortization of equipment, vehicles and leasehold improvements
was $2,204,000, $4,106,000 and $8,475,000 for the years ended December 31, 1997,
1998 and 1999, respectively.
Included in projects -in progress at December 31, 1998 is $20,828,000 for
deposits paid or payable on equipment not in service at year-end.
Deferred Financing Costs, Net
Deferred financing costs, net consist primarily of capitalized amounts for
underwriter fees, professional fees and other expenses related to the issuance
and subsequent registration of the $150,000,000 Senior Notes. These deferred
financing costs are being amortized on a straight-line basis (which approximates
the effective interest method) over the estimated 10-year term of the notes
beginning January 29, 1999. Other deferred financing costs are for the senior
notes exchange offering and costs relating to the senior credit facility.
Amortization expense for the years ended December 31, 1998 and 1999, was
$1,438,000 and $1,162,000, respectively, and is included within interest expense
in the accompanying statements of operations.
Other Assets
At December 31, other assets consist of the following:
1998 1999
------------------------------
Deferred financing costs $1,195,000 $5,648,000
Acquisition of lease rights -- 1,513,000
Long-term portion of prepaid expenses and deposits -- 849,000
Long-term portion of covenant not to compete 150,000 --
Other 44,000 209,000
------------------------------
$1,389,000 $8,219,000
==============================
During 1999, the Company purchased lease rights of additional space in its Los
Angeles facility. This amount is included in other assets as listed above and
is being amortized over the life of the lease.
Other Accrued Liabilities
Other accrued liabilities include approximately $1,018,000 and $397,000 as of
December 31, 1998 and 1999, respectively, of amounts collected from customers
for taxes due to various governmental and regulatory authorities.
F-10
Supplemental Statements of Cash Flow Information
1997 1998 1999
--------------------------------------
Cash paid during the period for:
Interest (net of amount capitalized) $ 924,000 $ 2,565,000 $8,723,000
Income taxes (net of refunds) 2,351,000 2,195,000 4,499,000
Supplemental disclosure of noncash transactions:
Acquisition of fixed assets using capital lease obligations 4,781,000 290,000 --
Issuance of the Preferred Stock in conjunction with the Transaction -- 13,156,000 --
Refinancing of capital lease obligation with note payable -- 1,599,000 --
Income Taxes
The Company provides for income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." SFAS No.
109 requires the asset and liability method of accounting for income taxes.
Under this method, deferred income taxes are recognized for the tax consequences
of "temporary differences" by applying the applicable statutory tax rate to the
differences between the financial statement carrying amounts and the tax basis
of existing assets and liabilities. Under SFAS No. 109, the effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date based on the applicable tax rate.
Other Comprehensive Income
In September 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes the disclosure requirements for comprehensive
income and its components within the financial statements. There were no items
of other comprehensive income for the years ended December 31, 1997, 1998 and
1999; therefore, comprehensive income is the same as net income (loss) for each
of these years.
Segment Reporting
The Company has adopted Statement of Financial Accounting Standards (SFAS) No.
131, "Disclosures about Segments of an Enterprise and Related Information." As
an integrated telecommunications provider, the Company has one reportable
operating segment. While the Company's chief decision-maker monitors the
revenue streams of various services, operations are managed and financial
performance is evaluated based upon the delivery of multiple services over
common networks and facilities. This allows the Company to leverage its costs
in an effort to maximize return. As a result, there are many shared expenses
generated by the various revenue streams; because management believes that any
allocation of the expenses to multiple revenue streams would be impractical and
arbitrary, management does not currently make such allocations internally. The
chief decision-maker does, however, monitor revenue streams at a more detailed
level than those depicted in the Company's historical general purpose financial
statements.
Specifically, the following table presents revenues by service type:
1997 1998 1999
-----------------------------------------------------
Local services $17,810,000 $28,147,000 $79,071,000
Long-distance services 5,133,000 6,328,000 7,974,000
Dedicated transport services 3,312,000 4,155,000 5,162,000
Products and services 2,073,000 2,104,000 1,485,000
Other 1,223,000 1,477,000 1,813,000
-----------------------------------------------------
$29,551,000 $42,211,000 $95,505,000
=====================================================
Local services revenues for the year ended December 31, 1999 include $26,308,000
of reciprocal compensation settlement payments (Note 5).
F-11
Other Recent Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and for Hedging Activities," effective for fiscal years beginning
after June 15, 1999. Management does not expect adoption of SFAS No. 133 in
future periods to have a significant impact on the Company's financial
statements.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB
101 provides guidance on applying generally accepted accounting principles to
revenue recognition in financial statements, and is effective for us in the
second quarter of 2000. While we believe that SAB 101 will have no material
effect on our current accounting policies, we will evaluate our current policies
to insure that they are in accordance with SAB 101.
Income (Loss) Per Share
Income (loss) per share has been calculated under SFAS No. 128, "Earnings per
Share." SFAS No. 128 requires companies to compute income (loss) per share
under two methods (basic and diluted). Basic net income (loss) per share is
calculated by dividing net income (loss) by the weighted average shares of
common stock outstanding during the period. Diluted net income (loss) per share
information considers the effect of dilutive securities (stock options and
convertible preferred stock) as follows:
For the Year Ended
December 31, 1999
--------------------------------------------------------
Income Shares Per Share
Basic net income per share:
Net income applicable to common stockholders $11,821,000 20,172,968 $0.59
Effect of dilutive securities:
Convertible redeemable preferred stock -- --
Stock options -- 1,120,860
--------------------------------------
Diluted net income per share:
Income available to common stockholders and
assumed conversions $11,821,000 21,293,828 $0.56
======================================
Conversion of the convertible redeemable preferred stock for the years ended
December 31, 1998 and 1999 and the effect of the exercise of stock options for
year ended December 31, 1998 are antidilutive and have been excluded from the
calculation of diluted income (loss) per share. The Company consummated an
initial public offering of its common stock a and conversion of all outstanding
convertible redeemable preferred stock on November 9, 1999 (see Note 1).
Basic and diluted income per share was the same for the year ended December 31,
1997 as there were no convertible preferred stock or stock options outstanding
during 1997.
The Company evaluated the requirements of the Securities and Exchange Commission
Staff Accounting Bulletin (SAB) No. 98 and concluded that there are no nominal
issuances of common stock or potential common stock that would be required to be
shown as outstanding for all periods presented herein as outlined in SAB No. 98.
3. LONG-TERM DEBT AND OTHER LONG-TERM OBLIGATIONS:
Long-term debt and other long-term obligations consisted of the following at
December 31, 1998 and 1999:
1998 1999
-------------------------------------
Senior Notes $ -- $150,000,000
Senior secured borrowings and other long-term obligations 100,000,000 --
Notes payable, less current portion 116,000 17,000
-------------------------------------
$100,116,000 $150,017,000
=====================================
On January 29, 1999, the Company issued $150,000,000 of Senior Notes at par.
The Senior Notes bear interest at 13.5 percent payable in semiannual
installments, with principal due on February 1, 2009.
F-12
Proceeds of the Senior Notes were used to repay $100,000,000 of senior secured
borrowings (including $9,000,000 of other long-term obligations subsequently
financed through senior secured borrowings) and to establish an interest reserve
account to cover initial interest payments due under the Senior Notes through
February 1, 2000.
The Senior Notes carry provisions that allow the Company, at its option, to (i)
redeem up to 35 percent of the notes with proceeds of certain-public offerings
of equity prior to February 1, 2002, (ii) redeem all or part of the notes at
specified prices on or after February 1, 2004, or (iii) offer to exchange the
notes within 180 days from the issue date for a new issue of identical debt
securities registered under the Securities Act of 1933, as amended (the
Securities Act). In August 1999, the Company completed the registration of
these notes under the Securities Act and on September 22, 1999 all of the
unregistered Senior Notes were exchanged for Senior Notes registered under the
Securities Act of 1933.
The basic covenants of these notes restrict (subject to certain limitations) the
Company's future ability to pay dividends, repurchase stock, pledge or sell
assets as security for other transactions, or engage in mergers and business
combinations. The covenants allow the Company to incur additional debt subject
to various limitations.
The Company has a three-year senior credit facility expiring June 15, 2002 that
provides for maximum borrowings of $40 million to finance working capital, the
cost of the Company's planned capital expansion and other corporate
transactions. The borrowings are secured by substantially all of the Company's
assets. Borrowings under this senior credit facility will bear interest, at the
Company's option, at (1) the Base Rate (as defined) or (2) the LIBOR Rate (as
defined) plus between 2.25 percent and 3.5 percent. As of December 31, 1999,
there were no amounts outstanding under this facility and the borrowing rate
would have been 9.25 percent. The credit facility requires the Company to meet
certain financial tests, including, without limitation, maximum levels of debt
as a ratio of earnings before interest, taxes, depreciation and amortization (as
defined), minimum interest coverage and maximum amount of capital expenditures.
The credit facility contains certain covenants which, among other things limit
the incurrence of additional indebtedness, investments, dividends, transactions
with affiliates, asset sales, acquisitions, mergers and consolidations,
prepayments of other indebtedness (including the Senior Notes), liens and
encumbrances and other matters customarily restricted in such agreements, unless
specific consent is obtained.
At December 31, 1998 and 1999, notes payable consisted of contracts payable to
banks and finance companies for vehicles, requiring monthly principal and
interest payments of $602 to $1,510 at interest rates from 0.9 percent to 8.2
percent due through June 2001. Notes payable are secured by Company owned
vehicles. Future principal payments consist of $99,000 and $17,000 in 2000 and
2001, respectively.
4. EXTRAORDINARY ITEM--LOSS ON EARLY EXTINGUISHMENT OF DEBT:
In conjunction with the Transaction (see Note 1) and the receipt of the senior
secured borrowings during 1998, as discussed in Note 3, the Company repaid
certain amounts outstanding under notes payable and capital leases for
equipment. The resulting loss in 1998 from the early extinguishment of the debt
of $695,000, less the applicable income tax benefit of $278,000, has been
reflected as an extraordinary item in the accompanying statements of operations
for the year ended December 31, 1998.
5. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases its five principal facilities in Stockton, Oakland, Los
Angeles, Las Vegas and Seattle pursuant to noncancellable operating leases that
expire in June 2002, November 2003, September 2006, August 2009 and December
2009, respectively. The lease expiring in June 2002 also contains five two-year
renewal options. The leases expiring in November 2003, September 2006, August
2009 and December 2009 also contain two five-year renewal options. The Company
also leases telephone equipment sites and telephone circuits on month-to-month,
annual and long-term noncancellable leases. Management of the Company expects
that these leases will be renewed or replaced by other leases in the normal
course of business.
F-13
The Company's future minimum lease payments with initial terms in excess of one
year as of December 31, 1999, are as follows:
Operating Leases
-------------------------------
Telephone
Circuits and
Space Equipment
-------------------------------
2000 $ 1,650,000 $ 6,894,000
2001 1,584,000 6,535,000
2002 1,400,000 4,805,000
2003 1,113,000 3,105,000
2004 1,043,000 1,462,000
2005 and thereafter 3,362,000 --
-------------------------------
$10,152,000 $22,801,000
===============================
Rental expense charged to operations for the years ended December 31, 1997, 1998
and 1999, for all operating leases for space was $432,000, $650,000 and
$1,260,000, respectively, and is included in selling, general and administrative
expense in the accompanying statements of operations. Rental expense charged to
operations for telephone circuits of approximately $6,000,000, $9,935,000 and
$12,729,000 for the years ended December 31, 1997, 1998 and 1999, respectively,
is included in operating costs in the accompanying statements of operations.
Rental expense paid to related parties was approximately $ -0-, $35,000 and
$163,000 for the years ended December 31, 1997, 1998 and 1999, respectively.
Purchase Commitments
At December 31, 1999, the Company has approximately $19,000,000 of purchase
orders outstanding for network equipment due for delivery during 2000. These
purchase orders are cancelable up to 60 days prior to delivery without penalty
and are expected to be financed from the proceeds received from the Senior
Notes, from internally generated cash flows, from borrowings under the senior
credit facility or from proceeds from the Company's initial public offering
consummated November 9, 1999.
In addition, the Company is in the process of implementing a new billing and
operations support system. Total estimated costs for this system aggregate
approximately $16,500,000 of which approximately $9,000,000 was incurred in
1999, $6,000,000 is estimated to be incurred in 2000 and $1,500,000 in 2001.
All of the amounts incurred in 1999 are recorded in projects in progress at
December 31, 1999.
During 1998 and 1999, the Company purchased approximately 50 percent and 56
percent of total fixed assets, respectively, from a single vendor.
Employment Agreements
The Company has entered into employment agreements with certain key executives
that provide for minimum annual base salaries, bonus entitlements upon the
achievement of certain objectives, and the issuance of stock options.
These employment agreements, which were approved by the Company's stockholders
in 1998 in connection with the Transaction (see Note 1), granted options to two
executives to purchase up to 568,750 shares of the Company's common stock. The
exercise price of these options of $0.48 per share approximated the fair market
value of the Company's common stock at the date of grant. These options vest
over various dates through October 2001 and expire at various dates through
October 2008 (see Note 6.
The employment agreements were effective as of or subsequent to the close of the
Transaction and have terms varying from one to three years; however, they may be
terminated by either party at an earlier date under certain circumstances. As
of December 31, 1998 and 1999, the Company accrued approximately $304,000 and
$811,000 in accrued payroll and related expenses in the accompanying balance
sheets for bonuses payable under these agreements.
F-14
Revenue Recognition and Legal Proceedings
The Company has established interconnection agreements with certain Incumbent
Local Exchange Carriers (ILECs). The Telecommunications Act of 1996 requires
ILECs to enter into interconnection agreements with Competitive Local Exchange
Companies (CLECs, such as the Company) and other competitors and requires state
Public Utilities Commissions (PUCs) to arbitrate such agreements.
The interconnection agreements outline, among other items, compensation
arrangements for calls originating or terminating in the other party's switching
equipment, payment terms, and level of services.
Various ILECs have disputed, and are continuing to dispute, that internet
traffic calls made to an ISP are not local calls, and as such are not covered by
the interconnection agreements. Further, two ILECs with which the Company has
interconnection agreements had withheld payments from amounts billed by the
Company under their agreements since August 1997, and have filed complaints with
the Superior Court of the State of California and the California and Nevada
Public Utility Commissions (PUC's). The Superior Court ordered the complaint
stayed pending the California PUC's review of the issues raised by the
complaint.
In February 1999, the Federal Communications Commission (FCC) issued a
Declaratory Ruling on the issue of reciprocal compensation for calls bound to
ISPs. The FCC ruled that the calls are jurisdictionally interstate calls. The
FCC, however, determined that this issue did not resolve the question of whether
reciprocal compensation is owed. The FCC noted a number of factors that would
allow the state PUCs to leave their decisions requiring the payment of
compensation undisturbed.
On June 24, 1999, the California PUC adopted a decision in the arbitration
proceeding between the Company and Pacific Bell which held that reciprocal
compensation would be payable for ISP calls under the new interconnection
agreement with Pacific Bell which became effective on June 29, 1999. Pacific
Bell has requested a rehearing of the decision, although Pacific Bell has paid
the full amount of billings for calls since the effective date of the new
agreement.
On September 9, 1999, the Company entered into a settlement agreement with
Pacific Bell regarding its claims for unpaid reciprocal compensation under their
prior interconnection agreement. Under the terms of the settlement agreement,
Pacific Bell agreed to pay $20.0 million to the Company and $20.0 million to
certain stockholders of the Company as of the date of the recapitalization (see
Note 1), in settlement of those claims. As a result of these payments, the
terms of the September 1998 recapitalization requiring additional distribution
to certain shareholders have been satisfied.
On September 2, 1999, Nevada Bell named the Company and others as defendants in
a suit to reverse the decision of the Public Utilities Commission of Nevada.
The Company is contesting the claims of Nevada Bell and no assurances can be
given concerning the outcome of this case or any resulting appeal.
On August 25, 1999, the Company along with the commissioners of the California
Public Utilities Commission and others, were named as a defendant in an action
filed by GTE California (GTE). The action challenges the legality of the
California Public Utilities Commission's decision regarding requiring reciprocal
compensation for traffic termination to ISPs. GTE argues that such calls to
ISPs are not local calls within the meaning of its agreement with the Company
even though they are dialed and billed as local calls. The Company is
contesting the claims of GTE.
In October 1999, GTE paid, and the Company recorded as revenue, $6,308,000 of
reciprocal compensation that GTE had preciously withheld. GTE has not waived
its rights to appeal, contest and seek subsequent reimbursements of amounts paid
for reciprocal compensation.
In February 2000, the California Public Utilities Commission commenced a
separate generic proceeding to develop its policy regarding reciprocal
compensation.
The Company cannot predict the impact of the FCC's ruling on existing state
decisions or the outcome of pending appeals or on additional cases in this
matter. Given the uncertainty concerning the final outcome of the PUC
proceedings, the possibility of future extended appeals or additional
litigation, and future decisions by the FCC, the Company continues to record the
revenue associated with reciprocal compensation billings to ILECs on a cash-
received basis.
F-15
The amounts withheld by the two ILECs which had withheld payments from amounts
billed by the Company under their agreements during the years ended December 31,
1997, 1998 and 1999 are as follows:
1997 1998 1999
--------------------------------------------
Total amount billed to specified ILECs during the year $14,858,000 $ 48,264,000 $ 58,866,000
Amount withheld by specified ILECs and not recorded as revenue in (3,793,000) (32,845,000) (29,855,000)
the Company's statements of operations
Amounts received for prior withholding and recorded as revenue -- 254,000 26,308,000
--------------------------------------------
Net amount recorded as revenue from the specified ILECs
during the year $11,065,000 $ 15,673,000 $ 55,319,000
============================================
6. STOCKHOLDERS' EQUITY:
Common Stock
In connection with the transactions in September 1998, certain stockholders of
the Company entered into a Registration Agreement, whereby at any time prior to
September 26, 2001, one of the stockholders of the Company may request that the
Company grant holders of the common stock of that stockholder the right to
purchase a certain number of shares of the Company's common stock (the "Rights
Offering"). The Rights Offering, covering 924,165 shares offered from the
stockholder to its shareholders, was consummated in connection with the initial
public offering of the Company's common stock in November 1999. Following 180
days after the Rights Offering, subject to certain limitations, stockholders of
the Company who are party to the Registration Agreement may request that the
Company register all or any portion of such stockholder's common stock in the
Company with the Securities and Exchange Commission (SEC). In addition, the
Registration Agreement provides that, subject to certain limitations, the
parties to the Registration Agreement and certain transferors of common stock
originally issued to the parties of the Registration Agreement may request that
the Company include any common stock held by such persons or entities with any
of the Company's common stock that the Company proposes to register.
Stock Split
On March 19, 1999, the Board of Directors authorized a ten-for-one split of the
Company's authorized and outstanding common stock and preferred stock. On
October 7, 1999, the Board of Directors authorized a 1.4-for-1 split of the
Company's outstanding common and preferred stock. In addition, on October 7,
1999, the Board of Directors approved a resolution to increase the authorized
shares of common stock to 50,000,000 shares. All share and per share data have
been restated to reflect these stock splits.
Convertible Redeemable Preferred Stock
The preferred stock has preference over common stock in liquidation equal to its
liquidation value of $25.72 per share, plus accrued dividends computed at a 10
percent rate, compounded quarterly (collectively, the Preference Amount). After
payment of the Preference Amount, the preferred stock and the common stock share
ratably in any distributions by the Company. As of the date of the initial
public offering in November 1999, all of the outstanding preferred stock and
cumulative dividends then outstanding were converted into common stock.
Stock Options
In January 1999, the Company's Board of Directors approved the terms of the 1999
Stock Incentive Plan (the "Plan") which authorizes the granting of stock
options, including restricted stock, stock appreciation rights, dividend
equivalent rights, performance units, performance shares or other similar rights
or benefits to employees, directors, consultants and advisors. Options granted
under the Plan have a term of ten years. In addition, options have been granted
to two senior officers outside of the 1999 Plan but governed by the rules of the
1999 plan. An aggregate of 3,150,000 shares of common stock have been reserved
for option grants.
F-16
A summary of the status of the Company's stock options plan at December 31, 1999
and changes during the years ended December 31, 1998 and 1999 are presented in
the table below:
Weighted
Weighted Average
Average Fair Value
Exercise Of Options
Outstanding Nonqualifying Total Price Granted
---------------------------------------------------------------------
Balance, December 31, 1997 -- -- -- --
Granted -- 568,750 568,750 $0.48 $0.08
----------------------------------------------
Balance, December 31, 1998 -- 568,750 568,750 0.48
Granted 1,325,865 366,335 1,692,200 5.06 3.00
Cancelled (36,300) -- (36,300) 2.57
----------------------------------------------
Balance, December 31, 1999 1,289,565 935,085 2,224,650 3.93
==============================================
Options outstanding, exercisable and vested by price rage at December 31, 1999
are as follows:
Number
Range of Number Weighted Average Vested and
Exercise Price Outstanding Contractual Life Exercisable
-----------------------------------------------------------------------------
$ 0.48 568,750 8.8 422,917
2.14 1,215,900 9.3 --
10.00 319,000 9.8 224,000
22.06 121,000 9.9 --
--------------- ---------------
2,224,650 646,917
=============== ===============
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Had compensation expense for the
Plan been determined based on the fair value at the grant dates, as prescribed
in SFAS No. 123, the Company's earnings and earnings per share would have been
as follows:
1997 1998 1999
--------------------------------------------
Net income (loss) attributable to common shareholders:
As reported $4,495,000 $(1,991,000) $11,821,000
Pro forma 4,495,000 (2,020,000) 11,423,000
Basic earnings per common share
As reported $ 32.11 $ (0.38) $ 0.59
Pro forma 32.11 (0.38) 0.57
Diluted earrings per common share:
As reported 32.11 (0.38) 0.56
Pro forma 32.11 (0.38) 0.54
The fair value of each option was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions used for the
grants: expected dividend yield of 0 percent in all periods; expected volatility
of 74 percent for 1999 and 0 percent for 1997 and 1998; weighted average risk-
free interest rates ranging from 4.9 percent to 6.17 percent for all periods
presented in the table above; and expected lives of four years for all periods.
F-17
7. INCOME TAXES:
The provision for income taxes consists of the following:
1997 1998 1999
----------------------------------------------------
Current:
Federal $1,783,000 $ 353,000 $ 6,795,000
State 503,000 245,000 --
Deferred:
Federal 546,000 861,000 5,595,000
State 165,000 102,000 721,000
----------------------------------------------------
$2,997,000 $1,561,000 $13,111,000
====================================================
The Company's provision for income tax differed from the amount computed by
applying the statutory federal income tax rate to income before income taxes and
extraordinary item, as follows:
1997 Rate 1998 Rate 1999 Rate
------------------------------------------------------------------------
Income tax determined by applying the statutory
federal income tax rate to income before income
taxes and extraordinary item $2,547,000 33.9% $ 446,000 34.0% $10,156,000 35.0%
State income taxes, net of federal income tax
benefit 450,000 6.0 230,000 17.5 470,000 1.6
Federal income tax effect of nondeductible costs
related to the Transaction (see Note 1) -- -- 885,000 67.6 -- --
Reciprocal compensation settlement -- -- -- -- 1,500,000 5.2
Changes in reserves -- -- -- -- 936,000 3.2
Other -- -- -- -- 49,000 0.2
------------------------------------------------------------------------
Provision for income taxes $2,997,000 39.9% $1,561,000 119.1% $13,111,000 45.2%
========================================================================
The cumulative balance sheet effects of deferred tax items are:
1997 1998 1999
------------------------------------------------------
Trade accounts receivable allowances $ 129,000 $ 171,000 $ 173,000
Vacation and other accrued expenses 26,000 76,000 130,000
Inventory reserves 46,000 46,000 95,000
Tax credits -- 876,000 151,000
State taxes 250,000 163,000 152,000
------------------------------------------------------
Deferred tax assets 451,000 1,332,000 701,000
------------------------------------------------------
Depreciation and amortization (1,097,000) (2,834,000) (5,982,000)
Capitalized interest -- (130,000) (884,000)
Reciprocal compensation settlement -- -- (980,000)
Other reserves (128,000) (105,000) (2,068,000)
------------------------------------------------------
Deferred tax liabilities (1,225,000) (3,069,000) (9,914,000)
------------------------------------------------------
Net deferred tax liability (774,000) (1,737,000) (9,213,000)
Less: Amount classified as current deferred tax asset 160,000 151,000 580,000
------------------------------------------------------
Net noncurrent deferred tax liability $ (934,000) $(1,888,000) $(8,633,000)
======================================================
F-18
Tax credits of $876,000 and $151,000, shown above, represent unused tax credits
associated with the payment of Alternative Minimum Tax (AMT) as of December 31,
1998 and 1999, respectively. Such credits, which do not expire, may be used to
offset future income taxes payable.
8. RELATED-PARTY TRANSACTIONS:
Bay Alarm Company (Bay Alarm)
Bay Alarm (a stockholder of the Company) and its subsidiary, InReach Internet,
LLC, are collectively one of the Company's largest customers of telephone
network services, comprising approximately $2,109,000, $2,680,000 and
$2,667,000, or 7.1 percent, 6.3 percent and 2.8 percent, of the Company's
revenues for the years ended December 31, 1997, 1998 and 1999, respectively.
The Company also had amounts due from Bay Alarm at December 31, 1998 and 1999.
These amounts are included in accounts receivable from related parties in the
accompanying balance sheets.
Bay Alarm provides the Company with security monitoring services at its normal
commercial rates. The Company has recorded $48,000, $58,000 and $60,000 as
selling, general and administrative expense for these services for the years
ended December 31, 1997, 1998 and 1999, respectively.
As outlined in Note 5, the Company leases its facility in Oakland from Bay
Alarm. In addition to rent paid under this lease, the company recorded selling,
general and administrative expense of $0, $59,000 and $35,000 for the years
ended 1997, 1998 and 1999, respectively, for related utility charges. In May
1999, the Company restructured the agreement to allow for direct payments to the
utility company.
Notes Receivable from Stockholder
In connection with the Transaction, a stockholder of the Company, who is also an
officer, purchased 37,500 shares of common stock from the Company for $250,000.
The Company received $50,000 in cash from the stockholder and entered into a
note receivable for the remaining balance of $200,000. Subsequent to the
Transaction, another officer of the Company acquired 6,247 shares of common
stock for $42,000. The Company received $9,000 in cash and entered into a note
receivable for the remaining $33,000 due from the officer. The notes accrue
interest at 5.54 percent and 5.12 percent, respectively, compounded annually,
with any unpaid accrued interest and principal due at the earlier of (1) the
sale of the above stock with proceeds received first applied to unpaid interest,
then to principal; (2) sale of the Company; (3) 60 days from the date the
stockholder is no longer an employee of the Company or a subsidiary; or (4)
September 16, 2003 and October 16, 2003, respectively.
9. RETIREMENT PLAN:
In October 1996, the Company adopted a 401(k) retirement plan (the Plan) for all
full-time employees who have completed six months of service. The plan year is
from January 1 to December 31, and the Company will contribute $0.50 for every
$1.00 contributed by the employee, subject to the Company's contribution not
exceeding 3 percent of the employee's salary. Participants become fully vested
after six years of service, although they vest incrementally on an annual basis
after two years of service and until the six-year period is completed. The
Company recorded selling, general and administrative expense of $63,000, $58,000
and $134,000 for the years ended December 31, 1997, 1998 and 1999, respectively,
for the Company's matching contributions.
Employees of the Company previously contributing to the CalPage 401(k)
retirement plan (with identical provisions to the Plan) were able to roll their
accumulated benefits into the Plan at date of commencement (October 1, 1996),
with all prior employer contributions becoming fully vested on the date of
rollover.
10. SALE OF ANSWERING SERVICE DIVISION:
In March 1997, the Company sold the customer base and other assets of its
answering service division for $420,000, payable $200,000 in cash and a
promissory note of $220,000. The promissory note was paid in October 1997 at a
discount of $18,000. The Company recognized a net gain of $385,000 on the sale
in the year ended December 31, 1997.
F-19
Exhibit Index
Exhibit
Number Description
------ -----------
2.1 Agreement of Merger, dated September 16, 1998, between PWT
Acquisition Corp. and Pac-West Telecomm, Inc., as amended
(Incorporated by reference to Exhibit 2.1 to the Registrant's
Registration Statement (No. 333-76779)).
2.2 Agreement and Plan of Merger, dated June 30, 1998, between PWT
Acquisition Corp., Pac-West Telecomm, Inc., Bay Alarm Company and
John K. La Rue, as amended (Incorporated by reference to Exhibit
2.2 to the Registrant's Registration Statement (No. 333-76779))
3.1(a) Amended and Restated Articles of Incorporation of Pac-West
Telecomm, Inc. (Incorporated by reference to Exhibit 3.1(a) to the
Registrant's Registration Statement (No. 333-86607)).
3.1(b) Certificate of Amendment of Articles of Incorporation
(Incorporated by reference to Exhibit 3.1(b) to the Registrant's
Registration Statement (No. 333-86607)).
3.2 Bylaws of the Company (Incorporated by reference to Exhibit 3.2 to
the Company's Registration Statement on Form S-1 (Reg. No. 333-
86607)).
4.1 Form of certificate representing common stock of Pac-West
Telecomm, Inc. (Incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement (No. 333-86607)).
10.1 Shareholders Agreement, dated September 16, 1998, between Pac-
West, John K. La Rue, Bay Alarm Company, certain named investors
and certain named executives (Incorporated by reference to Exhibit
10.1 to the Registrant's Registration Statement (No. 333-76779)).
10.2 Registration Rights Agreement, dated September 16, 1998, between
Pac-West, John K. LaRue, Bay Alarm Company, certain investors and
certain executives (Incorporated by reference to Exhibit 10.2 to
the Registrant's Registration Statement (No. 333-86607)).
10.3 Stock Purchase Agreement, dated September 16, 1998, between PWT
Acquisition Corp. and certain named investors (Incorporated by
reference to Exhibit 10.3 to the Registrant's Registration
Statement (No. 333-76779)).
10.4 Stock Purchase Agreement, dated September 16, 1998, between Pac-
West and certain named investors (Incorporated by reference to
Exhibit 10.4 to the Registrant's Registration Statement (No. 333-
76779)).
10.5 Pledge and Security Agreement, dated January 29, 1999, between
Pac-West and Norwest Bank Minnesota, N.A. (Incorporated by
reference to Exhibit 10.5 to the Registrant's Registration
Statement (No. 333-76779)).
**10.6(a) Pac-West Telecomm, Inc. 1999 Stock Incentive Plan (Incorporated by
reference to Exhibit 10.6(a) to the Registrant's Registration
Statement (No. 333-76779)).
**10.6(b) Pac-West Telecomm, Inc. 1999 Stock Incentive Plan form of notice
of Stock Option Award and Stock Option Award Agreement between
Pac-West and its grantees as designated (Incorporated by reference
to Exhibit 10.6(b) to the Registrant's Registration Statement (No.
333-76779)).
**10.7 Employment Agreement, dated June 30, 1998, between Pac-West and
John K. La Rue (Incorporated by reference to Exhibit 10.7 to the
Registrant's Registration Statement (No. 333-76779)).
**10.8 Executive Agreement, dated September 16, 1998, between Pac-West
and Wallace W. Griffin (Incorporated by reference to Exhibit 10.8
to the Registrant's Registration Statement (No. 333-76779)).
**10.9 Executive Agreement, dated October 30, 1998, between Pac-West and
Richard E. Bryson (Incorporated by reference to Exhibit 10.9 to
the Registrant's Registration Statement (No. 333-76779)).
**10.10 Employment Agreement, dated October 21, 1998, between Pac-West and
Dennis V. Meyer (Incorporated by reference to Exhibit 10.10 to the
Registrant's Registration Statement (No. 333-76779)).
**10.11 Employment Agreement, dated September 14, 1998, between Pac-West
and Jason R. Mills (Incorporated by reference to Exhibit 10.11 to
the Registrant's Registration Statement (No. 333-76779)).
**10.12 Confidentiality Agreement, dated September 16, 1998, between Pac-
West and John K. La Rue (Incorporated by reference to Exhibit
10.12 to the Registrant's Registration Statement (No. 333-76779)).
**10.13 Confidentiality Agreement, dated September 16, 1998, between Pac-
West and Wallace W. Griffin (Incorporated by reference to Exhibit
10.13 to the Registrant's Registration Statement (No. 333-76779)).
**10.14 Confidentiality Agreement, dated September 16, 1998, between Pac-
West and Richard E. Bryson (Incorporated by reference to Exhibit
10.14 to the Registrant's Registration Statement (No. 333-76779)).
**10.15 Confidentiality Agreement, dated October 22, 1998, between Pac-
West and Dennis V. Meyer (Incorporated by reference to Exhibit
10.15 to the Registrant's Registration Statement (No. 333-76779)).
**10.16 Confidentiality Agreement, dated September 16, 1998, between Pac-
West and Jason R. Mills (Incorporated by reference to Exhibit
10.16 to the Registrant's Registration Statement (No. 333-76779)).
10.17 Lease Agreement, dated as of June 23, 1995, as amended, by and
between Geremia Brothers and Pac-West for 4202 and 4210 Coronado
Avenue, Stockton, California (Incorporated by reference to Exhibit
10.17 to the Registrant's Registration Statement (No. 333-76779)).
10.18 Lease Agreement, dated as of July 3, 1996, as amended, by and
between One Wilshire Arcade Imperial, Ltd., Paramount Group, Inc.
and Pac-West for 624 South Grand Avenue, Los Angeles, California
(Incorporated by reference to Exhibit 10.18 to the Registrant's
Registration Statement (No. 333-76779)).
10.19 Balco Properties Office Lease, dated as of November 10, 1998, by
and between BalcoProperties and Pac-West for Franklin Building,
1624 Franklin Street, Suites 40, 100, Mezzanine, 201, 203, 210,
214 and 222, Oakland, California (Incorporated by reference to
Exhibit 10.19 to the Registrant's Registration Statement (No. 333-
76779)).
10.20 Lease Agreement, dated as of December 17, 1998, by and between
Wing Fong & Associates LLC and Pac-West for 302 and 304 East
Carson Street, Las Vegas, Nevada (Incorporated by reference to
Exhibit 10.20 to the Registrant's Registration Statement (No. 333-
76779)).
**10.21 Promissory Note, dated September 16, 1998, between Pac-West and
Wallace W, Griffin, and related Executive Stock Pledge Agreement
between same parties of even date (Incorporated by reference to
Exhibit 10.21 to the Registrant's Registration Statement (No.
333-75779)).
**10.22 Promissory Note, dated October 30, 1998, between Pac-West and
Richard Bryson, and related Executive Stock Pledge Agreement
between same parties of even date (Incorporated by reference to
Exhibit 10.22 to the Registrant's Registration Statement (No. 333-
76779)).
10.23(a) Loan and Security Agreement dated June 15, 1999, between Pac-West,
Union Bank of California and other lenders as designated
(Incorporated by reference to Exhibit 10.23(a) to the Registrant's
Registration Statement (No. 333-86607)).
10.23(b) Form of Addition of Lender and Consent and Amendment to Loan and
Security Agreement (Incorporated by reference to Exhibit 10.23(b)
to the Registrant's Registration Statement (No. 333-86607)).
10.24 Interconnection Agreement under Sections 251 and 252 of the
Telecommunications Act of 1996, dated June 29, 1999, between Pac-
West and Pacific Bell, and related Errata to Approved
Interconnection Agreement dated June 30, 1999 (Incorporated by
reference to Exhibit 10.24 to the Registrant's Registration
Statement (No. 333-76779)).
10.25 Telecommunication Facility Interconnection Agreement, dated June
21, 1996, between Pac-West and GTE California Inc. (Incorporated
by reference to Exhibit 10.25 to the Registrant's Registration
Statement (No. 333-76779)).
10.26 Master Interconnection and Resale Agreement for the State of
Nevada, dated January 15,1999, between Pac-West and The Nevada
Division of Central Telephone Company d/b/a Sprint of Nevada
(Incorporated by reference to Exhibit 10.26 to the Registrant's
Registration Statement (No. 333-76779)).
10.27 Indenture, dated January 29, 1999 between Pac-West Telecomm, Inc.
and Norwest Bank Minnesota, N.A., pursuant to which the Series B
131/2% Notes due 2009 will be issued (Incorporated by reference to
Exhibit 10.27 to the Registrant's Registration Statement (No. 333-
76779)).
10.28 Registration Rights Agreement, dated January 29, 1999 between Pac-
West Telecomm, Inc. and Nations Banc Montgomery Securities LLC,
CIBC Oppenheimer Corp. and First Union Capital Markets, as initial
purchasers of notes (Incorporated by reference to Exhibit 10.28 to
the Registrant's Registration Statement (No. 333-76779)).
**10.29 Employment Agreement, dated September 11, 1998, between Pac-West
and Gregory Joksch (Incorporated by reference to Exhibit 10.29 to
the Registrant's Registration Statement (No. 333-86607)).
**10.30 Confidentiality Agreement, dated September 11, 1998 between Pac-
West and Gregory Joksch (Incorporated by reference to Exhibit
10.30 to the Registrant's Registration Statement (No. 333-86607)).
*10.31 Agreement for Local Wireline Network Interconnection and Service
Resale between Pac-West Telecomm, Inc. and U.S. West
Communiations, Inc. for the State of Washington executed September
2, 1999.
*10.32 Agreement for Local Wireline Network Interconnection Between
Citizens Telecommunication Company of California, Inc. and Pac-
West Telecomm, Inc. dated November 1, 1999.
*10.33 Agreement for Local Wireline Network Interconnection and Service
Resale Between Pac-West Telecomm, Inc. and US West Communications,
Inc. for the State of Arizona dated September 2, 1999.
*10.35 Lease Agreement, dated as of September 10, 1999, by and between
David A. and Sandra L. Sabey and Pac-West Telecomm, Inc. for 12201
Tukwila International Blvd., Building B, Second Floor, Tukwila,
Washington.
*23.1 Consent of Arthur Andersen LLP
*27.1 Financial Data Schedule
* Newly Filed
** Management contract or compensatory plan or arrangement