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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, 2000 or
[_] Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
Commission File Number: 000-27743
PAC-WEST TELECOMM, INC.
(Exact name of registrant as specified in its charter)
California 68-0383568
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1776 W. March Lane, Ste. 250, Stockton, California 95207
(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,
2001 as reported on the Nasdaq National Market System, was approximately
$76,184,179. 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, 2001 Registrant had outstanding 36,001,488 shares of common
stock.
Documents Incorporated by Reference
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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;
. maintain and obtain sufficient leased transport capacity;
. effectively manage our working capital, including investments,
accounts receivable and inventory;
. 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 acquisitions and expansions;
. generate sufficient cash to service our indebtedness;
. have sufficient funds available to expand our business; and
. prevent interruption of services from system failures or power
outages.
2
We conduct a substantial amount of our operations in California and rely on
a continuous supply of power to conduct our operations. Although we have short-
term back-up plans and equipment for temporary outages, California's current
energy crisis could substantially disrupt our operations and increase our
expenses. The California Public Utilities Commission has recently approved
substantial rate increases. In addition, California has recently implemented,
and may continue to implement, rolling blackouts throughout the state. Although
state lawmakers are working to mimimize the impact and find solutions to rolling
blackouts, if blackouts interrupt our power supply we may be temporarily unable
to continue operations at our California facilities. Any such interruption in
our ability to provide service could damage our relationship with our customers
and have a negative impact on our operating results.
3
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-sized 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-sized businesses
for customized and integrated voice and data 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-sized 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-sized businesses and the
ability to provide competitively priced services.
We currently own and operate switches in, or near, Los Angeles (two
switches), Oakland and Stockton, California, Las Vegas, Nevada, Phoenix,
Arizona, Seattle, Washington, Denver, Colorado and Salt Lake City, Utah, with
digital connections in most local access and transport areas in these states. In
addition, in 2001, we plan to offer statewide coverage throughout most of the
local access and transport areas in Idaho, New Mexico and Oregon. Initially, we
intend to serve Idaho, New Mexico and Oregon through our existing switching
sites and new switching facilities near Salt Lake City, Utah and Phoenix,
Arizona, which were completed at the end of 2000. 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-sized 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 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.
4
Accordingly, during 2000, we entered into an Indeafeasible Right of Use (IRU)
agreement for dedicated fiber optics circuits of OC-48 capacity connecting major
metropolitan areas in California.
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, 2000, we had an installed capacity of 672,000 ports in
California, Nevada, Washington, Colorado, Arizona and Utah. We expect to have
eleven switches with operations in nine western states by the end of 2001, with
statewide local coverage in each of our target markets. During 2000, we
increased the capacity of our switching facilities in Los Angeles, Oakland and
Stockton and built switching sites in Phoenix, Arizona and near Denver, Colorado
and Salt Lake City, Utah. We are in the process of adding additional switches in
Los Angeles and Oakland, California.
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
continue to purchase, as we did in 2000, long-term rights of use in high
capacity dark fiber transport lines or IRU's. We believe that our broad market
coverage results in:
. 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;
. a higher volume of communications traffic both originating and
terminating on our network, which should result in improved operating
margins;
. enhanced reliability at competitive prices;
. the ability to leverage our investment in high capacity switching
equipment and electronics; and
. the opportunity for our network to provide backhaul carriage for other
telecommunications service providers, such as long distance and
wireless carriers.
5
Interconnection. We presently have interconnection agreements with Pacific
Bell, GTE, Roseville and Citizens Telecommunication 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, US West in Arizona, Utah, Idaho and
Colorado, and Sprint Spectrum L.P. We are currently negotiating and implementing
new interconnection agreements and the terms of the related reciprocal
compensation obligations. Our current agreements 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.
However, based on current market conditions, we expect the per minute reciprocal
compensation rate will continue to decline from historic rates under
interconnection agreements in the future. 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 lo
cations 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 approximately 105 Internet service providers, all of which
have operations in California, including XO Communications, EarthLink, Inc. and
McLeod USA Information Services. We are leveraging 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 enables 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-sized business market. We believe that small
and medium-sized 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.
6
We intend to become a leading provider of integrated communications services to
small and medium-sized businesses by providing a complete product offering of
system design, equipment installation and maintenance, voice, data and long
distance services, 24/7 support, broadband wireless service, which provides high
speed Internet access, 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.
To support the small and medium-sized business market, we have and will
continue to expand our sales, customer care and service delivery forces in
selected markets. From December 31, 1999 to December 31, 2000, our sales,
customer care and service delivery forces increased from 157 to 410
professionals. Of these resources, the direct sales force increased from 61 to
134 and customer service increased from 36 to 95 in the same period. Since the
end of the first quarter of 1999, our sales, customer care and service delivery
forces, including direct sales agents, have more than 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, voicemail, 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;
and
. wireless broadband service, which provides high-speed Internet access
for businesses and for subscribers of Internet service providers.
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.
7
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.
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 have been providing bundled high-
speed services through Covad Communications since the fourth quarter
of 1999; and
. Wireless Broadband Services, which provide wireless high-speed
internet access to our customers. We began providing wireless high-
speed services through Broadlink Communications in the fourth quarter
of 2000.
Equipment Sales. System design and equipment sales and installation are
essential components of our strategy of marketing to small and medium-sized
businesses. We offer our business customers technologically advanced systems
bundled together with local and long distance services.
Sales and Marketing
Sales. We have built an experienced direct sales force. Our direct sales
force was increased to 134 as of December 31, 2000, from 61 as of December 31,
1999. 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 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.
8
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 have built and intend to continue 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 and field account managers will
provide real time problem identification and 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-sized 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,
2000, eleven of our top fifteen customers were Internet service providers.
Approximately 17% of our accounts receivable as of December 31, 2000 were from
these Internet service providers. Management performs ongoing evaluations of the
creditworthiness of its customers and monitors collections. As necessary, an
allowance for doubtful accounts is recognized for potential uncollectible
accounts. During 2000, the Company increased the allowance for doubtful accounts
by approximately $2.3 million to $3.0 million as of December 31, 2000. For the
years ended December 31, 1998, 1999 and 2000, Internet service providers
accounted for approximately 23.3%, 19.3% and 19.3%, respectively, of our
revenues, not including reciprocal compensation related to terminating calls to
Internet service providers, long-distance services and dedicated transport
services.
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 free fax and voicemail 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 allow 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 have been
targeted with our managed modem product, including our new 64k and 128k
integrated services digital network, or ISDN, service as well as our 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. Refer to Note 2 to the accompanying consolidated financial
statements included in Item 8 of this Form 10-K for information related to
revenues by service type.
9
Seasonality
There is no seasonality to any of the Company's products or services.
Significant Relationships
Reciprocal compensation payments from incumbent local exchange carriers
accounted for approximately 37%, 58% and 45% of our revenues for the years ended
December 31, 1998, 1999 and 2000, respectively. Reciprocal compensation for 1999
includes amounts received in payment for settlements in connection with disputes
over previously withheld reciprocal compensation, which amounted to 28% of our
total 1999 revenues. 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 carriers 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 7 to the accompanying consolidated financial statements
under "Reciprocal Compensation and Legal Proceedings". Reciprocal compensation
payments from Pacific Bell accounted for approximately 33%, 46% and 35% of our
total revenues in 1998, 1999 and 2000, respectively. Reciprocal compensation
payments from GTE accounted for approximately 4%, 12% and 10% of our total
revenues in 1998, 1999 and 2000, respectively. No other entities accounted for
more than 10% of revenues for these periods.
Pacific Bell, from whom the Company is paid the largest amount of
reciprocal compensation, is also the Company's largest source of operating
costs, accounting for 50%, 49% and 35% of the Company's operating costs for the
years ended December 31, 1998, 1999 and 2000, 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, and Qwest Communications/US
West in Arizona, Colorado, Oregon, Utah and Washington. 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.
10
The Federal Communications Commission (FCC) adopted an order in 1999 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, 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 consolidation of 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.
11
Competition from International Telecommunications Providers. Under the
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.
Regulation
The following summary of regulatory developments and legislation does not
purport to describe all present and proposed federal, state and local
regulations and legislation affecting the telecommunications industry. Other
existing federal and state legislation and regulations are currently the subject
of judicial proceedings, legislative hearings and administrative proposals which
could change, in varying degrees, the manner in which this industry operates.
Neither the outcome of these proceedings, nor their impact upon the
telecommunications industry or the Company, can be predicted at this time. This
section also includes a brief description of regulatory and tariff issues
pertaining to the operation of the Company's business, which 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 carriers 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 incumbent local exchange carriers provide
unbundled access to operator and directory assistance service and determined
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.
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On July 18, 2000, the Eighth Circuit issued its order concerning the issues
left unresolved by the Supreme Court. It vacated the FCC's rules regarding the
discount on retail services that incumbent local exchange carriers must provide
to competitive local exchange carriers, the costing rules that must be applied
in determining the price of unbundled network elements from incumbent local
exchange carriers, and the requirement that incumbent local exchange carriers
must provision combinations of unbundled network elements that are not already
combined. The Supreme Court will hear the latter two issues in its coming term.
It is not possible to predict the outcome of that decision.
The Eighth Circuit decisions and their reversal by the Supreme Court
perpetuate continuing uncertainty about the rules governing the pricing, terms
and conditions of interconnection 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 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 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.
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 exchane 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.
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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.
ILECs 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 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
are based on our share of certain defined telecommunications end-user revenues.
We paid approximately $8,000 per month in subsidy payments during the first half
of 2000, and approximately $12,000 per month in the second half of 2000.
Currently, in 2001, we are paying approximately $20,000 per month. 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.
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, Verizon's application for New York, and SBC's applications for Texas,
Kansas and Oklahoma have been granted. A petition for such authority by Verizon
for Massachusetts 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.
14
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. Although the FCC order was stayed by the United States
Court of Appeals for the District of Columbia Circuit, that stay has now been
lifted. Accordingly, nondominant interstate services providers 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 under which they offer
their domestic interstate interexchange services. During 2001, we are required
to cancel our FCC tariffs as a result of the FCC's orders.
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
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. On February 2, 2001, the D.C. Circuit upheld the FCC rules
regarding pricing flexibility. The FCC has recently granted pricing flexibility
applications for switched access services provided by BellSouth in a number of
cities in its service territory. The FCC also granted flexible pricing authority
for dedicated transport and special access services provided by SBC entities in
certain cities, and for dedicated transport and special access services provided
by Verizon entities in certain cities. 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.
The FCC has made and is continuing to consider various reforms to the
existing rate structure for charges assessed on long distance carriers for
allowing them to connect to local networks. These reforms are designed to move
these "access charges," over time, to lower, cost-based rate levels and
structures. These changes will reduce access charges and will shift charges,
which had historically been based on minutes-of-use, to flat-rate, monthly per
line charges on end-user customers rather than long distance carriers.
15
On May 31, 2000 the FCC adopted the proposal of the Coalition for Affordable
Long Distance Service (CALLS) that significantly restructures and, reduces
in some respects, the interstate access charges of the regional Bell operating
company (RBOCs), AT&T, and Sprint. Among the more significant regulatory changes
established by the CALLS Order, the Bell operating companies (BOCs) are required
to reduce switched access charges to an average of $0.0055/minute. Price cap
incumbent local exchange carriers are additionally required to eliminate the
presubscribed interexchange carrier charge (PICC) as a separate charge and fold
it into an increased subscriber line charge (SLC). AT&T and Sprint have
committed in this proceeding to pass on access charge reductions to consumers,
and to eliminate minimum monthly usage charges. Although the CALLS Order will
not apply directly to competitive local exchange carriers, incumbent local
exchange carrier reductions in switched access charges may place some downward
pressure on competitive local exchange carriers to reduce their own switched
access charges. In addition, interexchange carriers (IXCs) other than AT&T and
Sprint are not subject to the CALLS Order, but may seek to alter their offerings
to conform to AT&T's and Sprint's commitments in this proceeding. A Petition for
Reconsideration of the CALLS Order is currently before the FCC.
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, more
than 30 states have issued decisions either initially or on reconsideration of
existing decisions. In twenty-four states, the commission determined
compensation is owed. Massachusetts, New Jersey, South Carolina, Louisiana,
Arizona, Colorado, and Iowa 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 declaratory 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.
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 rules establishing such rates. A number of states, including Colorado
and California, have initiated proceedings regarding intercarrier compensation
issues.
On March 5, 2001, the United States Supreme Court granted certiorari to
hear issues pertaining to state commission decisions enforcing reciprocal
compensation provisions in interconnection agreements. In a case on appeal from
the United States Court of Appeals for the Seventh Circuit, the Supreme Court
will hear argument related to the participation of state commissioners in
federal appeal proceedings and whether interconnection agreement enforcement
actions may be appealed to federal court. We cannot predict the Supreme Court's
decisions on these issues.
The FCC recently adopted new rules designed to make it easier and less
expensive for competitive local exchange carriers to obtain collocation in
central offices, by among other things, restricting the incumbent local exchange
carrier's ability to prevent certain types of equipment from being collocated
and requiring incumbent local exchange carriers to offer alternative collocation
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
collocation risks that permitted competitive local exchange carriers to
collocate 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 collocation,
rejected the FCC's effort to leave the choices of space in the incumbent local
exchange carrier central offices to the competitive local exchange carrier. 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.
In August 1998, the FCC determined that advanced services are
telecommunications services subject to regulation under Sections 251 and 252 of
the Telecom Act. In the same order, the FCC issued a notice of proposed
rulemaking on terms for the provision of such services on a separate subsidiary
basis. Permitting incumbent local exchange carriers to provision data services
through separate affiliates with fewer regulatory requirements could have a
material adverse impact on our ability to compete in the data services sector.
The FCC imposed conditions on the merger of SBC with Ameritech in October 1999
that permit the provisioning of advanced data services via separate subsidiaries
pursuant to various requirements.
16
The D.C. Circuit vacated the separate subsidiary requirement on January 9, 2001.
We cannot predict whether these requirements will ultimately prove enforceable,
nor whether they will deter anticompetitive conduct if they are enforceable.
On November 18, 1999 the FCC also adopted a new order requiring incumbent
local exchange carriers to provide line sharing, which would allow competitive
local exchange carriers to offer data services over the same lines that a
consumer uses for voice services without the competitive local exchange carrier
having to offer voice services. While we expect these new rules will be
beneficial to competitive local exchange carrier's, we cannot be certain that
these new rules will be implemented by the incumbent local exchange carrier's in
a favorable manner. Moveover, these rules have been appealed. We cannot predict
that the outcome of these rules on our business.
The FCC and many state public utilities commissions have implemented rules
to prevent unauthorized changes in a customer's pre-subscribed local and long
distance carrier services (a practice commonly known as "slamming.") Pursuant to
the FCC's slamming rules, a carrier found to have slammed a customer is subject
to substantial fines. In addition, the FCC's slamming rules were revised
effective November 2000 to include new provisions governing liability for
slamming, and provisions allowing state public utilities commissions to elect to
administer and enforce the FCC's slamming rules. These new slamming liability
rules substantially increase a carrier's possible liability for unauthorized
carrier changes, and may substantially increase a carrier's administrative costs
in connection with alleged unauthorized carrier changes (even if the carrier can
provide valid proof that such changes were authorized). Under the new rules,
carriers must immediately remove from the customer's bill all charges incurred
within 30 days following an alleged slam. If the FCC (or the relevant state
public utilities commission) determines that the carrier has slammed the
customer, and the customer has not yet paid the bill, the customer will be
absolved from any charges for the first 30 days following the slam (whereas if
the carrier provides clear and convincing proof that the consumer authorized the
change, the carrier may re-bill the customer.) If the FCC (or relevant state
public utilities commission) determines that a carrier has slammed a customer
and the customer has already paid the unauthorized carrier, the unauthorized
carrier must remit to the authorized carrier 150% of all payments received from
a slammed customer. The authorized carrier must in turn remit 50% of the amount
received from the unauthorized carrier back to the slammed customer. The new
slamming liability rules have been appealed to the United States Court of
Appeals for the District of Columbia Circuit. We cannot predict the effect that
these new liability rules will have on our business. The FCC also issued revised
rules in August 2000 that are expected to become effective in April 2001, or
shortly thereafter, regarding the procedures for changing a subscriber's pre-
subscribed carrier, and establishing new carrier reporting and registration
requirements.
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, Colorado, Texas, Idaho, Utah and New Mexico. Most states in
which we operate, or propose to operate, also require us to seek approval for
any transfers of control.
The implementation of the Telecommunications Act of 1996 is subject to
numerous state rulemaking proceedings on these issues. Thus, it is 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.
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 commissioners of the California Public
Utilities Commission and others, were named as a defendant in an action filed by
GTE California.
17
The action challenges the legality of the California Public Utilities Commission
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 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 have replaced 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, which 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 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 since 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.
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Nevada, Colorado and Utah 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 Commisison 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 another competitive local exchange carrier.
The Court accepted a stipulation of the parties to resolve the case by summary
judgment or by other dispositive motion. On March 1, 2000, Pac-West, the other
competitive local exchange carrier, 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 is completed. On March 21, 2001, the Court remanded the decision of the
Public Utilities Commission back to the Commission on procedural grounds.
On October 10, 2000, the Colorado public utilities commission commenced
workshops in a generic proceeding to develop its prospective policy regarding
reciprocal compensation. On November 9, 2000, the Utah Public Utilities
Commission opened a generic proceeding to develop its prospective policy
regarding reciprocal compensation. We cannot predict the outcome of the Colorado
or Utah proceedings, future appeals or additional pending cases involving
related issues, or of the applicability of such proceedings to our
interconnection agreements in those states. As a result, no assurance can be
given that we will continue to collect reciprocal compensation or whether we
will be entitled to reciprocal compensation for these types of calls in the
future.
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, 2000, we had 693 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.
19
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, 2000, we had 37 premise leases. The table
below lists our material facilities:
Approximate
Location Use Lease Expiration Square Footage
- -------- --- ---------------- --------------
Stockton, CA Corporate and administrative offices September 2007 43,600
Stockton, CA 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 area), WA Switching facility December 2009 16,851
Thornton (Denver area), CO Switching facility March 2010 24,316
Phoenix, AZ Switching facility April 2010 12,321
West Valley City (Salt Lake
City area), UT Switching facility December 2010 12,711
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 grow and we
expand into new markets. Each of our material leases is extendable at our
option. Our Stockton, California switching facility lease is extendable for five
two-year periods, and all other leases in the table above are extendable for two
five-year periods.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various legal proceedings, including the Pacific
Bell, GTE and California Public Utilities Commission proceedings, and the Nevada
Bell and Public Utilities Commission of Nevada proceeding related to reciprocal
compensation payment and other interconnection agreement issues. See "Business -
Regulation."
20
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, 2000 and 1999 (from and including November 4, 1999) as
reported by the Nasdaq stock market.
---------2000--------- ---------1999--------
-----------------------------------------------------------------------
High Low High Low
-----------------------------------------------------------------------
First quarter $ 40.13 $ 22.13 $ --- $ ---
Second quarter $ 28.50 $ 14.75 $ --- $ ---
Third quarter $ 22.38 $ 9.00 $ --- $ ---
Fourth quarter $ 11.95 $ 2.06 $ 29.38 $ 18.44
As of March 1, 2001 the number of shareholders of record of the
Company's common stock was 521.
We have not declared any cash dividends on our common stock during the
fiscal year 1999 and 2000, 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.
We have issued securities in the following transactions, each of which,
unless otherwise indicated, was intended to be exempt from the registration
requirements of the Securities Act of 1933, as amended, by virtue of Section
4(2) or Regulation D thereunder.
On February 2, 2000, we issued 442,103 shares of common stock with an
aggregate value of $8,400,000 to the former shareholders of Installnet, Inc. and
two related companies in exchange for their interests in the three companies.
On October 5, 2000, we issued 36,136 shares of common stock with an
aggregate value of $586,848 to BTC Corp in exchange for certain assets of BTC
Corp.
On November 29, 2000, we issued 13,548 shares of common stock with an
aggregate value of $160,000 to CJ Transition Inc. in exchange for certain assets
of Communications Specialists Inc.
21
ITEM 6. SELECTED FINANCIAL DATA
This section presents selected historical financial data of the Company.
You should read carefully the consolidated 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
consolidated 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 financial data for the period from our
commencement on October 1, 1996 to December 31, 1996, and for the years ended
December 31, 1997, 1998, 1999 and 2000. 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 or when collectibility is reasonably
assured. See Revenue Recognition in Note 2 to the accompanying consolidated
financial statements and Note 7 to the accompanying consolidated financial
statements under Reciprocal Compensation and Legal Proceedings and "Regulation -
California, Nevada, Colorado and Utah Regulatory Proceedings and Judicial
Appeals" in Item 1 of this Form 10-K.
Adjusted EBITDA represents earnings before interest, net; income taxes;
depreciation and amortization; and income or loss on asset dispositions; further
adjusted for the costs of merger and recapitalization; transaction bonuses and
consultant's costs; cumulative effect of changes in accounting principle; and
the extraordinary item. Included in other (income) expense, net is interest
income of $(15,000), $(5,000), $(90,000), $(327,000), $(3,690,000) and
$(7,564,000), and (income) loss on asset dispositions, net of $(19,000),
$16,000, $(29,000) $(3,000), $0 and $580,000 for the predecessor telephone and
answering service divisions 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, 1999 and 2000,
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. The Company adopted SEC Staff Accounting Bulletin No. 101 (SAB 101)
"Revenue Recognition in Financial Statements" in the fourth quarter of 2000,
retroactive to January 1, 2000. SAB 101 provides guidance on applying generally
accepted accounting principles to revenue recognition in financial statements.
(See Note 2 in the accompanying notes to the consolidated financial statements
for further discussion.)
22
Predecessor
Telephone and Pac-West Telecomm, Inc.
Answering
Service Divisions
----------------- ---------------------------------------------------------
Period from
Commencement
Nine Month on Oct. 1,
Period Ended 1996 Year Ended
September 30, to Dec. 31, December 31,
1996 1996 1997 1998 1999 2000
--------------- ------- ------ ------ -------- ----
(in thousands) (in thousands, except per share amounts)
Statements of Operations Data:
Revenues................................................ $ 8,737 $ 4,232 $29,551 $ 42,211 $ 95,505 $139,090
Costs and expenses:
Operating costs....................................... 4,202 2,064 12,060 15,344 20,510 42,388
Selling, general and administrative:
Selling, general and administrative................. 3,123 1,519 7,367 10,779 22,855 54,026
Transaction bonuses and consultant's costs (1)...... -- -- -- 3,798 -- --
Depreciation and amortization......................... 549 299 2,204 4,106 8,689 20,905
------- ------- ------- -------- --------- --------
Income from operations.............................. 863 350 7,920 8,184 43,451 21,771
Interest expense........................................ 33 105 932 4,199 18,124 18,932
Gain on disposal of answering service division.......... -- -- (385) -- -- --
Costs of merger and recapitalization (1)................ -- -- -- 3,004 -- --
Other (income) expense, net............................. (34) 11 (119) (330) (3,690) (6,984)
------- ------- ------- -------- --------- --------
Income before provision for income taxes,
extraordinary item and cumulative effect of
change in accounting principle.................... 864 234 7,492 1,311 29,017 9,823
Provision for income taxes.............................. 345 94 2,997 1,561 13,111 4,791
------- ------- ------- -------- --------- --------
Income (loss) before extraordinary item and cum-
ulative effect of change in accounting principle.. 519 140 4,495 (250) 15,906 5,032
Extraordinary item--loss on early extinguishment of
debt, net of income tax benefit of $278 (1).......... -- -- -- (417) -- --
Cumulative effect of change in accounting principle,
net of income tax benefit of $943 (2)................ -- -- -- -- -- (1,415)
------- ------- ------- -------- --------- --------
Net income (loss)....................................... $ 519 $ 140 $ 4,495 $ (667) $ 15,906 $ 3,617
======= ======= ======= ======== ========= ========
Income (loss) per share before extraordinary item and
cumulative effect of change in accounting
principle:
Basic................................................ $ 1.00 $ 32.11 $ (0.30) $ 0.59 $ 0.14
Diluted.............................................. $ 1.00 $ 32.11 $ (0.30) $ 0.56 $ 0.13
Net income (loss) per share:
Basic................................................ $ 1.00 $ 32.11 $ (0.38) $ 0.59 $ 0.10
Diluted.............................................. $ 1.00 $ 32.11 $ (0.38) $ 0.56 $ 0.10
Weighted average shares outstanding:
Basic................................................ 140 140 5,244 20,173 35,838
Diluted.............................................. 140 140 5,244 21,294 37,662
Other Financial Data:
Adjusted EBITDA......................................... $ 1,412 $ 649 $10,124 $ 16,088 $ 52,140 $ 42,676
Adjusted EBITDA margin %................................ 16.2% 15.3% 34.3% 38.1% 54.6% 30.7%
Cash provided by (used in):
Operating activities................................. $ 1,092 $ 75 $ 5,876 $ 12,033 $ 41,439 $ 41,762
Investing activities................................. (2,523) (1,682) (6,619) (42,031) (135,966) (67,841)
Financing activities................................. 1,778 1,549 3,658 41,631 161,979 66
Balance Sheet Data (as of period end):
Cash and cash equivalents............................... $ 746 $ 688 $ 3,603 $ 15,236 $ 82,688 $ 56,675
Short-term investments.................................. -- -- -- -- 70,138 43,904
Restricted cash......................................... -- -- -- -- 10,087 --
Working capital......................................... 626 398 2,598 15,532 151,492 72,932
Property and equipment, net............................. 5,883 9,483 19,079 57,294 105,189 201,514
Total assets............................................ 8,641 12,966 27,528 82,493 290,100 360,792
Total long-term debt and capital leases................. 2,536 5,690 12,206 100,116 150,017 165,459
Convertible redeemable preferred stock, including
accrued cumulative dividends of $1,324 in 1998....... -- -- -- 46,324 -- --
Stockholders' equity (deficit).......................... 4,037 4,177 8,672 (74,113) 106,250 119,757
(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 accompanying consolidated
financial statements.
(2) Reflects effect of the adoption of SAB 101 in the fourth quarter of 2000,
retroactive to January 1, 2000. See Note 2 to the accompanying consolidated
financial statements.
23
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-sized 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-sized 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. As discussed in Note 1 to the accompanying
consolidated financial statements, we acquired the customer base and certain
assets of Napa Valley Telecom (Napa Telecom) in January 2000, acquired all of
the oustanding stock of Installnet, Inc. and two related companies
(collectively, Installnet) in February 2000, acquired the customer base and
certain assets of BTC Corp (Baron Telecommunications) in September 2000, and
acquired the customer base and assets of Communications Specialists, Inc. (CSI)
in November 2000. Each of these acquisitions has been included in our results of
operations from the date of acquisition.
For the years ended December 31, 1999 and 2000, recognizing compensation
from other communications companies for completing their customers' calls only
to the extent such compensation was actually received in cash, or collectibility
was reasonably assured, we had net revenues of approximately $95.5 million and
$139.1 million, respectively, and adjusted EBITDA of approximately $52.1 million
and $42.7 million, respectively.
As of December 31, 2000, we had 185,524 lines in service, a 76% increase
from December 31, 1999. For the year ended December 31, 2000, our minutes of use
were 23.7 billion, an increase of 56% over 1999.
Factors Affecting Operations
Revenues. We derive our revenues from monthly recurring charges, usage
charges, amortization of 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. Initial non-recurring charges include payments
received for installation services. The Company's adoption of SAB 101 changed
the timing of when revenue is recognized for non-refundable up-front payments
received for installation services. Historically, these amounts have been
recognized in the period received. Under the revised revenue recognition policy,
these payments, and related costs up to the amount of revenues, are recognized
as revenue and expense ratably over the the term of the service contracts,
generally 24 to 36 months. Any costs in excess of recognized revenues are
expensed in the current period.
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 providers and other customers. For the years
ended December 31, 1998, 1999 and 2000, recorded reciprocal compensation
accounted for approximately 37, 58% and 45%, respectively, of our revenues. From
1997 through 1999, 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 agreements 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.
24
The total reciprocal compensation withheld by Pacific Bell and GTE and not
included in revenues was $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. 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 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 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 decision 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.
While the incumbent local exchange carriers have been paying us the full
amount of our reciprocal compensation billings since the latter half of 1999,
some of these payments may be subject to a reservation of rights to appeal and
incumbent local exchange carriers may contest or seek subsequent reimbursement
of amounts previously paid by them for reciprocal compensation.
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 current agreement is significantly lower than it was
under our previous agreement. Based on current market conditions, we expect the
per minute reciprocal compensation rate will continue to decline from historic
rates under interconnection agreements in the future.
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 carriers. 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.
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, 1998, 1999 and 2000.
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.
25
Revenues for the year ended December 31, 1999 include a settlement received in
connection with previously withheld reciprocal compensation of $26.3 million.
Net income for 2000 includes a charge related to a change in accounting
principle upon the Company's adoption of SAB 101 of $(1.4) million, net of
income tax benefit of $0.9 million.
Year Ended December 31,
-----------------------
1998 1999 2000
---- ---- ----
Statements of Operations Data:
Revenues..................................... 100.0% 100.0% 100.0%
Operating costs.............................. 36.4 21.5 30.5
Selling, general and administrative expenses. 34.5 23.9 38.8
Depreciation and amortization expense........ 9.7 9.1 15.0
Income from operations....................... 19.4 45.5 15.7
Net income (loss)............................ (1.6) 16.7 2.6
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Consolidated revenues for the year ended December 31, 2000 increased $43.6
million to $139.1 million from $95.5 million for the same period ended in 1999,
which included settlement payments totaling $26.3 million received in connection
with previously withheld reciprocal compensation. The increase in revenues is
primarily attributed to an increase of $6.9 million in paid local
interconnection revenues, an increase of $3.2 million in switched access
charges, an increase of $8.5 million and $3.5 million in recurring charges and
installation charges billed directly to Internet service providers and business
customers, respectively, an increase of $7.6 million in local and long distance
usage revenues, an increase of $2.6 million in dedicated transport revenues and
$8.6 million in product and service revenues from Installnet, which we acquired
in February 2000.
In 1999, we activated a new higher capacity switch in Oakland, installed a
second switching system at our Los Angeles facility, while continuing to expand
the switching capacity of the existing Los Angeles facility, and completed
construction of a switching facility in Las Vegas and near Seattle, Washington.
In 2000, we increased the capacity of our switching facilities in Oakland and
Stockton and completed new switching facilities in, or near, Phoenix, Arizona,
Denver, Colorado and Salt Lake City, Utah. As a result of additional switching
facilities, increased utilization of expanded switch capacities and acquisitions
completed during 2000, our revenues for the twelve month period ended December
31, 2000 increased 46% from the same period ended 1999. Additionally, we
increased the number of access lines to small and medium-sized businesses to
47,645 as of December 31, 2000, an increase of 101% from the same period ended
in 1999. The Company attributed this growth to the increased size of its sales
force and continued strong demand from customers for bundled communications
services.
The total number of access lines in service increased 76% to 185,524 as of
December 31, 2000 from 105,147 as of December 31, 1999. Billable minutes of use
were 23.7 billion for the twelve months ended December 31, 2000, up 56% from
15.2 billion billed during the same period in 1999.
The number of inbound local calls and minutes subject to reciprocal
compensation revenues in accordance with interconnection agreements increased
34% and 78%, respectively, for the year ended December 31, 2000 over 1999. The
significant increases in inbound local calls and minutes, partially offset by
payments of previously withheld reciprocal compensation in 1999, resulted in a
$6.9 million or 12% increase in paid interconnection revenues for the year ended
December 31, 2000 over 1999. Excluding the 1999 settlement of $26.3 million for
comparative purposes, these revenues increased 114%. Additionally, revenues from
switched access charges increased $3.2 million, or 126%.
Direct billings to Internet service providers increased during the twelve
months of 2000 by $8.5 million, or 46%, from the same period in 1999. Lines in
service to Internet service providers increased from 76,596 lines at December
31, 1999 to 126,762 lines at December 31, 2000, an increase of 65%.
Direct billings to small and medium-sized business customers increased
during 2000 by $3.5 million, or 177%, from the same period in 1999. Lines in
service to these customers increased from 17,163 lines at December 31, 1999 to
34,436 lines at December 31, 2000, an increase of 101%.
26
The $7.6 million increase in outbound local and long distance revenues,
including 800 number and travel card calls, represented a 96% increase in 2000
over 1999. This increase is directly related to internal growth and the
acquisition of Napa Telecom customers, acquired in January 2000. The Company
continues to focus on providing services to high-volume, telecommunication
intensive users and to small and medium-sized businesses.
The $2.6 million, or 50%, increase in dedicated transport revenues
primarily relates to increased data networking services for private corporate
networks.
Our consolidated operating costs for 2000 increased $21.9 million to $42.4
million from $20.5 million in 1999. This increase in costs was primarily due to
an increase in network operations associated with a higher level of
telecommunications activity. In addition, we continued to make significant
investments in our telephone infrastructure to accommodate the future growth of
our communications services. Excluding the reciprocal compensation settlement of
$26.3 million in 1999, costs of sales and operating costs represented 30% of
revenues for both years.
Our consolidated selling, general and administrative expenses for the year
ended December 31, 2000 increased $31.2 million to $54.0 million from $22.9
million in 1999. The increase in selling, general and administrative expenses
was primarily the result of additional payroll expenses incurred in connection
with the retention of employees acquired from acquisitions and the hiring of
additional employees to accommodate growth in our business, including 110
additional employees in our sales and marketing departments; 57 additional
network employees; 96 additional service technicians; 59 additional customer
service representatives; and 100 additional employees in other administration
and information technology functions. These new hires increased the total number
of Pac-West employees from 271 at December 31, 1999 to 693 at December 31, 2000.
In addition, selling, general and administrative expenses for the year ended
December 31, 2000 include approximately $989,000 of provision for doubtful
accounts, an increase of $714,000 over 1999. Excluding the reciprocal
compensation settlement of $26.3 million in 1999, our selling, general and
administrative expenses were 39% and 33% of revenues for the years ended
December 31, 2000 and 1999, respectively.
Our consolidated depreciation and amortization expense for the year ended
December 31, 2000 increased $12.2 million to $20.9 million from $8.7 million for
the same period in 1999. Depreciation and amortization as a percentage of
revenues increased to 15% for the year ended December 31, 1999 from 13%,
excluding the reciprocal compensation settlement of $26.3 million in 1999. The
increase in depreciation and amortization expense was primarily due to
additional depreciation expense incurred on purchases of equipment between
periods. During the twelve months ended December 31, 2000, the Company purchased
an additional $69.3 million of equipment, excluding $21.3 million of purchases
under a capital lease facility and $23.0 million of dedicated fiber optics
circuits purchased in June 2000, which we have not started depreciating as they
have not yet been placed in service.
Our consolidated interest expense for the year ended December 31, 2000
increased $0.8 million to $18.9 million from $18.1 million in 1999. Interest
expense over these two periods is related to 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. Interest expense is net
of amounts capitalized of $2.5 million and $2.3 million for the years ended
December 31, 2000 and 1999, respectively.
Our consolidated interest income for the year ended December 31, 2000
increased $3.9 million to $7.6 million from $3.7 million for the same period in
1999. In November 1999, the Company received $118.1 million net proceeds from
the initial public offering of our common stock which resulted in higher cash
balances between periods. Interest income includes realized gains and losses on
investments.
Our effective income tax rate for the year ended December 31, 2000 and 1999
was 49% and 45%, respectively. These tax rates reflect the applicable federal
and state statutory income tax rates along with the tax impact of the non-
deductibility of certain acquisition-related amortization expense and the tax
impact of the reciprocal compensation settlement in 1999.
27
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 providers. In addition, new service orders from small and
medium-sized 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-sized 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-sized 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-sized
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.
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.
28
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 1999 and 1998,
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.
Quarterly Operating and Statistical Data
The following table sets forth unaudited operating and statistical data for
each of the specified quarters of 1999 and 2000. The operating and statistical
data for any quarter are not necessarily indicative of results for any future
period.
Quarter Ended
--------------------------------------------------------------------------
1999 2000
---- ----
--------------------------------------------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- -------- ------- ------- ------- -------- -------
Ports equipped....................... 251,520 309,120 309,120 460,800 460,800 518,400 576,000 672,000
Lines sold to date................... 74,026 80,984 97,117 116,391 135,143 164,800 181,045 198,980
Lines in service to date............. 67,691 76,263 88,009 105,147 124,340 151,957 169,050 185,524
Estimated data lines (% of installed
lines)............................... 85% 82% 76% 73% 72% 77% 75% 83%
Lines on switch %.................... 96% 96% 96% 96% 94% 96% 94% 93%
Internet service provider and
enhanced communications service
provider customer lines
(collocated) %................... 83% 81% 83% 83% 84% 88% 76% 80%
Quarterly minutes of use switched
(in millions)........................ 3,116 3,523 4,020 4,552 5,387 5,653 6,140 6,487
Metropolitan statistical areas served 25 25 25 25 26 27 27 29
Capital expenditures (in thousands).. $3,633 $18,275 $11,371 $23,091 $11,610 $43,518 $16,292 $42,228
Employees............................ 168 187 216 271 370 429 629 693
Liquidity and Capital Resources
Net cash provided by operating activities was $41.8 million for the year
ended December 31, 2000 compared to $41.4 million for the same period ended
1999. Income from operations before depreciation and amortization decreased by
$9.5 million in the year ended 2000 from the year ended 1999 due to the
reciprocal compensation settlement of $26.3 million received in 1999, which was
partially offset by increased operating income in 2000. On June 30, 2000, the
Company entered into a Indefeasible Right of Use (IRU) agreement to acquire
dedicated fiber optics circuits at a price of approximately $23.0 million.
29
Of this amount, $5.8 million was paid on July 28, 2000 and the balance is in
other accrued liabilities which is payable on June 30, 2001. (See Note 7 to the
accompanying consolidated financial statements.) Other operating cash
requirements, specifically trade receivables and trade payables have increased
to accommodate the Company's growth.
Net cash used in investing activities was $67.8 million for the year ended
December 31, 2000 compared to $136.0 million for 1999. During 2000, we invested
$92.3 million in new equipment, not including $21.3 million of equipment being
financed under a capital lease facility. To pay for these investments we used
cash generated from operating activities and redeemed $26.5 million of our
short-term investments. During 1999, we invested $56.4 million in new switching
and related equipment and invested $70.1 million of cash in short-term
investments and used $9.5 million, net to fund the interest reserve trust
account for the February 2, 2000 semi-annual interest payment on the senior
notes which was paid in 2000.
Net cash provided by financing activities was $66,000 for the year ended
December 31, 2000 compared to $162.0 million for 1999. Net cash provided during
the year ended 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.
The local telecommunications service 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 $42.5 million, $56.4 million and $113.6 million for the years ending
December 31, 1998, 1999 and 2000, respectively. Of the $92.3 million of capital
expenditures during 2000, not including the capital lease facility of $21.3,
$49.1 million was included in projects in progress as of December 31, 2000 and
therefore is not being depreciated until placed in service in 2001. Our business
plan, as currently contemplated, anticipates capital expenditures, excluding
acquisitions, of approximately $65 million in 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, or fall below, 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 our 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, 2000, there were no amounts outstanding under this
facility and the borrowing rate would have been approximately 8.89%. Any
borrowings under our senior credit facility will be secured by substantially all
of our assets. The senior credit facility has a three year term expiring June
2002.
In 2000, the Company secured a lease facility of up to $30 million to be
used exclusively for the acquisition of networking equipment and related
services sold by Cisco Systems, Inc. As of December 31, 2000 the Company
purchased approximately $21.3 million of equipment under this facility, which is
being accounted for as a capital lease.
Our principal sources of funds for 2001 and 2002 are anticipated to be
current cash and short-term investment balances, cash flows from operating
activities, and if necessary, borrowings under the senior credit facility. We
believe that these funds will provide us with sufficient liquidity and capital
resources for us to fund our business plan through 2002. No assurance can be
given, however, that this will be the case. The foregoing statements do not take
into account additional acquisitions which, if made, are expected to be funded
through a combination of cash and equity. Depending upon our rate of growth and
profitability, and/or 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.
Our 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.
30
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.
Inflation
We do not believe that inflation has had any material effect on our
business over the past three years.
31
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, 2000, 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, 2000. 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
$100.6 million of cash equivalents and short-term investments at December 31,
2000 by approximately $1,006,000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements required by Item 8,
together with the notes thereto and the report thereon of the independent public
accountants dated February 9, 2001, are set forth on pages F-1 through F-22 of
this Form 10-K. The consolidated financial statement schedule listed under Item
14(a)2, together with the report thereon of the independent public accountants
dated February 9, 2001, are set forth on pages F-23 and F-24 of this Form 10-K
and should be read in conjunction with our consolidated financial statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth certain information as of December 31, 2000 with
respect to Pac-West's current directors, executive officers, and key employees:
Name Age Position(s)
---- --- -----------
Executive Officers:
Wallace W. Griffin............................... 62 President, Chief Executive Officer and Director
John K. La Rue................................... 51 Executive Vice President and Director
Richard E. Bryson................................ 47 Chief Financial Officer
H. Ravi Brar..................................... 32 Vice President--Customer Operations
Joel A. Effron................................... 56 Senior Vice President--Sales and Marketing
Rae Kohan........................................ 36 Vice President--Sales, Business Markets
Dennis V. Meyer.................................. 62 Vice President--Finance and Treasurer
Gregory Joksch................................... 44 Vice President--Information Technologies
Harry W. Wilson.................................. 57 Vice President--Human Resources
John F. Sumpter.................................. 52 Vice President--Regulatory
Directors:
Jerry L. Johnson.................................. 53 Chairman of the Board of Directors
A. Gary Ames...................................... 56 Director
David G. Chandler................................. 42 Director
Mark S. Fowler.................................... 59 Director
Samuel A. Plum.................................... 56 Director
Dr. Jagdish N. Sheth.............................. 62 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 and as a Director. He also has overall responsibilities for network,
purchasing and warehouse operations. Mr. La Rue has over thirty-one years of
experience in the telecommunications industry.
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.
33
Joel A. Effron has served as our Senior Vice President of Sales and
Marketing since April 1997. From 1994 to 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 twenty-five years of experience in the
telecommunications industry with extensive senior management experience in
marketing, planning, policies and procedures and manpower development.
Rae Kohan has served as our Vice President of Sales, Business Markets since
October 2000. From 1998 until 2000, he served in various management rolls
including our Branch Sales Manager, Bay Area General Manager, and General
Manager of Sales for California, Nevada and Arizona. From 1990 to 1998, Mr.
Kohan worked at Pitney Bowes as Regional Manager. Mr. Kohan has over twelve
years of sales management experience.
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 of 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.
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.
Harry W. Wilson has served as our Vice President of Human Resources since
April 2000. From 1998 to 2000, Mr. Wilson was the Corporate Director of Human
Resources for Sumiden Wire Products. From 1994 to 1998, Mr. Wilson was Corporate
Director of Employee Relations for Packard Bell/Nec. Prior to that, he served as
the Vice President of Human Resources for a division of Litton Industries. Mr.
Wilson has over 25 years of management experience.
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 Customer Operations since
October 2000, and prior to such time, he 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 our Company. 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.
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 E-
Communications 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, and 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 OAO Technology Solutions
and Sotas Inc., and as a director of aligne, Inc., G.S Capital, L.P., Dynegy,
Inc., ThinAirApps, Inc. and Vitts Networks, Inc.
34
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.
Inc. from 1984 to 1987. Mr. Chandler serves as a director of the following
companies: E-M Solutions, Encore Paper Company, Gibraltar Packaging Group,
Morton Grove Pharmaceuticals, Inc., Pharma Research Corporation, Engineering
Materials Corp., Pre Delivery Services Corp 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 counsel to the firm. Mr. Fowler also serves as a director of
Talk.com 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., Metallurg
Holdings, Inc., Pentech Financial Services Inc. and Nebvision 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. and Wipro Limited.
A. Gary Ames has served as one of our Directors since July 2000. Mr. Ames
served as President and Chief Executive Officer of MediaOne International, a
provider of broadband and wireless communications from 1995 until his retirement
in June 2000. From 1989 to 1995, he served as President and Chief Executive
Officer of U.S. West Communications, a regional provider of residential and
business telephone services, and operator and carrier services. Mr. Ames also
serves as a director of Albertsons, Inc., Tektronix, Inc., Infowave Software and
etrieve, Inc.
Mark J. DeNino and Bruce A. Westphal resigned their positions as directors
at Pac-West effective March 1, 2000 and March 16, 2000, respectively. Gary Ames
was appointed as a director by the Board of Directors on July 3, 2000, to fill
the Class 1 directorship vacated by Mr. Westphal. The Board of Directors has not
yet identified and nominated any person to fill the vacant Class II directorship
of Mr. DeNino. When it identifies a person to fill the vacant Class II
directorship it will appoint such person to serve on the Board of Directors
until the end of the term of the class of directorship. See "Management -Classes
of the Board."
All members of the Board of Directors set forth in this report, except
Messrs. Fowler, Sheth and Ames, have been elected in accordance with a
shareholders agreement that was entered into in connection with our
recapitalization in September 1998. There are no 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.
35
Classes of the Board
Our Board of Directors is 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, Chandler and Ames 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 2003 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, Mark S. Fowler and Dr. Jagdish N. Sheth. The audit committee
consists of David G. Chandler, Mark S. Fowler and A. Gary Ames.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended, 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 Nasdaq Stock Market, as required. These
persons are required 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 Forms 5 were not
required for those persons, the Company believes that during the fiscal year
ended December 31, 2000, except for Richard E. Bryson, Samuel A. Plum, Harry W.
Wilson and Dr. Jagdish N. Sheth, each of whom filed one Form 4 late, and Jerry
L. Johnson, who we understand intends to file a Form 5 reporting one transaction
late, the Company's executive officers, directors and greater than ten percent
beneficial owners complied with all applicable Section 16(a) filing
requirements. Each of the Form 4s filed late reported one transaction late with
the exception of the Form 4 filed late by Mr. Plum, which reported six
transactions late.
36
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,
2000 and 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 $5,440 and $18,419 of life
insurance and long-term disability insurance premiums we paid on behalf of Mr.
Griffin for the years ended December 31, 2000 and 1999, respectively, and
includes $2,539 of long-term disability insurance premiums we paid on behalf of
Mr. La Rue for the year ended December 31 1999.
Summary Compensation Table for the Years Ended December 31, 2000 and 1999
Name and Principal Regular All Other
Position Held Salary Bonus Commissions Compensation
------------- ------ ----- ----------- ------------
Current Executives:
Wallace W. Griffin
President, Chief Executive Officer and Director
Fiscal year 2000............................. $ 350,000 $ 175,000 --- $ 12,051
Fiscal year 1999............................. 350,000 175,000 --- 23,845
John K. La Rue
Executive Vice President and Director
Fiscal year 2000............................. 350,000 140,000 --- 5,998
Fiscal year 1999............................. 350,000 140,000 --- 7,746
Richard E. Bryson
Chief Financial Officer
Fiscal year 2000............................. 225,000 90,000 --- 4,833
Fiscal year 1999............................. 225,000 90,000 --- 3,783
Rae Kohan
Vice President of Sales, Business Markets
Fiscal year 2000............................. 94,375 --- 81,408 2,667
Joel A. Effron
Senior Vice President of Sales and Marketing
Fiscal year 2000............................. 127,074 45,000 --- 4,441
Fiscal year 1999............................. 121,264 30,316 --- 3,380
Previous Executives:
Brian K. Johnson
Senior Vice President and General Manager -
Business Markets
Fiscal year 2000............................. 193,338 50,000 --- 4,825
Fiscal year 1999............................. 150,370 56,000 --- 3,648
Jason R. Mills
Vice President of Network Operations
Fiscal year 2000............................. 208,750 --- --- 6,492
Fiscal year 1999............................. 185,000 50,000 --- 5,341
Stock Incentive Plans
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 and 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.
In addition, we have established the 1998 Griffin and Bryson Non-Qualified
Stock Incentive Plans, and the 2000 Napa Valley Non-Qualified 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 certain of our employees.
37
An aggregate of 5,375,500 shares of common stock have been reserved for
option grants under the 1999 Stock Incentive Plan, the 1998 Griffin and Bryson
Non-Qualified Stock Incentive Plans, and the 2000 Napa Valley Non-Qualified
Stock Incentive Plan. These plans are 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, 2000, we had granted options outstanding with respect to
3,925,825 shares of common stock under all plans. As of December 31, 2000,
63,436 options have been exercised.
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 2000
The table below provides information regarding stock options granted to the
named executive officers during 2000. None of the named executive officers
received SAR's. All options referred to below vest over a period of four years
are exercisable to purchase shares of our common stock in accordance with the
Company's 1999 Stock Incentive Plan. In addition, options granted to the named
executive officers below with the exception of those options granted to Mr.
Kohan become fully vested upon a change in control.
Potential Realizable
% of Total Value at Assumed
Number of Options Annual Rates of Stock
Securities Granted to Price Appreciation for
Name Underlying Employees Exercise or Option Term
---- Options in Fiscal Base Price Expiration -----------
Granted (#) Year ($/Sh) Date 5% ($) 10% ($)
----------- ---- ------ ---- ------ -------
Current Executives
Wallace W. Griffin............... 150,000 8.5% $ 4.06 12/01/2010 $383,000 $971,000
John K. La Rue .................. 70,000 4.0 4.06 12/01/2010 179,000 453,000
Richard E. Bryson................ 95,000 5.4 4.06 12/01/2010 243,000 615,000
Rae Kohan........................ 3,000 0.2 22.50 01/24/2010 42,000 108,000
Rae Kohan........................ 5,000 0.3 14.13 09/01/2010 44,000 113,000
Rae Kohan........................ 15,000 0.9 8.69 11/01/2010 82,000 208,000
Rae Kohan........................ 9,000 0.5 4.06 12/01/2010 23,000 58,000
Joel A. Effron................... 15,000 0.9 4.06 12/01/2010 38,000 97,000
Previous Executives:
Jason R. Mills................... 15,000 0.9 4.06 12/01/2010 38,000 97,000
38
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, 2000. Brian Johnson, a previous executive, exercised 17,500 stock
options in 2000. No other named executive officers exercised options in 2000.
Name Number of Unexercised Options Value of Unexercised In-the-Money
----
at Year End Options at Year End
Exercisable Non-Exercisable Exercisable Non-Exercisable
----------- --------------- ----------- ----------------
Current Executives
Wallace W. Griffin.................. 487,847 150,000 $ 1,036,000 $ ---
John K. La Rue...................... 56,000 238,000 72,800 218,400
Richard E. Bryson................... 231,986 167,917 425,749 221,751
Rae Kohan........................... 1,750 37,250 2,275 6,825
Joel A. Effron...................... 17,500 67,500 22,750 68,250
Previous Executives:
Jason R. Mills...................... 26,250 93,750 34,125 102,375
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, Mr. Fowler and Mr. Ames, 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. In 2000, we granted stock options to Mr. Ames to purchase 35,000
shares of our common stock at a strike price of $17.50. The stock options will
vest over a three-year period with 33 1/3% vesting at the end of each year.
During 2000, Dr. Sheth, Mr. Fowler and Mr. Ames each received 10,500 additional
stock options pursuant to the terms of our 1999 Stock Incentive Plan. These
options have a strike price of $4.06, which was the closing price of the stock
at the date of issuance. We pay for the reasonable out-of-pocket expenses
incurred by each director in connection with attending board and committee
meetings.
Employment Agreements
Mr. Griffin entered into an employment agreement with us in 1998 as of the
recapitalization. Mr. Griffin's employment agreement has a term of three years,
provides for an initial base salary of $350,000 and bonus upon our achievement
of certain objective and subjective criteria which shall be about 40% of his
base salary.
The employment agreement also provides for participation in all benefit
plans made available to Pac-West executives, and may be terminated earlier by us
or the respective executive under certain conditions.
39
Upon termination by us without cause, as defined in his employment
agreement, Mr. Griffin will be entitled to receive severance payments, subject
to certain conditions, equal to his base salary for the greater of the remainder
of the term of employment under the employment agreement or the six-month period
thereafter.
If the employment period is terminated as a result of Mr Griffin's
disability, then he 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. In
addition, he will be entitled to receive (1) an amount equal to his base salary
for the one-year period after the termination of the employment period; and (2)
a prorated amount of any annual bonus otherwise payable to him for the fiscal
year in which his employment is terminated.
If the employment period is terminated as a result of Mr. Griffin's death,
then he 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 a prorated amount of any annual bonus
otherwise payable to him for the fiscal year in which his employment is
terminated. If we terminate the employment period for cause or if he resigns for
any reason, other than a termination without cause under the respective
employment agreement, then he will be entitled to receive his base salary
through the date of termination and we will have no further liability whatsoever
to him.
On November 27, 2000, our Board of Directors approved an Agreement
Regarding Compensation on Change of Control for most executives, including
Messrs. Griffin, La Rue, Bryson, Effron and Mills. These agreements provide for
one year's base salary and health plan benefits in the event of a merger or
combination of the Company into another entity, or the sale or disposition of
all, or substantially all, of the Company's assets.
On November 20, 2000, the Company and Mr. Brian Johnson entered into an
agreement covering Mr. Johnson's resignation, effective December 16, 2000. The
terms of the agreement provided for accelerated vesting of 17,500 shares of
stock options which were scheduled to vest at the end of February 2001, and
contain various covenants agreed to by Mr. Johnson.
Indebtedness of Management
In connection with their respective 1998 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. During 2000, Mr. Bryson repaid his promissory note in
full.
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.
40
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, 2001 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) 13.6%
925 Ygnacio Valley Road
Walnut Creek, CA 94596
Safeguard Scientifics, Inc.................................... 4,871,257(4) 13.5
800 The Safeguard Building
435 Devon Park Drive
Wayne, PA 19087
SCP Private Equity Partners, L.P.............................. 3,652,649(5) 10.2
435 Devon Park Drive, Building 300
Wayne, PA 19087
William Blair Capital Partners VI, L.P........................ 3,652,649(6) 10.2
222 West Adams Street
Chicago, IL 60606
TL Ventures III L.P. and related entities.................. 2,408,826(7) 6.7
700 Building
435 Devon Park Drive
Wayne, PA 19087-1990
Directors and Named Executive Officers:
A. Gary Ames.................................................. 1,000(8) *
Richard E. Bryson............................................. 318,445(9) *
David G. Chandler............................................. 3,652,649(10) 10.2
Joel A. Effron................................................ 37,000(11) *
Mark S. Fowler................................................ 12,667(12) *
Wallace W. Griffin............................................ 987,347(13) 2.7
Brian K. Johnson.............................................. 35,000(14) *
Jerry L. Johnson.............................................. 30,192(15) *
Rae Kohan..................................................... 2,500(16) *
John K. La Rue................................................ 992,288(17) 2.8
Jason R. Mills................................................ 52,500(18) *
Samuel A. Plum................................................ 3,717,649(19) 10.3
Jagdish N. Sheth.............................................. 19,667(20) *
All of Pac-West's directors and
executive officers as a group (18 persons)......................... 10,000,405(21) 27.0
(1) The number of shares includes shares of common stock subject to options
exercisable within sixty (60) days of March 1, 2001.
(2) Shares of common stock exercisable within sixty (60) days of March 1,
2001 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.
41
(3) Based solely upon a schedule 13G, dated February 9, 2000, filed jointly
by Bay Alarm Securities LLC (Bay Alarm) and the Westphal Family
Foundation (Westphal Foundation), Bay Alarm is the direct beneficial
owner of 4,840,930 shares of common stock and Westphal Foundation is the
direct beneficial owner of 50,000 shares of common stock.
(4) Based solely upon a Schedule 13G, dated March 1, 2001, Safeguard
Delaware, Inc. (SDI) is the record owner of 2,430,467 shares, Safeguard
Scientifics (Delaware), Inc. (SSD) is the record owner of 32,352 shares,
and SFINT, Inc. is the record owner of 612 shares. Safeguard Scientifics,
Inc. (Safeguard) is the sole stockholder of each of SDI and SSD, and SSD
is the sole stockholder of SFINT, Inc., which also includes an aggregate
of 2,408,826 shares owned of record by the following entities: TL
Ventures III, L.P. (TL III), 1,939,484 shares; TL Ventures III Offshore,
L.P. (TL III Offshore), 406,005 shares; and TL Ventures III Interfund,
L.P. (TL III Interfund), 63,337 shares. TL III, TL III Offshore and TL
III Interfund are venture capital funds which are required by their
governing documents to make all investment, voting and disposition
actions in tandem. TL Ventures III LLC, of which SDI is a member, is a
co-general partner of TL Ventures III Management, L.P., the sole general
partner of TL Ventures III, L.P., and the sole general partner of TL
Ventures III Interfund. TL Ventures III LLC has sole authority and
responsibility for all investment, voting and disposition decisions for
TL III and TL III Interfund, which powers, other than investments, are
exercised through its three-member board of managers, by majority vote.
TL Ventures III Offshore Ltd. is the sole general partner of TL Ventures
Offshore Partners, L.P., which is the sole general partner of TL III
Offshore. As such, it has sole authority and responsibility for
investment, voting and disposition decisions for TL III Offshore, which
powers are exercised through its three-member board of directors, by
majority vote. A representative of SDI serves as a member of the board of
managers of TL Ventures III LLC and as a member of the board of directors
of TL Ventures III Offshore Ltd. and, therefore, may be deemed to possess
indirect beneficial ownership of the shares owned by TL III, TL III
Offshore and TL III Interfund
(5) 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.
(6) Based solely upon an amended Schedule 13G, dated February 14, 2001, 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.
(7) Based solely upon an amended Schedule 13G, dated February 9, 2001, filed
jointly by TL III, TL III Interfund, TL Ventures III Management, LP, TL
Ventures III LLC, TL Ventures III Offshore Partners, L.P. and TL Ventures
III Offshore, Ltd., TL III, TL III Offshore and TL III Interfund are
venture capital funds which are required by their governing documents to
make all investment, voting and disposition actions in tandem. TL III is
the record holder of 1,939,484 shares; TL III Offshore is the record
holder of 406,005; and TL III Interfund is the record holder of 63,337
shares. TL Ventures III LLC is the sole general partner of TL Ventures
III Management L,.P., the sole general partner of TL III and TL Ventures
III LLC is the sole general partner of TL III Interfund. As such, TL
Ventures III LLC has sole authority and responsibiltiy for all
investment, voting and disposition decisions for TL III and TL III
Interfund, which powers, other than investments, are exercised through
its three-member board of managers by majority vote.
42
Investment decisions require a majority vote of the members of TL
ventures III LLC. TL Ventures III Offshore Ltd. is the sole general
partner of TL Ventures Offshore Partners L.P., which is the sole general
partner of TL III Offshore. As such, it has sold authority and
responsibility for investment, voting and disposition descisions for TL
III Offshore, which powers are exercised through its three-member board
of directors, by majority vote.
(8) The shares of common stock shown as benefically owned by Mr. Ames include
1,000 shares of common stock owned directly by Mr. Ames.
(9) The shares of common stock shown as beneficially owned by Mr. Bryson
include 231,987 vested shares subject to options. In addition, Mr. Bryson
is the direct beneficial owner of 20,458 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.
(10) 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.
(11) The shares of common stock shown as beneficially owned by Mr. Effron
include 35,000 shares subject to vested options and 2,000 shares of
common stock owned directly by Mr. Effron.
(12) The shares of common stock shown as beneficially owned by Mr. Fowler
include 11,667 shares subject to vested options and 1,000 shares of
common stock owned directly by Mr. Fowler.
(13) The shares of common stock shown as beneficially owned by Mr. Griffin
include 487,847 shares subject to vested options and 219,500 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.
(14) The shares of common stock shown as beneficially owned by Mr. Johnson
include 17,500 shares subject to vested options and 17,500 shares of
common stock owned directly by Mr. Johnson. In December 2000, Mr. Johnson
ceased to be an employee of the Company. The number of shares of common
stock shown as benefically owned by Mr. Johnson is based solely upon
copies of reports filed by Mr. Johnson with the Securities Exchange
Commission pursuant to Section 16 of the Securities Exchange Act of 1934
provided to the Company.
(15) The shares of common stock shown as beneficially owned by Mr. Johnson
include 30,078 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.
(16) The shares of common stock shown as benefically owned by Mr. Kohan
include 2,500 shares subject to vested options.
43
(17) The shares of common stock shown as beneficially owned by Mr. La Rue
include 112,000 subject to vested options and 691,068 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 189,220 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.
(18) The shares of common stock shown as beneficially owned by Mr. Mills
include 26,250 shares of common stock subject to vested options and
11,000 shares of common stock owned directly by Mr. Mills.
(19) The shares of common stock shown as beneficially owned by Mr. Plum
include 16,000 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.
(20) The shares of common stock shown as beneficially owned by Dr. Sheth
include 11,667 shares subject to vested option, 3,000 shares of common
stock owned directly by Dr. Sheth and 5,000 shares of common stock owned
by Sheth and Associates, Inc., a wholly-owned corporation of Dr. Sheth's.
(21) 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 20 as well as 100,000 shares subject
to vested options attributable to, and 41,650 shares of common stock
beneficially owned by executive officers other than the named executive
officers.
44
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:
. 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;
. 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
. 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, the representations and warranties expired
thirty days after receipt of the audited financial statements for fiscal 1999,
except those relating to tax matters which survive until the expiration of the
applicable statute of limitations and certain other representations and
warranties which survive indefinitely.
45
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 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. These non-compete agreements expired September 16,
2000.
In accordance with his employment agreement, Mr. Griffin has agreed to
forfeit any severance obligations owing to him in the event of his breach of
noncompetition provisions in restricted territories including the United States
of America, Canada and the territories and jurisdictions in 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. These provisions remain in effect for varying
periods following the termination of the employment agreements.
Indebtedness of Management
In connection with the 1998 recapitalization , Mr. Wallace W. Griffin, our
President, Chief Executive Officer and Director, purchased 37,500 shares of
common stock from the Company for $250,000. The Company received $50,000 in cash
from Mr. Griffin and entered into a note receivable for the remaining balance of
$200,000. The note accrues interest at 5.54 percent and compounds 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 Mr. Griffin is no
longer an employee of the Company or a subsidiary; or (4) September 16, 2003.
In December 2000, the Company entered into two notes receivable totaling
$105,000 with H. Ravi Brar, a Vice President of the Company. The notes accrue
interest at 6.1 percent per annum and are payable upon demand. The notes are
secured by a pledge of 38,000 shares of the Company's common stock.
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, 2001, an affiliate of Bay Alarm Company held approximately 13.6% of our
outstanding common stock. Sales to Bay Alarm accounted for approximately
$1,211,000, $912,000 and $797,000, or 2.9%, 1.0% and 0.6%, of our revenues for
the years ended December 31, 1998, 1999 and 2000, respectively.
46
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 $1,469,000, $1,755,000 and $1,743,000, or 3.5%, 1.8% and 1.3%, of
our revenue for the years ended December 31, 1998, 1999 and 2000, respectively.
47
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The consolidated financial statements of Pac-West Telecomm,
Inc. and its subsidiaries for the year ended December 31,
2000, together with the Report of Independent Public
Accountants, are set forth on Pages F-1 through F-23 of this
Form 10-K. The supplemental financial information listed and
appearing hereafter should be read in conjunction with the
consolidated 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, 1998, 1999 and 2000 as
applicable:
Report of Independent Public Accountants on Supplemental
Schedule F-24
Schedule II -Valuation and Qualifying Accounts F-25
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 consolidated
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 Company'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 Company's Registration Statement (No. 333-76779))
3.1 Amended and Restated Articles of Incorporation of Pac-West Telecom,
Inc. (Incorporated by reference to Exhibit A to the Company's
Proxy Statement dated June 26,2000).
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 Company'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 Company's Registration Statement (No. 333-76779)).
48
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
Company'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 Company'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 Company'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 Company'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 Company'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 Company'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
Company'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
Company'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
Company'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
Company'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
Company'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 Company'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 Company'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 Company'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 Company's Registration Statement (No. 333-76779)).
49
+10.16 Confidentiality Agreement, dated September 16, 1998, between Pac-
West and Jason R. Mills (Incorporated by reference to Exhibit 10.16
to the Company'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 Company'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 Company's
Registration Statement (No. 333-76779)).
10.19 Balco Properties Office Lease, dated as of November 10, 1998, by and
between Balco Properties 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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company's Registration Statement (No. 333-
76779)).
50
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 Company'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
Company'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 Company'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
(Incorporated by reference to Exhibit 10.31 to the Company's Annual
Report on Form 10-K for the period ending December 31,1999).
10.32 Agreement for Local Wireline Network Interconnection Between
Citizens Telecommunication Company of California, Inc. and Pac-West
Telecomm, Inc. dated November 1, 1999 (Incorporated by reference
to Exhibit 10.32 to the Company's Annual Report on Form 10-K for
the period ending December 31,1999).
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
(Incorporated by reference to Exhibit 10.33 to the Company's Annual
Report on Form 10-K for the period ending December 31,1999).
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 (Incorporated by reference to Exhibit 10.34 to the
Company's Annual Report on Form 10-K for the period ending
December 31,1999).
10.35 Interconnection Agreement under Sections 251 and 252 of the
Telecommunications Act of 1996 by and between Nevada Bell and Pac-
West Telecomm, Inc. executed August 25, 1999 (Incorporated by
reference to Exhibit 10.34 to the Company's Quarterly Report on
Form 10-Q for the period ending March 31, 2000).
10.36 Pac-West Telecomm, Inc. and US West Communications, Inc.
Interconnection Agreement for the State of Oregon dated January 31,
2000 (Incorporated by reference to Exhibit 10.36 to the Company's
Quarterly Report on Form 10-Q for the period ending March 31, 2000).
10.37 Adoption Letter dated February 2, 2000 between Pac-West Telecomm,
Inc. and GTE Northwest Incorporated of Interconnection, Resale and
Unbundling Agreement Between GTE Northwest Incorporated and Electric
Lightwave, Inc. for the State of Oregon (Incorporated by reference
to Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for
the period ending March 31, 2000).
10.38 Interconnection, Resale and Unbundling Agreement between GTE
Northwest Incorporated and Electric Lightwave, Inc. for the State of
Oregon (Incorporated by reference to Exhibit 10.38 to the Company's
Quarterly Report on Form 10-Q for the period ending March 31, 2000).
10.39 Lease Agreement, dated as of February 4, 2000, by and between North
Valley Tech LLC and Pac-West Telecomm, Inc. for E. 84th Avenue,
Suite 100, Thornton, Colorado (Incorporated by reference to Exhibit
10.39 to the Company's Quarterly Report on Form 10-Q for the period
ending March 31, 2000).
10.40 Lease Agreement, dated February 4, 2000, by and between Park Central
Mall, L.L.C. and Pac-West Telecomm, Inc. for 3110 North Central
Avenue, Suite 75, Building 2, Phoenix, Arizona (Incorporated by
reference to Exhibit 10.40 to the Company's Quarterly Report on
Form 10-Q for the period ending March 31, 2000).
10.41 Interconnection Agreement Between US West Communications, Inc. and
Pac-West Telecomm, Inc. For Colorado dated May 8, 2000
(Incorporated by reference to Exhibit 10.41 to the Company's
Quarterly Report on Form 10-Q for the period ending June 30, 2000).
10.42 Lease Agreement, dated March 8, 2000, by and between Stockton March
Partners and Pac-West Telecomm, Inc. for 1776 West March Lane,
Stockton, California (Incorporated by reference to Exhibit 10.42 to
the Company's Quarterly Report on Form 10-Q for the period ending
June 30, 2000).
10.43 IRU Agreement, dated June 30, 2000, by and between Qwest
Communications Corporation and Pac-West Telecomm, Inc. (Confidential
Materials omitted and filed separately with the Securities and
Exchange Commission) (Incorporated by reference to Exhibit 10.43 to
the Company's Quarterly Report on Form 10-Q for the period ending
June 30, 2000).
51
+10.44 1998 Griffin Non-Qualified Stock Incentive Plan (Incorporated by
reference to Exhibit 10.44 to the Company's Quarterly Report on Form
10-Q for the period ending September 30, 2000).
+10.45 1998 Bryson Non-Qualified Stock Incentive Plan (Incorporated by
reference to Exhibit 10.45 to the Company's Quarterly Report on Form
10-Q for the period ending September 30, 2000.
+10.46 2000 Napa Valley Non-Quaified Stock Incentive Plan (Incorporated by
reference to Exhibit 10.46 to the Company's Quarterly Report on Form
10-Q for the period ending September 30, 2000).
+10.47 2000 Employee Stock Purchase Plan (Incorporated by reference to
Exhibit 10.47 to the Company's Quarterly Report on Form 10-Q for the
period ending September 30, 2000).
10.48 Lease Agreement , dated August 29, 2000, by and between Boyd
Enterprises Utah, LLC and Pac-West Telecomm, Inc. for 2302 S.
Presidents Drive, West Valley City, Utah.
+*10.49 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. Wallace W. Griffin and Pac-West
Telecomm, Inc.
+*10.50 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. John K. La Rue and Pac-West
Telecomm, Inc.
+*10.51 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. Richard E. Bryson and Pac-West
Telecomm, Inc.
+*10.52 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. Joel A. Effron and Pac-West
Telecomm, Inc.
*10.53 Interconnection Agreement Between Roseville Telephone Company. and
Pac-West Telecomm, Inc. for the State of California dated September
18, 2000.
+*10.54 Mutual Settlement Agreement, dated November 16, 2000, by and between
Mr. Brian K. Johnson and Pac-West Telecomm, Inc.
*23.1 Consent of Arthur Andersen LLP.
* Filed with this report
+ Management contract or compensatory plan or arrangement
(b) Reports on Form 8-K
None
52
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 30, 2001.
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
/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
/s/ A. Gary Ames
- ------------------------- Director
A. Gary Ames
53
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Arthur Andersen LLP, Independent Public Accountants................................ F-2
Consolidated Balance Sheets.................................................................. F-3
Consolidated Statements of Operations........................................................ F-5
Consolidated Statements of Changes in Stockholders' Equity (Deficit)......................... F-6
Consolidated Statements of Cash Flows........................................................ F-7
Notes to Consolidated 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 consolidated balance sheets of Pac-West
Telecomm, Inc. (a California corporation) and subsidiaries as of December 31,
1999 and 2000, and the related consolidated statements of operations, changes in
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pac-West Telecomm,
Inc. and subsidiaries as of December 31, 1999 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
As explained in the Revenue Recognition section of Note 2 to the consolidated
financial statements, effective January 1, 2000, the Company changed its method
of accounting for revenue recognition on certain non-refundable up-front
installation payments through the adoption of Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements."
Arthur Andersen LLP
San Jose, California,
February 9, 2001
F-2
PAC-WEST TELECOMM, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 2000
ASSETS
1999 2000
-------------- ---------------
CURRENT ASSETS:
Cash and cash equivalents $ 82,688,000 $ 56,675,000
Restricted cash 10,087,000 -
Short-term investments 70,138,000 43,904,000
Trade accounts receivable, net of allowances of $675,000 and $3,003,000
as of December 31, 1999 and 2000, respectively 8,339,000 19,106,000
Accounts receivable from related parties 63,000 34,000
Income tax receivable 195,000 2,257,000
Inventories 952,000 4,272,000
Prepaid expenses and other current assets 2,786,000 3,482,000
Deferred financing costs, net 864,000 853,000
Deferred tax assets 580,000 2,475,000
--------------- ---------------
Total current assets 176,692,000 133,058,000
--------------- ---------------
PROPERTY AND EQUIPMENT:
Network and other communication equipment 71,142,000 114,325,000
Equipment under capital leases - 21,311,000
Office furniture 934,000 2,046,000
Business software and computer equipment 2,706,000 19,586,000
Vehicles 1,199,000 2,053,000
Leasehold improvements 11,661,000 23,971,000
Projects in progress 32,405,000 49,065,000
--------------- ---------------
120,047,000 232,357,000
Less: Accumulated depreciation and amortization (14,858,000) (30,843,000)
--------------- ---------------
Property and equipment, net 105,189,000 201,514,000
--------------- ---------------
COSTS IN EXCESS OF NET ASSETS OF ACQUIRED BUSINESSES, net 209,000 18,756,000
OTHER ASSETS, net 8,010,000 7,464,000
--------------- ---------------
Total assets $ 290,100,000 $ 360,792,000
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
PAC-WEST TELECOMM, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 2000
LIABILITIES AND STOCKHOLDERS' EQUITY
1999 2000
----------------- ------------------
CURRENT LIABILITIES:
Current portion of notes payable $ 99,000 $ 16,000
Current obligations under capital leases - 5,852,000
Accounts payable 13,158,000 18,681,000
Accrued payroll and related expenses 1,719,000 3,872,000
Accrued interest on senior notes 8,435,000 8,437,000
Other accrued liabilities 1,269,000 4,209,000
Fiber IRU liability - 17,240,000
Deferred revenues - 1,819,000
Income taxes payable 520,000 -
----------------- ------------------
Total current liabilities 25,200,000 60,126,000
----------------- ------------------
SENIOR NOTES 150,000,000 150,000,000
CAPITAL LEASES, less current portion - 15,459,000
NOTES PAYABLE, less current portion 17,000 -
----------------- ------------------
Total long-term debt 150,017,000 165,459,000
----------------- ------------------
DEFERRED REVENUES, less current portion - 735,000
----------------- ------------------
DEFERRED INCOME TAXES 8,633,000 14,715,000
----------------- ------------------
Total liabilities 183,850,000 241,035,000
----------------- ------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value:
Authorized shares--100,000,000
Issued and outstanding shares--35,393,326 and 35,948,549 at
December 31, 1999 and 2000, respectively 35,000 36,000
Additional paid-in capital 173,345,000 183,568,000
Notes receivable from stockholders (233,000) (200,000)
Retained deficit (66,897,000) (63,280,000)
Accumulated other comprehensive income - 277,000
Deferred stock compensation - (644,000)
----------------- ------------------
Total stockholders' equity 106,250,000 119,757,000
----------------- ------------------
Total liabilities and stockholders' equity $ 290,100,000 $ 360,792,000
================= ==================
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
PAC-WEST TELECOMM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
1998 1999 2000
-------------------------------------------------
REVENUES $ 42,211,000 $ 95,505,000 $ 139,090,000
-------------------------------------------------
COSTS AND EXPENSES:
Operating 15,344,000 20,510,000 42,388,000
Selling, general and administrative:
Selling, general and administrative 10,779,000 22,855,000 54,026,000
Transaction bonuses and consultant's costs 3,798,000 -- --
Depreciation and amortization 4,106,000 8,689,000 20,905,000
-------------------------------------------------
Total costs and expenses 34,027,000 52,054,000 117,319,000
-------------------------------------------------
Income from operations 8,184,000 43,451,000 21,771,000
-------------------------------------------------
OTHER EXPENSE (INCOME):
Interest expense 4,199,000 18,124,000 18,932,000
Costs of merger with PWT Acquisition Corp. and recapitalization 3,004,000 -- --
Interest income (327,000) (3,690,000) (7,564,000)
(Income) loss on asset dispositions, net (3,000) -- 580,000
-------------------------------------------------
Total other expense, net 6,873,000 14,434,000 11,948,000
-------------------------------------------------
Income before provision for income taxes, extraordinary
item, and cumulative effect of change in accounting
principle 1,311,000 29,017,000 9,823,000
PROVISION FOR INCOME TAXES 1,561,000 13,111,000 4,791,000
-------------------------------------------------
Income (loss) before extraordinary item and cumulative
effect of change in accounting principle (250,000) 15,906,000 5,032,000
EXTRAORDINARY ITEM: Loss on early extinguishment of debt, net of
income tax benefit of $278,000 (417,000) -- --
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE,
net of income tax benefit of $943,000 -- -- (1,415,000)
-------------------------------------------------
Net income (loss) (667,000) 15,906,000 3,617,000
ACCRUED PREFERRED STOCK DIVIDENDS (1,324,000) (4,085,000) --
-------------------------------------------------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCKHOLDERS $ (1,991,000) $ 11,821,000 $ 3,617,000
=================================================
INCOME (LOSS) PER SHARE BEFORE EXTRAORDINARY ITEM AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
Basic $ (0.30) $ 0.59 $ 0.14
Diluted $ (0.30) $ 0.56 $ 0.13
LOSS PER SHARE FROM EXTRAORDINARY ITEM:
Basic $ (0.08) $ -- $ --
Diluted $ (0.08) $ -- $ --
LOSS PER SHARE FROM CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE:
Basic $ -- $ -- $ (0.04)
Diluted $ -- $ -- $ (0.03)
NET INCOME (LOSS) PER SHARE:
Basic $ (0.38) $ 0.59 $ 0.10
Diluted $ (0.38) $ 0.56 $ 0.10
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 5,244,191 20,172,968 35,837,552
Diluted 5,244,191 21,293,828 37,661,717
The accompanying notes are an integral part of these consolidated financial
statements
F-5
PAC-WEST TELECOMM, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
Notes Accumulated Deferred Total
Common Stock Additional Receivable Retained Other stock Stockholders'
---------------------- Paid in From Earnings Comprehen- Compensa- Equity
Shares Amount Capital Stock holders (Deficit) sive Income tion (Deficit)
-------------------------------------------------------------------------------------------------------
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 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 --- --- (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
Issuance of common stock
for acquisitions/other 491,787 1,000 9,180,000 --- --- --- --- 9,181,000
Exercise of stock options 63,436 135,000 --- --- --- --- 135,000
Repayment of notes
receivable --- --- --- 33,000 --- --- --- 33,000
Unrealized gain on
investments --- --- 277,000 --- 277,000
Deferred stock compensation --- --- 908,000 --- --- --- (908,000) ---
Amortization of deferred
stock compensation --- --- --- --- --- --- 264,000 264,000
Net income --- --- --- --- 3,617,000 --- --- 3,617,000
-------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 35,948,549 $ 36,000 $183,568,000 $ (200,000) $(63,280,000) $ 277,000 $(644,000) $119,757,000
=======================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
PAC-WEST TELECOMM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
1998 1999 2000
----------------------------------------------------
OPERATING ACTIVITIES:
Income (loss) before extraordinary item and cumulative effect of
change in accounting principle $ (250,000) $ 15,906,000 $ 5,032,000
Adjustments to reconcile income (loss) before extraordinary item
and cumulative effect of change in accounting principle to net
cash provided by operating activities:
Costs of merger with PWT Acquisition Corp. and recapitalization 3,004,000 -- --
Depreciation and amortization 4,106,000 8,689,000 20,905,000
Amortization of deferred financing costs 1,438,000 1,162,000 853,000
Amortization of deferred stock compensation -- -- 264,000
Net loss on asset dispositions -- -- 580,000
Interest earned on restricted cash -- (629,000) (38,000)
Allowance for doubtful accounts 100,000 275,000 1,983,000
Deferred income tax provision 963,000 6,316,000 4,787,000
Changes in operating assets and liabilities, net of acquisitions:
Increase in trade accounts receivable (1,061,000) (3,991,000) (10,248,000)
Decrease in accounts receivable from related parties 97,000 1,000 29,000
(Increase) decrease in income tax receivable (1,971,000) 1,776,000 (2,062,000)
Increase in inventories (117,000) (505,000) (1,761,000)
Increase in prepaid expenses and other current assets (263,000) (1,975,000) (489,000)
(Increase) decrease in other assets 91,000 (2,541,000) (253,000)
Increase in accounts payable 3,988,000 8,011,000 401,000
Increase in accrued interest on Senior Notes -- 8,435,000 2,000
Increase (decrease) in income taxes payable -- 520,000 (537,000)
Increase (decrease) in accrued payroll and related expenses and
other liabilities 1,908,000 (11,000) 22,314,000
----------------------------------------------------
Net cash provided by operating activities 12,033,000 41,439,000 41,762,000
----------------------------------------------------
INVESTING ACTIVITIES:
Purchases of property and equipment (42,176,000) (56,370,000) (92,337,000)
(Purchases) redemptions of short-term investments, net -- (70,138,000) 26,511,000
Proceeds from disposal of equipment 145,000 -- 46,000
Purchase of restricted cash investments, net of redemptions of
$10,238,000 and $10,125,000 in 1999 and 2000, respectively -- (9,458,000) 10,125,000
Costs of acquisitions, net of cash received -- -- (12,186,000)
----------------------------------------------------
Net cash used in investing activities (42,031,000) (135,966,000) (67,841,000)
----------------------------------------------------
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 10,514,000 -- --
Proceeds from repayment of notes receivable from stockholders -- -- 33,000
Repayments on notes payable (2,658,000) (132,000) (100,000)
Principal payments on capital leases (828,000) -- --
Payment for deferred financing costs (1,195,000) (6,022,000) (2,000)
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 -- 135,000
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) -- --
----------------------------------------------------
Net cash provided by financing activities 41,631,000 161,979,000 66,000
----------------------------------------------------
Net increase (decrease) in cash and cash equivalents 11,633,000 67,452,000 (26,013,000)
CASH AND CASH EQUIVALENTS:
Beginning of year 3,603,000 15,236,000 82,688,000
----------------------------------------------------
End of year $ 15,236,000 $ 82,688,000 $ 56,675,000
====================================================
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
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-sized
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 success of the Company is dependent upon several factors. These factors
include the Company's ability to penetrate additional markets and to manage and
adequately finance 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 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 preexisting 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 consolidated statements of operations. Under the terms of the
Transaction, the preexisting 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 7 for discussion of settlement payment). After consummation of the
Transaction, the preexisting Stockholders held approximately 28 percent of the
issued and outstanding common stock of the Company. As a result of the continued
significant ownership interests of the preexisting Stockholders, no adjustments
have been made to the historical carrying amounts of the Company's assets and
liabilities as a result of the Transaction.
In November 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.
In January 2000, the Company acquired the customer base and certain other assets
of Napa Valley Telecom (Napa Telecom), a switch based, long distance
telecommunications company which was headquartered in Napa Valley, California.
In February 2000, the Company acquired all of the outstanding stock of
Installnet, Inc. and two related companies (collectively, Installnet), which is
headquartered in Southern California. Installnet was primarily engaged in the
business of selling, installing and maintaining telecommunications equipment. In
September 2000, the Company acquired the customer base and certain other assets
of BTC Corp (Baron Telecommunications), which was headquartered in Seattle,
Washington. Baron Telecommunications provided telecommunications equipment to
small and medium-sized businesses in Seattle and surrounding areas. Effective
November 1, 2000, the Company acquired the customer base and assets of
Communication Specialists, Inc. (CSI), a telecommunications company located in
Salt Lake City, Utah. (See Note 5.)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of the Company and
its subsidiaries as of the date of acquisition. All intercompany accounts and
transactions have been eliminated. The following subsidiaries of Pac-West
Telecomm, Inc. are included in the respective consolidated financial statements;
Installnet, Inc., D.B.D Consulting, Inc. and U.S. Net Solutions, Inc.
Concentration of Customers and Suppliers
- ----------------------------------------
The relative concentrations of customers and suppliers of the Company are:
1998 1999 2000
--------------------------
Revenues (percent of revenues): Incumbent Local Exchange 37% 58% 45%
Carriers (ILECs, see Note 7)
Expenses (percent of operating costs): largest supplier 50% 49% 35%
F-8
In 1998, 1999 and 2000, the Company's largest source of operating costs was also
the largest incumbent local exchange carrier (ILEC).
For the years ended December 31, 1998, 1999 and 2000, ISPs accounted for
approximately 23.3%, 19.3% and 19.3%, respectively, of our revenues, not
including reciprocal compensation related to terminating calls to ISPs, long-
distance services and dedicated transport services. Approximately 17% of our
accounts receivable as of December 31, 2000 were from our largest ISPs.
Management performs ongoing evaluations of the creditworthiness of its customers
and monitors collections. As necessary, an allowance for doubtful accounts is
recognized for potential uncollectible accounts. During 2000, the Company
increased its allowance for doubtful accounts by approximately $2.3 million.
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 reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the period. 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 in which
the Company operates and the continued deregulation or alternative regulation of
telecommunications services in many jurisdictions.
Revenue Recognition
- -------------------
In December 1999, the Securities and Exchange Commission (SEC) 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 became effective
for the Company during the fourth quarter of 2000, retroactive to January 1,
2000. In accordance with SAB 101, the Company recognizes revenue when there is
pervasive evidence of an arrangement, delivery of the product or performance of
the service has occurred, the selling price is fixed and determined and
collectibility is reasonably assured. The Company's adoption of SAB 101 changed
the timing of when revenue is recognized for non-refundable up-front payments
received for installation services. Historically, these amounts have been
recognized in the period received. Under the revised revenue recognition policy,
these payments, and related costs up to the amount of revenues, are recognized
as revenue and expense ratably over the term of the service contracts, generally
24 to 36 months. Any costs in excess of recognized revenues are expensed in the
current period. As of December 31, 2000, $2,554,000 of installation payments
received and $999,000 of associated costs were deferred and are included in
deferred revenues and other assets, respectively, in the accompanying
consolidated balance sheets.
The cumulative effect of this accounting change was $1,415,000, net of income
tax benefit of $943,000, and was taken as a charge to the first quarter of 2000.
The accounting change did not have a material effect on quarterly revenue and
quarterly earnings during 2000. The Company has restated its results for the
first three quarters of the year ended December 31, 2000, as reflected in Note
12. The pro forma impact of this change on years prior to 2000 has not been
presented as the impact of such change is immaterial to the individual years
presented.
Revenues from the sale of telecommunications products are recognized upon
installation, or if no installation is required, upon shipment. Revenues from
service access agreements are recognized as 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 (CLECs),
such as the Company, to receive this type of compensation is the subject of
numerous regulatory and legal challenges (see Note 7). Until this issue is
ultimately resolved, the Company will continue to recognize reciprocal
compensation as revenue when received in cash or when collectibility is
reasonably assured.
Two ILECs with which the Company has interconnection agreements (see Note 7) had
withheld payments from amounts billed by the Company under their agreements from
1997 to 1999. In September and October 1999, settlements were entered into with
these ILECs. Under the terms of the settlements, the ILECs paid an aggregate of
$26.3 million to the Company. These reciprocal compensation settlements were
included in revenues for the year ended December 1999 in the period received.
Cash Equivalents
- ----------------
The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents.
Restricted Cash
- ---------------
Restricted cash at December 31, 1999 represented 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. Such
payments were made in 2000.
F-9
Short-Term Investments
- ----------------------
All investments with a maturity of greater than three months at the date of
purchase 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 and 2000 were classified as
available-for-sale and appropriately carried at fair value. Such investments
consisted of corporate and investment grade U.S. and municipal debt securities.
Realized gains and losses are included in interest income in the accompanying
consolidated statements of operations. Differences between cost and fair value
are recorded as unrealized gains and losses as other comprehensive income, a
separate component of stockholders' equity. At December 31, 2000, $277,000 was
recorded as unrealized gain on investments. As of December 31, 1999, the cost of
these investments approximated their market value. (See Note 4.)
Inventories
- -----------
Inventories consist of telephone equipment, parts and installation materials,
which are valued at the lower of cost or market value. All inventory is
classified as finished goods. Cost is determined by the average-cost method.
Provisions are made to reduce slow moving inventory to reflect its estimated net
realizable value.
Property and Equipment
- ----------------------
Property and equipment is stated at cost and includes network and other
communication equipment, equipment under capital leases, office furniture,
business software and computer equipment, vehicles, leasehold improvements, and
projects in progress. Expenditures for repairs and maintenance, which do not
extend the useful life of the property and equipment, are charged to expense as
incurred. Upon retirement, the asset cost and related accumulated depreciation
are relieved from the consolidated financial statements. Gains and losses
associated with dispositions or impairment of property and equipment are
reflected as (income) loss on asset dispositions, net in the accompanying
consolidated 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 the Company's
incremental borrowing rate during the period of asset construction. In 1998,
1999 and 2000, the Company capitalized $303,000, $2,346,000 and $2,462,000,
respectively, of interest related to capital projects.
Depreciation and amortization of property and equipment was $4,106,000,
$8,475,000 and $17,651,000 for the years ended December 31, 1998, 1999 and 2000,
respectively.
During the last quarter of 2000, approximately $8.9 million of networking
equipment was returned to the supplier in exchange for credits for the full
purchase price. The difference between the net book value of the equipment and
the credits received, approximately $(0.7) million, is included in (income) loss
on asset dispositions, net. See Note 6 for discussion of purchase commitments
and financing of the new networking equipment.
During 1999, the Company purchased approximately 56 percent of its total capital
expenditures for the year from a single vendor. During 2000, the Company
purchased approximately 22% and 19% of its total capital expenditures for the
year from two vendors.
Intangible and Long-lived Assets
- --------------------------------
In accordance with Statement of Financial Accounting Standards (SFAS) No. 121
(SFAS 121), "Accounting for the Impairment of Long-Lived Assets to be Disposed
Of", the Company periodically evaluates the carrying amount of long-lived assets
and certain identifiable intangible assets when events or circumstances have
occurred which indicate the remaining estimated useful life of these assets may
be impaired. Determination of impairment is based on an estimate of undiscounted
future cash flows resulting from the use of the asset and its eventual
disposition. If the Company determines an asset has been impaired, the
impairment is recorded based on the fair value of the impaired asset. During the
fourth quarter of 2000, it was determined that certain internal-use computer
software purchased externally did not meet management's expectations. Under
provisions of SFAS 121 the Company recorded an impairment loss for this business
software of approximately $1.3 million, which is included in (income) loss on
asset dispositions, net in the accompanying consolidated statements of
operations. The software project was subsequently implemented utilizing internal
resources and systems.
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. Amortization expense for the years ended December
31, 1998, 1999 and 2000, was $1,438,000, $1,162,000 and $853,000 respectively,
and is included in interest expense in the accompanying consolidated statements
of operations.
Other Assets
- ------------
At December 31, other assets consist of the following:
F-10
1999 2000
--------------------------------
Deferred financing costs $ 5,648,000 $ 4,808,000
Acquisition of lease rights 1,513,000 1,254,000
Long term portion of deferred installation costs --- 516,000
Long-term portion of prepaid expenses and deposits 849,000 781,000
Employee receivable --- 105,000
--------------------------------
$ 8,010,000 $ 7,464,000
================================
During 1999, the Company purchased lease rights of additional space in its Los
Angeles facility. This amount is included in other assets and is being amortized
on a straight-line basis over the life of the lease, which is 69 months.
Other Accrued Liabilities
- -------------------------
At December 31, other accrued liabilities consist of the following:
1999 2000
--------------------------------
Taxes payable, collected from customers $ 397,000 $ 582,000
Acquisition holdbacks --- 1,060,000
Accrued warranty and maintenance --- 402,000
Other 872,000 2,165,000
--------------------------------
$ 1,269,000 $ 4,209,000
================================
Supplemental Statements of Cash Flows Information
- -------------------------------------------------
1998 1999 2000
-------------------------------------------------
Cash paid during the period for:
Interest (net of amount capitalized) $ 2,565,000 $ 8,723,000 $ 20,250,000
Income taxes (net of refunds) 2,195,000 4,499,000 2,253,000
Noncash transactions during the period for:
Acquisition of fixed assets using capital lease obligations 290,000 -- 21,311,000
Issuance of the Preferred Stock in conjunction with the
Transaction 13,156,000 -- --
Refinancing of capital lease obligation with note payable 1,599,000 -- --
Issuance of common stock for acquisitions -- -- 9,147,000
Income Taxes
- ------------
The Company provides for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes" (SFAS 109). SFAS 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 130). SFAS No. 130 establishes the disclosure requirements for
comprehensive income (loss) and its components within the financial statements.
For the year ended December 31, 2000 there was $277,000 of other comprehensive
income pertaining to the net unrealized investment gains. The Company had no
items of other comprehensive income (loss) for the years ended December 31, 1998
and 1999; therefore, comprehensive income (loss) was the same as net income
(loss) for each of those years.
Segment Reporting
- -----------------
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", (SFAS 131). SFAS 131 establishes standards
in which public companies disclose certain information about operating segments
in the company's financial reports. 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
F-11
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
consolidated financial statements.
Specifically, the following table presents revenues by service type:
1998 1999 2000
--------------------------------------------------
Local services $ 28,147,000 $ 79,071,000 $ 102,970,000
Long-distance services 6,328,000 7,974,000 16,128,000
Dedicated transport services 4,155,000 5,162,000 7,663,000
Products and services 2,104,000 1,485,000 9,942,000
Other 1,477,000 1,813,000 2,387,000
--------------------------------------------------
$ 42,211,000 $ 95,505,000 $ 139,090,000
==================================================
Local services revenues for the year ended December 31, 1999 include $26,308,000
of reciprocal compensation settlement payments (See Note 7).
Other Recent Pronouncements
- ---------------------------
The FASB issued SFAS No. 133, "Accounting for Derivative Instruments and for
Hedging Activities" (SFAS 133) and SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities, an amendment of FASB
Statement No. 133" (SFAS 128), in June 1998 and June 2000, respectively. As
amended, SFAS 133 establishes accounting and reporting standards for derivative
instruments and hedging activities including recognizing all derivatives as
either assets or liabilities in the financial statement at fair value. The
adoption of SFAS 133 does not impact the Company's financial statements as the
Company does not invest in derivatives or participate in hedging activities.
In March 2000, the FASB issued FASB Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation - an Interpretation of APB No.
25" (FIN 44). FIN 44 became effective July 1, 2000. FIN 44 clarifies the
application of Accounting Principles Board Opinion No. 25 for certain issues,
specifically, (a) the definition of an employee, (b) the criteria for
determining whether a plan qualifies as a compensatory plan, (c) the accounting
consequence of various modifications to the terms of a previous fixed stock
compensation award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. The Company has adopted the provisions of FIN
44 with no material effect on its results of operations or financial position.
Income (Loss) Per Share
- -----------------------
Income (loss) per share has been calculated under SFAS No. 128, "Earnings per
Share", (SFAS 128). SFAS 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 as follows:
For the Year Ended
December 31, 2000
------------------------------------------------
Income Shares Per Share
Basic income per share:
Income applicable to common stockholders before
cumulative effect of change in accounting $5,032,000 35,837,552 $0.14
principle, net
Cumulative effect of change in accounting principle, (1,415,000) 35,837,552 (0.04)
net
--------------- -----------------
Net income applicable to common stockholders $3,617,000 35,837,552 $0.10
===================================================
Effect of dilutive securities:
Stock options 1,824,165
-----------------
Diluted net income per share:
Income available to common stockholders and diluted
stock options (treasury stock method) before
cumulative effect of change in accounting $5,032,000 37,661,717 $0.13
principle, net
Cumulative effect of change in accounting principle, (1,415,000) 37,661,717 (0.03)
net
--------------- -----------------
Net income available to common stockholders and
dilutive stock options $3,617,000 37,661,717 $0.10
===================================================
F-12
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:
Stock options 1,120,860
-----------------
Diluted net income per share:
Net income available to common stockholders and
dilutive stock options $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. In November 1999, the Company
consummated an initial public offering of its common stock and converted all
outstanding convertible redeemable preferred stock and cumulative dividends (see
Note 1).
The Company evaluated the requirements of the SEC Staff Accounting Bulletin No.
98 (SAB 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 98.
3. 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, 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 consolidated statements of operations for the year ended
December 31, 1998.
4. INVESTMENTS:
The following tables summarize the Company's investments in securites as of
December 31, 2000:
Unrealized
Cost Gains, net Fair Market Value
-----------------------------------------------------------------------
Cash and equivalents $ 20,991,000 $ --- $ 20,991,000
U.S. government agencies 23,893,000 124,000 24,017,000
Municipals 15,215,000 --- 15,215,000
Collaterized mortgage obligation 992,000 12,000 1,004,000
Corporate bonds 17,428,000 55,000 17,483,000
Assets backed securites 9,282,000 86,000 9,368,000
-----------------------------------------------------------------------
$ 87,801,000 $ 277,000 $ 88,078,000
=======================================================================
Reported as:
Cash and cash equivalents $ 44,174,000
Short term investments 43,904,000
----------------------
Total $ 88,078,000
======================
The following tables summarize the Company's investments in securites as of
December 31, 1999:
Unrealized
Cost Gains, net Fair Market Value
-----------------------------------------------------------------------
Cash and equivalents $ 52,591,000 $ --- $ 52,591,000
U.S. government agencies 22,867,000 --- 22,867,000
Municipals 9,000,000 --- 9,000,000
Collaterized mortgage obligation --- --- ---
Corporate bonds 25,381,000 --- 25,381,000
Assets backed securites 9,608,000 --- 9,608,000
-----------------------------------------------------------------------
-----------------------------------------------------------------------
$ 119,447,000 $ --- $ 119,447,000
=======================================================================
Reported as:
Cash and cash equivalents $ 49,309,000
Short term investments 70,138,000
----------------------
Total $ 119,447,000
======================
F-13
5. COSTS IN EXCESS OF NET ASSETS OF ACQUIRED BUSINESSES:
Costs in excess of net assets of acquired businesses primarily relates to the
acquisitions of Napa Telecom, Installnet, Baron Telecommunications and CSI.
These costs consist of the following at December 31, 2000:
Baron
Napa Telecom Installnet Telecommunications CSI Other* Total
------------------------------------------------------------------------------------------------
Purchase Price:
Cash $4,517,000 $ 4,386,000 $ 1,823,000 $ 1,042,000 $ 209,000 $ 11,977,000
8,400,000 9,147,000
Common stock -- 587,000 160,000 --
Expenses 55,000 418,000 35,000 23,000 4,000 535,000
------------------------------------------------------------------------------------------------
Total 4,572,000 13,204,000 2,445,000 1,225,000 213,000 21,659,000
Less net assets
(deficit) acquired 847,000 (1,622,000) 655,000 165,000 -- 45,000
------------------------------------------------------------------------------------------------
Total excess costs 3,725,000 14,826,000 1,790,000 1,060,000 213,000 21,614,000
Less accumulated
amortization (744,000) (1,942,000) (85,000) (33,000) (54,000) (2,858,000)
------------------------------------------------------------------------------------------------
Unamortized balance at
December 31, 2000 $2,981,000 $ 12,884,000 $ 1,705,000 $ 1,027,000 $ 159,000 $ 18,756,000
================================================================================================
*Cash was paid prior to January 2000 for "other" acquisitions.
Costs in excess of net assets acquired for Napa Telecom are being amortized on a
straight-line basis over 60 months beginning January 1, 2000. Costs in excess of
net assets acquired for Installnet, Baron Telecommunications and CSI are being
amortized on a straight-line basis over 84 months beginning February 1,
September 1, and November 1, 2000, respectively. Amortization expense related to
costs in excess of net assets of acquired businesses of $14,000 and $2,844,000
was recorded in 1999 and 2000, respectively. Refer to Note 2, Intangible and
Long-lived Assets, for the Company's policies regarding periodic evaluations of
intangible assets.
The following is a summary of the acquired assets and liabilities:
Baron
Napa Telecom Installnet Telecommunications CSI Total
---------------------------------------------------------------------------------------
Cash $ 35,000 $ 30,000 $ -- $ -- $ 65,000
Accounts receivable 770,000 1,673,000 364,000 62,000 2,869,000
Allowance for doubtful accounts (142,000) (175,000) (50,000) -- (367,000)
Inventories 50,000 1,211,000 225,000 73,000 1,559,000
Prepaid expenses -- 54,000 -- -- 54,000
Current tax assets -- 48,000 -- -- 48,000
Equipment and vehicles 134,000 1,105,000 141,000 30,000 1,410,000
Accumulated depreciation -- (455,000) -- -- (455,000)
Other assets -- 41,000 -- -- 41,000
---------------------------------------------------------------------------------------
Total assets acquired 847,000 3,532,000 680,000 165,000 5,224,000
Accounts payable and accrued
liabilities -- 5,097,000 25,000 -- 5,122,000
Income taxes payable -- 17,000 -- -- 17,000
Deferred income taxes -- 40,000 -- -- 40,000
---------------------------------------------------------------------------------------
Total liabilities acquired -- 5,154,000 25,000 -- 5,179,000
---------------------------------------------------------------------------------------
Net assets (deficit) acquired
$ 847,000 $(1,622,000) $ 655,000 $ 165,000 $ 45,000
======================================================================================
F-14
6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS:
At December 31, long-term debt and capital lease obligations consisted of the
following:
1999 2000
------------------------------------
Senior Notes $150,000,000 $150,000,000
Notes payable, less current portion 17,000 --
Capital Lease, less current portion -- 15,459,000
------------------------------------
$150,017,000 $165,459,000
------------------------------------
On January 29, 1999, the Company issued $150,000,000 of Senior Notes at par. The
Senior Notes bear interest at 13.5 percent per annum payable in semiannual
installments, with all principal due in full on February 1, 2009.
The indenture for the Senior Notes provides that the Company, at its option, may
(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). On September 22, 1999 all of the unregistered
Senior Notes were exchanged for Senior Notes registered under the Securities
Act.
The indenture for the Senior Notes provides for certain basic covenants of these
notes, which generally restrict 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. As of December 31, 2000,
the Company is in compliance with all covenants.
The Company has a three-year senior credit facility expiring June 15, 2002 that
provides for maximum borrowings of up to $40 million to finance working capital,
the cost of the Company's planned capital expansion and other corporate
transactions. This facility is 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 and
2000, there were no amounts outstanding under this facility. As of December 31,
2000 the borrowing rate would have been 8.89 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.
The Company is in compliance with all covenants.
In October 2000, the Company secured a lease facility of up to $30 million to be
used exclusively for networking products and services. Equipment financed under
this facility will be leased for a term of 36 months at which time the Company
may purchase the equipment at fair market value. Purchases under this facility
will be accounted for as a capital lease. As of December 31, 2000 the Company
purchased approximately $21.3 million of equipment under this facility. Upon
acceptance of the networking products the Company will pay recurring monthly
lease payments over a term of three years. No payments were made in 2000. As of
December 31, 2000, future obligations related to capital leases are as follows:
----------------
Capital Leases
----------------
2001 $ 5,921,000
2002 7,197,000
2003 7,197,000
2004 1,366,000
----------------
21,681,000
----------------
Less: portion representing interest 370,000
----------------
Capital lease payable, current and long-term $ 21,311,000
================
F-15
7. COMMITMENTS AND CONTINGENCIES:
Operating Leases
- ----------------
The Company leases nine principal facilities. Four facilities are located in
California including two in Stockton and one in each of Oakland and Los Angeles,
in addition to locations in or around Las Vegas, NV, Seattle, WA, Phoenix, AZ,
Denver, CO, and Salt Lake City, UT. The leases are pursuant to noncancellable
operating leases that expire in June 2002, September 2007, November 2003,
September 2006, October 2009, December 2009, April 2010, March 2010 and December
2010, respectively. The lease expiring in June 2002 contains five two-year
renewal options and the other eight leases 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.
The Company's future minimum lease payments with initial terms in excess of one
year as of December 31, 2000, are as follows:
Operating Leases
-------------------------------------
Telephone Circuits
Space and Equipment
-------------------------------------
2001 $3,639,000 $9,833,000
2002 3,730,000 7,354,000
2003 3,564,000 5,103,000
2004 3,259,000 3,365,000
2005 2,981,000 971,000
2006 and thereafter 9,909,000 --
-------------------------------------
$ 27,082,000 $ 26,626,000
=====================================
Rental expense charged to operations for the years ended December 31, 1998, 1999
and 2000, for all operating leases for space was $650,000, $1,260,000 and
$3,244,000, respectively, and is included in selling, general and administrative
expense in the accompanying consolidated statements of operations. Rental
expense charged to operations for telephone circuits of approximately
$9,935,000, $12,729,000 and $24,530,000 for the years ended December 31, 1998,
1999 and 2000, respectively, is included in operating costs in the accompanying
consolidated statements of operations. Rental expense paid to related parties
was approximately $35,000, $163,000 and $158,000 for the years ended December
31, 1998, 1999 and 2000, respectively.
Purchase Commitments
- --------------------
At December 31, 2000, the Company has approximately $5.0 million of purchase
orders outstanding for network equipment due for delivery during 2001. These
purchase orders are cancelable up to 60 days prior to delivery without penalty
and the Company expects to finance them with available cash, internally
generated cash flows, or from borrowings under the senior credit facility.
In addition, the Company implemented new billing and operations support systems.
Total estimated costs for these systems aggregate approximately $15 million, of
which approximately $9 million was incurred in 1999, $4 million was incurred in
2000 and approximately $2 million is expected to be incurred in 2001. The
majority of the $13 million incurred as of December 31, 2000 is included in
business software and computers at December 31, 2000.
The Company also implemented a new enterprise and financial software system.
Total estimated costs for this system are $5 million, of which approximately $3
million has been incurred, most of which is recorded in business software and
computer equipment as of December 31, 2000, in the accompanying consolidated
balance sheets.
On June 30, 2000, the Company entered into an Indefeasible Right of Use ("IRU")
agreement with Qwest Communications to acquire dedicated fiber optics circuits
of OC-48 capacity connecting major metropolitan areas in California. The IRU
agreement is for a term of 20 years and includes one-dollar purchase options at
the end of the term. The total cost of the IRU is approximately $23.0 million of
which $5.8 million was paid on July 28, 2000 and the balance is payable on June
30, 2001. The purchase price of approximately $23.0 million is included in
projects-in-progress and $17.2 million is classified in Fiber IRU liability in
the accompanying consolidated balance sheets.
F-16
Employment Agreements
- ---------------------
The Company entered into employment agreements in 1998 with certain key
executives that provided for minimum annual base salaries, bonus entitlements
upon the achievement of certain objectives, and the issuance of stock options.
All but two of the employment agreements expired in 2000.
On November 27, 2000, the Company's Board of Directors approved an Agreement
Regarding Compensation on Change of Control with eight officers. These
agreements provide for one year's base salary and health plan benefits in the
event of a merger or combination of the Company into another entity, or the sale
or disposition of all, or substantially all, of the Company's assets.
Two of the 1998 employment agreements, which were approved by the Company's
stockholders 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 8).
Reciprocal Compensation and Legal Proceedings
- ---------------------------------------------
The Company has established interconnection agreements with certain ILECs. The
Telecommunications Act of 1996 requires ILECs to enter into interconnection
agreements with 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, reciprocal
compensation arrangements for calls originating or terminating in the other
party's switching equipment, payment terms, and level of services.
Various ILECs have alleged, and are continuing to allege, 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 filed complaints with the
Superior Court of the State of California and the California and Nevada 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 million to the Company and $20 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 were 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
court has remanded the decision of the PUC of Nevada back to the Commission on
procedural grounds.
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.
F-17
In October 1999, GTE paid, and the Company recorded as revenue, $6,308,000 of
reciprocal compensation that GTE had previously withheld. GTE has not waived its
rights to appeal, contest or 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. Similarly, in the latter of 2000, the Colorado and Utah
Commissions commenced similar investigations into intercarrier compensation
issues.
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 when received
in cash or when collectibility is reasonably assured.
Following is a summary of amounts billed to ILECs during each of the three years
ended December 31, 2000, and payments withheld by two ILECs during the two the
years ended December 31, 1998 and 1999:
1998 1999 2000
-------------- --------------- ---------------
Total amount billed to ILECs during the year $ 48,264,000 $ 58,866,000 $ 62,194,000
Amount withheld by ILECs and not recorded as revenue in the
Company's statements of operations (32,845,000) (29,855,000) ---
Amounts received for prior withholding and recorded as revenue 254,000 26,308,000 ---
-------------- --------------- ---------------
Net amount recorded as revenue from the ILECs
during the year $ 15,673,000 $ 55,319,000 $ 62,194,000
============== =============== ===============
8. 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 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 and Increases in Authorized Shares
- ----------------------------------------------
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. All share and per share data
have been restated to reflect these stock splits.
On October 7, 1999, the Board of Directors approved a resolution to increase the
authorized shares of common stock to 50,000,000 shares and then further
increased the authorized shares of common stock to 100,000,000 in 2000. In
addition, in 2000 the Board of Directors also authorized the issuance of
10,000,000 shares of preferred stock at their discretion. No preferred shares
were issued as of December 31, 2000.
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 pursuant to the 1998 Griffin and Bryson Non-Qualified
Stock Incentive Plans. In May 2000 the Board of Directors approved the 2000 Napa
Valley Non-Qualified Stock Incentive Plan. An aggregate of 5,375,500 shares of
common stock have been reserved for option grants.
A summary of the status of the Company's stock option plans at December 31, 2000
and changes during the years ended December 31, 1998, 1999 and 2000 are
presented in the table below:
F-18
Exercise
Qualifying Nonqualifying Total Price
------------ --------------- ------------ -----------
Balance, December 31, 1997 -- -- -- $ --
Granted -- 568,750 568,750 0.48
------------ --------------- ------------
Balance, December 31, 1998 -- 568,750 568,750 0.48
Granted 1,325,865 366,335 1,692,200 5.06
Cancelled (36,300) -- (36,300) 2.57
------------ --------------- ------------
Balance, December 31, 1999 1,289,565 935,085 2,224,650 3.93
Granted 1,761,183 390,617 2,151,800 13.84
Exercised (63,436) -- (63,436) 2.14
Cancelled (328,210) (58,979) (387,189) 18.65
------------ -------------- ------------
Balance, December 31, 2000 2,659,102 1,266,723 3,925,825 $ 7.99
============ ============== ============
Options outstanding, exercisable and vested by price range at December 31, 1999,
are as follows:
Number Weighted Average
Range of Number Weighted Average Remaining Vested and Exercise Price of
Exercise Price Outstanding Contractual Life Exercisable Options Exercisable
------------------ -------------- ---------------------------- ------------- ---------------------
$ 0.48 568,750 8.8 422,917 $ 0.48
2.14 1,215,900 9.3 -- 2.14
10.00 319,000 9.8 224,000 10.00
22.06 121,000 9.9 -- 22.06
-------------- ------------ ----------------
2,224,650 646,917 $ 3.93
============== ============ ================
Options outstanding, exercisable and vested by price range at December 31, 2000,
are as follows:
Number Weighted Average
Range of Number Weighted Average Vested and Exercise Price of
Exercise Prices Outstanding Remaining Contractual Life Exercisable Options Exercisable
------------------------ -------------- ---------------------------- ------------- ---------------------
$ 0.48 - 4.06 2,544,926 8.7 828,321 $ 1.00
8.69 - 35.00 1,380,899 9.2 268,464 11.00
-------------- ------------ ----------------
3,925,825 1,096,785 $ 3.45
============== ============ ================
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", (SFAS 123), to disclose pro forma
information regarding options granted to its employees based on specified
valuation techniques that produce estimated compensation charges. These amounts
have not been reflected in the Company's consolidated statements of operations
because no compensation arises when the price of the employees' stock options
equals the market value of the underlying stock at the date of grant, as in our
case. Had compensation expense for the plans been determined based on the fair
value at the grant dates, as prescribed in SFAS 123, the Company's earnings and
earnings per share would have been as follows:
F-19
1998 1999 2000
--------------- --------------- --------------
Net income (loss) attributable to common stockholders:
As reported $(1,991,000) $11,821,000 $ 3,617,000
Pro forma (2,020,000) 11,423,000 (9,636,000)
Basic earnings (loss) per common share
As reported $ (0.38) $ 0.59 $ 0.10
Pro forma (0.38) 0.57 (0.27)
Diluted earrings (loss) per common share:
As reported $ (0.38) $ 0.56 $ 0.10
Pro forma (0.38) 0.54 (0.26)
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 0, 74 and 100 percent for 1998, 1999 and 2000, respectively; weighted average
risk-free interest rates ranging from 4.9 to 6.23 percent for all periods
presented in the table above; and expected lives of four years for all periods.
Employee Stock Purchase Plan
- ----------------------------
In 2000, the Company established the 2000 Employee Stock Purchase Plan (the
Purchase Plan) under which 1,000,000 shares of common stock have been reserved
for issuance. Full-time employees may designate up to 10% of their compensation,
not to exceed 400 shares each six month period, or $25,000 worth of common stock
in any one calendar year, which is deducted each pay period for the purchase of
common stock under the Purchase Plan. On the last business day of each six month
period, shares of common stock are purchased with the employees' payroll
deductions at 85% of the lesser of the market price on the first or last day of
the six month period. The Purchase Plan will terminate no later than May 2,
2020. On January 3, 2001, the Company issued 44,789 shares to employees for
amounts withheld during 2000 under this plan.
9. INCOME TAXES:
The provision for income taxes consists of the following:
1998 1999 2000
----------------------------------------
Current:
Federal $ 353,000 $ 6,795,000 $ 4,000
State 245,000 -- --
Deferred:
Federal 861,000 5,595,000 4,457,000
State 102,000 721,000 330,000
----------------------------------------
$ 1,561,000 $ 13,111,000 4,791,000
========================================
F-20
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,
extraordinary item and cumulative effect of change in accounting principle, as
follows:
1998 Rate 1999 Rate 2000 Rate
------------- --------- ---------------- -------- ---------------- -------
Income tax determined by applying the
statutory federal income tax rate to income
before income taxes, extraordinary item,
and cumulative effect of change in
accounting principle $ 446,000 34.0% $10,156,000 35.0% $ 3,438,000 35.0%
State income taxes, net of federal income
tax benefit 230,000 17.5 470,000 1.6 215,000 2.2
Non-deductible amortization of costs in
excess of net assets of acquired businesses -- -- -- -- 680,000 6.9
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 -- --
Federal income tax effect of non-deductible
amortization of deferred stock
compensation -- -- -- -- 92,000 0.9
Changes in reserves -- -- 936,000 3.2 313,000 3.2
Other -- -- 49,000 0.2 53,000 0.6
------------- --------- ---------------- -------- ---------------- -------
Provision for income taxes $1,561,000 119.1% $13,111,000 45.2% $ 4,791,000 48.8%
============= ========= ================ ======== ================ =======
The cumulative balance sheet effects of deferred tax items are:
1999 2000
---------- ------------
Trade accounts receivable allowances $ 173,000 $ 1,054,000
Deferred revenue -- 768,000
Vacation and other accrued expenses 130,000 289,000
Inventory reserves 95,000 145,000
Tax credits 151,000 232,000
State taxes 152,000 2,197,000
--------- ------------
Deferred tax assets 701,000 4,685,000
--------- ------------
Depreciation and amortization (5,982,000) (9,742,000)
Capitalized interest (884,000) (1,324,000)
Software development costs -- (4,445,000)
Reciprocal compensation settlement (980,000) --
Other reserves (908,000) (1,414,000)
--------- ----------
Deferred tax liabilities (8,754,000) (16,925,000)
--------- ----------
Net deferred tax liability (8,053,000) (12,240,000)
Less: Amount classified as current deferred tax asset 580,000 2,475,000
--------- ----------
Net noncurrent deferred tax liability $(8,633,000) $(14,715,000)
========= ==========
10. 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 $2,680,000, $2,667,000 and
$2,540,000, or 6.4 percent, 2.8 percent and 1.9 percent, of the Company's
revenues for the years ended December 31, 1998, 1999 and 2000, respectively. The
Company also had amounts due from Bay Alarm at December 31, 1999 and 2000. These
amounts are included in accounts receivable from related parties in the
accompanying consolidated balance sheets.
Bay Alarm provides the Company with security monitoring services at its normal
commercial rates. The Company has recorded $58,000, $60,000 and $69,000 as
selling, general and administrative expense for these services for the years
ended December 31, 1998, 1999 and 2000, respectively. As outlined in Note 7, 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 $59,000, $35,000 and $0 for the years ended 1998,
F-21
1999 and 2000, 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 Stockholders
- ----------------------------------
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, which is in the
accompanying consolidated balance sheet as a component of stockholders equity.
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,
which was paid in full in 2000. These two notes accrue interest at 5.54 percent
and 5.12 percent, respectively, compounded annually. In December 2000, the
Company entered into two notes receivable with another officer of the Company
for $105,000. The notes accrue interest at 6.1 percent and are payable upon
demand. The notes are secured by a pledge of 38,000 shares of the Company's
common stock.
11. Retirement plan
The Company has 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 contributes $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 are eligible to participate in the Plan
after 6 months of service and become fully vested after six years, although they
vest incrementally on an annual basis after two years of service. The Company
recorded selling, general and administrative expense of $58,000, $134,000 and
$247,000 for the years ended December 31, 1998, 1999 and 2000, respectively, for
the Company's matching contributions.
F-22
12. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA
The following is a summary of quarterly consolidated financial results. The
amounts have been restated from previously reported amounts to conform to the
requirements of SAB 101. (See Note 2, Revenue Recognition.)
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
2000 as restated:
Net sales $ 30,391,000 $ 33,204,000 $ 36,270,000 $ 39,225,000
Gross margin $ 20,511,000 $ 23,187,000 $ 25,444,000 $ 27,560,000
Income before cumulative effect of change
in accounting principle (net of taxes) $ 2,145,000 $ 1,334,000 $ 991,000 $ 562,000
Cumulative effect of change in
accounting method (net of taxes) $ (1,415,000) $ --- $ --- $ ---
Net income $ 730,000 $ 1,334,000 $ 991,000 $ 562,000
Per share:
Income before cumulative effect of change
in accounting principle:
Basic $ .06 $ .04 $ .03 $ .02
Diluted $ .06 $ .04 $ .03 $ .02
Cumulative effect of change in accounting
principle (net of taxes)
Basic $ (.04) $ --- $ --- $ ---
Diluted $ (.04) $ --- $ --- $ ---
Net income:
Basic $ .02 $ .04 $ .03 $ .02
Diluted $ .02 $ .04 $ .03 $ .02
2000 as reported:
Net sales $ 30,807,000 $ 33,340,000 $ 35,981,000 $ 39,225,000
Gross margin $ 20,783,000 $ 23,159,000 $ 25,062,000 $ 27,560,000
Net income $ 2,308,000 $ 1,317,000 $ 761,000 $ 562,000
Net income per share:
Basic $ .06 $ .04 $ .02 $ .02
Diluted $ .06 $ .04 $ .02 $ .02
1999 as reported:
Net sales $ 14,416,000 $ 15,848,000 $ 37,016,000 $ 28,225,000
Gross margin $ 10,354,000 $ 11,157,000 $ 31,222,000 $ 22,262,000
Net income $ 647,000 $ 157,000 $ 10,022,000 $ 5,080,000
Net income (loss) applicable to common
shareholders $ (495,000) $ (1,026,000) $ 8,795,000 $ 4,547,000
Net income per share:
Basic $ (.03) $ (.06) $ .50 $ .16
Diluted $ (.03) $ (.06) $ .43 $ .16
F-23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON SUPPLEMENTAL SCHEDULE
To the Board of Directors and Stockholders
of Pac-West Telecomm, Inc.
We have audited in accordance with auditing standards, generally accepted
in the United States, the consolidated financial statements of Pac-West
Telecomm, Inc. included in this Form 10-K, and have issued our report thereon
dated February 9, 2001. Our audits were made for the purpose of forming an
opinion on the basic consolidated financial statements taken as a whole. The
accompanying Schedule II, "Valuation and Qualifying Accounts," is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic consolidated financial statements. This schedule has been subjected to
the auditing procedures applied in the audits of the basic consolidated
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
Arthur Andersen LLP
San Jose, California
February 9, 2001
F-24
PAC-WEST TELECOMM, INC.:
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 2000
- -----------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs and Other End of
Description Period Expenses Accounts Deductions Period
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts $ 675,000 $ 989,000 $ 1,361,000 $ 22,000 $ 3,003,000
- -----------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1999
- -----------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs and Other End of
Description Period Expenses Accounts Deductions Period
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts $ 400,000 $ 275,000 $ --- $ --- $ 675,000
- -----------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1998
- -----------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs and Other End of
Description Period Expenses Accounts Deductions Period
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts $ 300,000 $ 100,000 $ --- $ --- $ 400,000
- -----------------------------------------------------------------------------------------------------------------------------
F-25
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 Company'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 Company's Registration Statement (No. 333-76779))
3.1 Amended and Restated Articles of Incorporation of Pac-West Telecom,
Inc. (Incorporated by reference to Exhibit A to the Company's
Proxy Statement dated June 26,2000).
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 Company'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 Company'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
Company'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 Company'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 Company'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 Company'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 Company'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 Company'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
Company'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
Company'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
Company'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
Company'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
Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company's
Registration Statement (No. 333-76779)).
10.19 Balco Properties Office Lease, dated as of November 10, 1998, by and
between Balco Properties 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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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
Company'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 Company'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
(Incorporated by reference to Exhibit 10.31 to the Company's Annual
Report on Form 10-K for the period ending December 31,1999).
10.32 Agreement for Local Wireline Network Interconnection Between
Citizens Telecommunication Company of California, Inc. and Pac-West
Telecomm, Inc. dated November 1, 1999 (Incorporated by reference
to Exhibit 10.32 to the Company's Annual Report on Form 10-K for
the period ending December 31,1999).
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
(Incorporated by reference to Exhibit 10.33 to the Company's Annual
Report on Form 10-K for the period ending December 31,1999).
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 (Incorporated by reference to Exhibit 10.34 to the
Company's Annual Report on Form 10-K for the period ending
December 31,1999).
10.35 Interconnection Agreement under Sections 251 and 252 of the
Telecommunications Act of 1996 by and between Nevada Bell and Pac-
West Telecomm, Inc. executed August 25, 1999 (Incorporated by
reference to Exhibit 10.34 to the Company's Quarterly Report on
Form 10-Q for the period ending March 31, 2000).
10.36 Pac-West Telecomm, Inc. and US West Communications, Inc.
Interconnection Agreement for the State of Oregon dated January 31,
2000 (Incorporated by reference to Exhibit 10.36 to the Company's
Quarterly Report on Form 10-Q for the period ending March 31, 2000).
10.37 Adoption Letter dated February 2, 2000 between Pac-West Telecomm,
Inc. and GTE Northwest Incorporated of Interconnection, Resale and
Unbundling Agreement Between GTE Northwest Incorporated and Electric
Lightwave, Inc. for the State of Oregon (Incorporated by reference
to Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for
the period ending March 31, 2000).
10.38 Interconnection, Resale and Unbundling Agreement between GTE
Northwest Incorporated and Electric Lightwave, Inc. for the State of
Oregon (Incorporated by reference to Exhibit 10.38 to the Company's
Quarterly Report on Form 10-Q for the period ending March 31, 2000).
10.39 Lease Agreement, dated as of February 4, 2000, by and between North
Valley Tech LLC and Pac-West Telecomm, Inc. for E. 84th Avenue,
Suite 100, Thornton, Colorado (Incorporated by reference to Exhibit
10.39 to the Company's Quarterly Report on Form 10-Q for the period
ending March 31, 2000).
10.40 Lease Agreement, dated February 4, 2000, by and between Park Central
Mall, L.L.C. and Pac-West Telecomm, Inc. for 3110 North Central
Avenue, Suite 75, Building 2, Phoenix, Arizona (Incorporated by
reference to Exhibit 10.40 to the Company's Quarterly Report on
Form 10-Q for the period ending March 31, 2000).
10.41 Interconnection Agreement Between US West Communications, Inc. and
Pac-West Telecomm, Inc. For Colorado dated May 8, 2000
(Incorporated by reference to Exhibit 10.41 to the Company's
Quarterly Report on Form 10-Q for the period ending June 30, 2000).
10.42 Lease Agreement, dated March 8, 2000, by and between Stockton March
Partners and Pac-West Telecomm, Inc. for 1776 West March Lane,
Stockton, California (Incorporated by reference to Exhibit 10.42 to
the Company's Quarterly Report on Form 10-Q for the period ending
June 30, 2000).
10.43 IRU Agreement, dated June 30, 2000, by and between Qwest
Communications Corporation and Pac-West Telecomm, Inc. (Confidential
Materials omitted and filed separately with the Securities and
Exchange Commission) (Incorporated by reference to Exhibit 10.43 to
the Company's Quarterly Report on Form 10-Q for the period ending
June 30, 2000).
+10.44 1998 Griffin Non-Qualified Stock Incentive Plan (Incorporated by
reference to Exhibit 10.44 to the Company's Quarterly Report on Form
10-Q for the period ending September 30, 2000).
+10.45 1998 Bryson Non-Qualified Stock Incentive Plan (Incorporated by
reference to Exhibit 10.45 to the Company's Quarterly Report on Form
10-Q for the period ending September 30, 2000.
+10.46 2000 Napa Valley Non-Quaified Stock Incentive Plan (Incorporated by
reference to Exhibit 10.46 to the Company's Quarterly Report on Form
10-Q for the period ending September 30, 2000).
+10.47 2000 Employee Stock Purchase Plan (Incorporated by reference to
Exhibit 10.47 to the Company's Quarterly Report on Form 10-Q for the
period ending September 30, 2000).
10.48 Lease Agreement , dated August 29, 2000, by and between Boyd
Enterprises Utah, LLC and Pac-West Telecomm, Inc. for 2302 S.
Presidents Drive, West Valley City, Utah.
+*10.49 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. Wallace W. Griffin and Pac-West
Telecomm, Inc.
+*10.50 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. John K. La Rue and Pac-West
Telecomm, Inc.
+*10.51 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. Richard E. Bryson and Pac-West
Telecomm, Inc.
+*10.52 Agreement Regarding Compensation in change of Control, dated
December 1, 2000 by and between Mr. Joel A. Effron and Pac-West
Telecomm, Inc.
*10.53 Interconnection Agreement Between Roseville Telephone Company. and
Pac-West Telecomm, Inc. for the State of California dated September
18, 2000.
+*10.54 Mutual Settlement Agreement, dated November 16, 2000, by and between
Mr. Brian K. Johnson and Pac-West Telecomm, Inc.
*23.1 Consent of Arthur Andersen LLP.
* Filed with this report
+ Management contract or compensatory plan or arrangement