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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
Mark One
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-27743
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PAC-WEST TELECOMM, INC.
(Exact name of registrant as specified in its charter)
California 68-0383568
(State or other (I.R.S. Employer
jurisdiction Identification No.)
of 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
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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)
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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,
2002 as reported on the Nasdaq National Market System, was approximately
$7,556,079. 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, 2002, the Registrant had outstanding
36,148,487 shares of common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Pac-West Telecomm, Inc.'s Proxy Statement, to be delivered to
its shareholders in connection with its Annual Meeting of Shareholders to be
held June 11th, 2002, which will be filed with the Securities and Exchange
Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year, are incorporated by reference into Items 10 through 13 of Part
III of this Annual Report on Form 10-K.
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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:
. anticipated cost savings resulting from our restructuring plan, which was
approved and announced in August of 2001;
. 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;
. retain our key Internet service provider and other wholesale 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;
. receipt of full and timely payments from our customers;
. 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;
. respond to competitors in our existing and planned markets;
. generate sufficient cash to service our indebtedness;
. raise sufficient additional capital, if required, on acceptable terms and
on a timely basis;
. have sufficient funds available to expand our business;
. maintain our securities designation in the Nasdaq National Market System;
and
. prevent interruption of services from system failures or power outages.
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PART I
Item 1. Business
The terms "the Company," "Pac-West," "we," "our," "us," and similar terms as
used in this Form 10-K, refer to Pac-West Telecomm, Inc.
Our Company
Pac-West is a provider of wholesale and retail 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 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 each local access and
transport area (LATA) 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 gross profit
margins and positive cash flows.
In August 2001, the Company approved and announced a restructuring plan that
contained certain business initiatives designed to respond to certain
unfavorable market conditions, including the suspension of our expansion plans
into Idaho and New Mexico and the closure of our switch facility in Utah, which
was completed in December 2001. The restructuring plan also provided for a
reduction in workforce and the exit from certain lower margin services,
including residential resale and customer owned and maintained equipment
(COAM). For additional information regarding our restructuring plan, please
refer to Note 3 to our accompanying consolidated financial statements included
in Item 8 of this Annual Report on Form 10-K.
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 opening of local markets to competition, 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 newer entrants to achieve penetration of the large,
established local exchange services market.
We currently provide services in California, Nevada, Washington, Oregon,
Colorado and Arizona with digital connections in most local access and
transport areas in these states. As described above in "Our Company," in August
2001 we approved and announced a restructuring plan that included, among other
things, the suspension of our expansion plans into certain states including
Idaho and New Mexico and the closure of our switch facility in Utah.
Network
We built our network to capitalize on the significant growth in demand for
internet access and switched data and voice communications in addition to 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
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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 provision increased demand, and
provide low-cost redundancy. We also seek to maximize our operating profits by
carrying a high percentage of our customer-originated traffic on our network.
In addition to leasing our transport lines, in our high volume areas of
California we have a twenty year Indefeasible Right of Use (IRU) agreement for
dedicated fiber optics circuits of OC-48 capacity connecting major metropolitan
areas. These fiber optics circuits are expected to be operational by the middle
of 2002 and are intended to provide us with greater flexibility in creating and
managing data and voice services and result in cost savings.
Our network enables Internet service providers 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 SuperPOPs. 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 LATA. 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.
Our network also enables us to provide our small and medium-sized businesses
with instant Internet access and high-speed data transport, giving them the
ability to send and receive e-mail, exchange data between branch offices, and
quickly download information from the Internet. By capitalizing on the growing
demands of our small and medium-sized business customers, we increase the
incremental usage of our network as the peak hours for these customers are
during the day, the opposite of the peak hours of our Internet service
providers.
As of December 31, 2001, we had an installed capacity of 652,800 ports in
California, Nevada, Washington, Colorado, and Arizona. We currently own and
operate eight Alcatel digital tandem switches in or near Los Angeles (two
switches), Oakland and Stockton, California, Las Vegas, Nevada, Phoenix,
Arizona, Seattle, Washington and Denver, Colorado, and are in the process of
adding additional switches in Los Angeles, Stockton and Oakland, California. We
currently expect to complete and begin operating these additional switches
during the second and third quarters of 2002. As described above in "--Our
Company," in August 2001, the Company approved and announced a restructuring
plan that included, among other things, the suspension of our expansion plans
and the closure of our switch facility in Utah.
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 duration 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; and
. lower maintenance costs through reduced training and spare parts
requirements.
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 markets. In
addition, as discussed above, we
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have purchased long-term rights of use in high capacity dark fiber transport
lines (IRU) connecting the major metropolitan areas in California. We believe
that our broad market coverage results in:
. 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;
. the opportunity for our network to provide backhaul carriage for other
telecommunications service providers, such as long distance and wireless
carriers; and
. access to 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.
Interconnection. We presently have interconnection agreements with Pacific
Bell, Verizon (formerly known as GTE), Citizens Telecommunication Company of
California, Inc. and Roseville Telephone Co. in California, Central Telephone
Company (d/b/a Sprint of Nevada) and Nevada Bell in Nevada, Qwest (formerly
known as U S West) and Verizon in Washington and Oregon, Qwest 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 with Pacific Bell and Verizon. Our current
agreements will remain in force during renegotiation. However, based on current
market conditions and recent regulatory rulings, the per minute reciprocal
compensation rate is declining.
As discussed in further detail in Note 7 to the accompanying consolidated
financial statements, to the extent that the April 27, 2001 federal regime for
intercarrier compensation for Internet service provider-bound traffic applies
to the Company and is adopted by incumbent local exchange carriers exchanging
traffic with the Company, reciprocal compensation or intercarrier compensation
rates will continue to decline for the foreseeable future. It is not possible
to estimate the full impact of the FCC Order at this time because the federal
regime does not alter existing contracts except to the extent that they
incorporate changes of federal law, and because adoption of the federal regime
is within the discretion of the incumbent local exchange carrier exchanging
traffic with competitive local exchange carriers on a state-by-state basis. In
the event an incumbent local exchange carrier determines not to adopt the
federal regime, the incumbent local exchange carrier must pay the same rate for
Internet service provider traffic as for calls subject to reciprocal
compensation.
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 the
growing demand in our current markets by leveraging our customer base and
focusing on the internet access and small and medium-sized business markets as
well as continuing to expand the portfolio of products we offer. We also
continue to focus on becoming the low-cost provider by reducing our costs and
concentrating on products that provide higher margins to the Company.
Capitalize on growing demand in our current markets. The demand for
internet access, and data and voice communications services in our current
markets continues to grow. Significant increases over the last several years 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. Additionally, we
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believe that small and medium-sized business customers have increasing needs
for advanced communications services. By capitalizing on the growing demands of
Internet service providers and small and medium-sized businesses in the markets
we currently serve, we believe that we will not only increase our revenues, but
also increase the incremental usage of our network as the peak hours of usage
for each of these customers generally occur at different times.
Leverage and focus on our existing wholesale customer base. We are a
leading supplier of Internet access and other Internet infrastructure services
in California serving approximately 85% of the nation's largest retail Internet
service providers in this market in addition to other types of service
providers. We have chosen to concentrate our efforts in California as it is one
of the largest economies in the world and we believe that it offers one of the
world's most sophisticated markets. We also operate in Nevada, Washington,
Oregon, Colorado and Arizona. We have selected our current markets based on a
number of considerations, including the number of potential customers, the
number of competitors and the presence of multiple transmission facility
suppliers.
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 believe that by originating and terminating calls on our
network, we can continue to achieve cost savings. We also believe that we are
differentiated by the architecture and coverage of our network, which offers
our customers the following benefits:
. switching systems that support high calling volumes and long duration
times for Internet service provider calls;
. statewide local calling capabilities through established physical
locations in each local access and transport area within a state, which
reduces Internet service providers' transmission costs; and
. the ability to collocate Internet modems and servers in fewer locations,
which enables Internet service providers to achieve broad geographic
coverage while minimizing capital expenditures.
Focus on the small and medium-sized business market. We believe that small
and medium-sized businesses have significant and increasing needs for advanced
communications 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 have limited resources and
expertise to design, purchase and maintain these kinds of systems and services.
We also believe that incumbent local exchange carriers, which currently have
most of the market share in California, and other competitive local exchange
carriers, do not adequately serve these target customers. We intend to continue
our efforts in becoming a leading provider of integrated communications
services to small and medium-sized businesses in our target retail markets
(California and Nevada) by providing a complete product offering of system
design, equipment installation and maintenance, voice, data and long distance
services, 24/7 support and subscription services with multi-year contracts. We
believe that this product mix will enable us to quickly penetrate target
markets and build customer loyalty.
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 the current markets we serve and any new markets
we may enter. Salespeople with experience in a particular market provide us
with extensive knowledge of our target customer base through existing
relationships with these customers. To support the small and medium-sized
business market, we continuously monitor our sales, customer care and service
delivery forces in the markets we serve to ensure that we can continue to
provide our customers with superior service.
Expand portfolio of products and services that provide higher margins and
exit lower-margin products. In order to achieve our growth objectives, we
expect to continue introducing new and innovative products and services that
provide high margins. We recently added several new products to our portfolio,
including:
. Data Advantage, a data transport offering for small and medium business
customers with multiple locations, which can be bundled with our current
voice offerings or provided as a stand alone service;
. Data Advantage Internet Access, an integrated solution for small and
medium business customers that includes data transport and dedicated,
"always on" Internet access;
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. Wholesale Local Services via IP, wholesale local services that we began
trials for in the last part of 2001, which enables Voice over IP (VoIP)
service providers to expand their service offerings; and
. Usage Based Managed Modems, a network wide expansion of our current
Managed Modems service to include subscription service based on a usage
per port basis in addition to a fixed per port basis. This provides
wholesale customers the flexibility to be billed on a usage basis versus
a per port basis.
Decrease costs. During 2001, we initiated several actions to decrease our
costs. Among other things, we put processes in place to reduce redundancies and
we continue to renegotiate contracts for potential cost savings. Our
restructuring plan also included a reduction in our workforce. Primarily as a
result of this reduction, our workforce decreased from 693 to 407 professionals
during the year ended 2001. The implementation of our restructuring plan com
bined with other actions to decrease costs resulted in cost savings of $4.4
million in the fourth quarter of 2001 from the previous quarter. We expect to
maintain these cost savings, however no assurance can be made that the
implementation of the restructuring plan, or additional efforts, will continue
to improve our financial results in the future.
Products and Services
Our products and services are designed to appeal to the sophisticated
telecommunications needs of our target customers, which fall primarily into two
categories: small and medium businesses, to whom we provide retail services,
and Internet and other types of service providers, to whom we provide wholesale
services.
Wholesale Services to Internet and other types of service providers. As a
wholesale services provider, we offer a number of network services to several
long-standing customer groups as well as new and emerging markets. These
services are typically combined into a packaged solution primarily consisting
of:
Multi-Rate Center Foreign Exchange Services. This service offers our
customers the ability to establish local points of presence (POPs)
throughout our network with minimal capital investment, which dramatically
expands their coverage, while at the same time reduces their overall costs.
Managed Modems. 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 local points of presence throughout
our coverage area.
Collocation. Collocation enables our customers to install their
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 LATA, reduces their capital
expenditures and maintenance requirements. We receive monthly rental revenue
from the Internet service provider for the space power used.
Retail services for small and medium businesses. We provide integrated
voice and data communications solutions through two primary service packages:
Direct Digital Telephone Service (DDTS). This service is an integrated
solution consisting of system design, equipment installation and maintenance
combined with voice and data communications services. For a monthly fee, we
offer feature-rich digital telephone sets bundled together with local and
long distance services, Centrex-type direct inward dialing, voice mail and
maintenance. Additionally, our Data Advantage and Data Advantage Internet
services are commonly added to this bundled service.
Facilities Based Dial Tone (FBDT). This service is marketed toward small
and medium businesses, which already own a phone system. For a monthly fee,
we provide these customers with an integrated
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solution of voice and data services, typically consisting of local and long
distance services, data transport and Internet access services.
The major components of these bundled offerings are:
Local Services. We provide local dial-tone services to business
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 that 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.
Data Transport and Internet Access. We provide data communications
solutions that enable business customers with multiple locations to connect
their sites through our data network. Additionally, we offer business
customers the ability to access the public Internet via a dedicated
broadband T1 or fractional T1 connection.
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 compliment our core local and long distance
services.
Exited Services. As described above in "--Our Company," in August 2001 the
Company approved and announced a restructuring plan that included, among other
things, the exiting from low margin services and operations, including
residential resale and COAM equipment.
Sales and Marketing
Sales. We have built an experienced direct sales force. 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. In connection with our
restructuring plan described above in "--Our Company," our direct sales force
decreased from 134 employees as of December 31, 2000 to 89 employees as of
December 31, 2001. As a result, we now have nine retail sales offices, all of
which are located in California and Nevada. Additionally, we have restructured
our Wholesale Markets sales division and deployed, for the first time, an
experienced "outside" sales force to source new customer opportunities from
around the country. With wholesale sales executives now on both coasts and in
the central United States, we have greater access to current and prospective
customers than ever before. Our incumbent "inside" sales team has been retained
as Account Managers to administer the growth and maintenance of our largest
wholesale customers and Internet Service Providers. Finally, our agent sales
program has been revitalized and re-launched with an experienced management
staff, attractive new success-based, residual commission schedule and
engagement contract for Telecommunications Agents and Value Added Resellers
(VARs).
Marketing. In our existing markets, we seek to position ourselves as a high
quality alternative to incumbent local exchange carriers for integrated
telecommunications services by offering network reliability, superior customer
support and bundled solutions 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
implementing targeted advertising and promotional efforts.
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Vertical Markets. We have accelerated our focus on several vertical markets
within both our retail and wholesale product lines. We have concentrated on
specific customer requirements within these vertical markets, developing unique
product bundles which appeal directly to these customer groups.
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, and enhanced
communications service providers, many of which are communications-intensive
users. For the three month period ended December 31, 2001, ten of our top
fifteen customers were Internet service provider customers. For the years ended
December 31, 2001, 2000 and 1999, Internet service provider revenue accounted
for approximately 22%, 19%, and 19%, respectively, of our total revenues, and
accounted for approximately 15% and 17% of our accounts receivable as of
December 31, 2001 and 2000, respectively. This Internet service provider revenue
does not include reciprocal compensation related to terminating calls to
Internet service providers, long distance services and dedicated transport
services.
Management performs ongoing evaluations of the creditworthiness of our
customers and monitors collections. As necessary, an allowance for doubtful
accounts is recognized for potential uncollectible accounts. During 2001, the
Company recognized a $3.2 million provision for doubtful accounts, included in
selling, general and administrative expenses in the accompanying consolidated
statements of operations included in Item 8 to this Annual Report on Form 10-K.
This provision reflects increased accounts receivable write-offs as a result of
an increase in customer delinquencies and bankruptcies.
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 T1
and fractional T1 services, to provide a secure, reliable, and 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.
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Financial Information about Industry Segments
Pac-West operates in a single industry segment, telecommunications services.
Operations are managed and financial performance is evaluated based on the
delivery of multiple communications services to customers over common networks
and facilities. Please refer to Note 2 to our accompanying consolidated
financial statements included in Item 8 of this Annual Report on Form 10-K for
information related to revenues by service type.
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 42%, 45% and 58% of our revenues for the years
ended December 31, 2001, 2000 and 1999, respectively. Reciprocal compensation
recorded as revenue in 1999 includes payments received 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 all or a significant portion of such payments in
the future could adversely affect our financial condition. For further
information related to reciprocal compensation please refer to the discussion
below in "--Regulation" and in Note 7 to our accompanying consolidated
financial statements included in Item 8 of this Annual Report on Form 10-K.
Reciprocal compensation payments from Pacific Bell accounted for approximately
33%, 35% and 46% of our total revenues in for the years ended December 31,
2001, 2000 and 1999, respectively. Reciprocal compensation payments from
Verizon accounted for approximately 7%, 10% and 12% of our total revenues in
2001, 2000 and 1999, 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 35%, 35% and 49% of the Company's operating costs for the years
ended December 31, 2001, 2000 and 1999, respectively.
Competition
The telecommunications industry is highly competitive. We believe that the
principal competitive factors affecting our business will be pricing levels and
pricing policies, customer service, accurate billing, and, to a lesser extent,
variety of services. Our ability to compete effectively will depend upon our
continued ability to maintain high quality, market-driven services at prices
generally equal to or below those charged by our competitors. To maintain our
competitive posture, we believe that we must be in a position to reduce our
prices in order to meet reductions in rates, if any, by others. Any such
reductions could adversely affect us. Many of our current and potential
competitors have financial, personnel, and other resources, including brand
name recognition, substantially greater than ours as well as other competitive
advantages over us.
Incumbent Local Exchange Carriers. In each of the markets we target, we
will compete principally with the incumbent local exchange carrier serving that
area, such as Pacific Bell and Verizon in California, and Qwest Communications
in Arizona, Colorado, Oregon, and Washington. Some incumbent local exchange
carriers in our territory, including Verizon, are offering long distance
services to their local telephone customers. The incumbent local exchange
carriers, including Pacific Bell and Qwest, are actively seeking removal of
federal regulatory restrictions that prevent them from entering the long
distance market. Many experts expect the incumbent local exchange carriers to
be successful in entering the long distance market in a number of states
10
within the next year and in most states within a year or two thereafter. We
believe the incumbent local exchange carriers 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. For more information, please refer to
discussion below in ''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
regulatory initiatives, which allow competitive local exchange carriers such as
ourselves to interconnect with incumbent local exchange carrier facilities,
provide us with increased business opportunities, such interconnection
opportunities have been, and likely will continue to be, accompanied by
increased pricing flexibility for, and relaxation of regulatory oversight of,
the incumbent local exchange carriers.
The 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. Pacific Bell has recently petitioned for
pricing flexibility in certain of its markets in which we compete.
Implementation of the FCC's order could have a material adverse effect on us,
however, 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 Qwest
Communications and U S West, and of 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 significantly 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
11
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, usually from the incumbent local exchange
carrier, 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 stabilize with few players remaining. In addition, alternative
competing technologies regarding this service may emerge. Our competitors in
this market include other telecommunications companies, including integrated
online services providers with their own communications networks. Many of these
competitors have greater financial, technological, marketing, personnel and
other resources than ours.
Competition from International Telecommunications Providers. Under the
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
12
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. In 1997, certain of these rules were vacated on appeal to the U.S.
Court of Appeals for the Eighth Circuit. In January 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 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. In November 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. The FCC recently initiated a Triennial Review of
the appropriateness of its unbundled network element designations. As a result
of this proceeding, the FCC may add, subtract, or leave unchanged the unbundled
network elements.
In July 2000, the U.S. Court of Appeals for 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 heard
argument on these issues and a decision is expected by June 2002. 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 at the FCC or
in other Circuit Courts of Appeal 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
13
other telecommunications carriers for resale at discounted rates, based on
the costs avoided by the incumbent local exchange carrier in the wholesale
offering;
Interconnection. Requires all incumbent local exchange carriers and
competitive local exchange carriers to permit their competitors to
interconnect with their facilities. Requires all incumbent local exchange
carriers to permit interconnection at any technically feasible point within
their networks, on nondiscriminatory terms, at prices based on cost, which
may include a reasonable profit. At the option of the carrier seeking
interconnection, collocation of the requesting carrier's equipment in the
incumbent local exchange carriers' premises must be offered, except where an
incumbent local exchange carrier can demonstrate space limitations or other
technical impediments to collocation;
Unbundled Access. Requires all incumbent local exchange carriers to
provide nondiscriminatory access to unbundled network elements, including
certain network facilities, equipment, features, functions, and
capabilities, at any technically feasible point within their networks. Such
access must be on nondiscriminatory terms, at prices based on cost, which
may include a reasonable profit;
Number Portability. Requires all incumbent local exchange carriers and
competitive local exchange carriers to permit users of telecommunications
services to retain existing telephone numbers without impairment of quality,
reliability or convenience when switching from one telecommunications
carrier to another;
Dialing Parity. Requires all incumbent local exchange carriers and
competitive local exchange carriers to provide ''1+'' equal access to
competing providers of telephone exchange service and toll service, and to
provide nondiscriminatory access to telephone numbers, operator services,
directory assistance, and directory listing, with no unreasonable dialing
delays; and
Access to Rights-of-Way. Requires all incumbent local exchange carriers
and competitive local exchange carriers to permit competing carriers access
to poles, ducts, conduits and rights-of-way at regulated prices.
Incumbent local exchange carriers are required to negotiate in good faith
with carriers requesting any or all of the above arrangements. If the
negotiating carriers cannot reach agreement within a prescribed time, either
carrier may request arbitration of the disputed issues by the state regulatory
commission. Where an agreement has not been reached, incumbent local exchange
carriers remain subject to interconnection obligations established by the FCC
and state regulatory commissions.
In May 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.
During 2001, we paid approximately $21,000 per month in subsidy payments. 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 order.
Such appeals were consolidated and transferred to the U.S. Court of Appeals for
the Fifth Circuit. In July 1999, the Fifth Circuit affirmed most portions of
the May 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.
14
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 applications for New York, Massachusetts,
Pennsylvania, and Connecticut, and SBC's applications for Texas, Arkansas,
Kansas, Missouri, and Oklahoma have been granted. Petitions for such authority
by Verizon for Vermont, Rhode Island, and New Jersey are 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.
With respect to our domestic service offerings, we have filed tariffs with
the FCC stating the rates, terms and conditions for our interstate access
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 and international services, and
prohibiting the use of such tariffs. That order became effective on May 1,
2000. All such domestic tariffs had to be terminated by July 31, 2001, and all
international tariffs by January 28, 2002. 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. Accordingly, nondominant interstate and
international service providers are no longer 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 and international services.
In June 1997, the FCC issued another order which allows non-dominant
carriers, such as ourselves, to offer interstate access services without the
filing of tariffs. The obligation to provide non-discriminatory, just and
reasonable prices remains unchanged under the Communications Act of 1934. While
tariffs provided a means of providing notice of prices, terms and conditions,
we intend to rely primarily on our sales force and direct marketing to provide
such information to our customers.
To the extent we provide interexchange telecommunications service, we are
required to pay access charges to incumbent local exchange carriers and other
competitive local exchange carriers when we use the facilities of those
companies to originate or terminate interexchange calls. Also, as a competitive
local exchange carrier, we provide access services to other interexchange
service providers. The interstate access charges of incumbent local
15
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. In several orders adopted in recent years, the FCC has made major
changes in the structure of access charges. Under the FCC's orders,
per-minute-use access charges have been significantly replaced, in part, with
higher monthly fees to end users and, in part, with the new interstate
universal service system. 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 companies, AT&T, and Sprint. Among the more
significant regulatory changes established by the CALLS Order, the Bell
operating companies are required to reduce switched access charges to an
average of $0.0055 per minute. Price cap incumbent local exchange carriers are
additionally required to eliminate the presubscribed interexchange carrier
charge as a separate charge and fold it into an increased subscriber line
charge. 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, long distance
carriers 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. The Order was appealed to the U.S. Court of Appeals for the
District of Columbia Circuit. The Court remanded the case to the FCC.
In August 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. On February 2, 2001, the District of Columbia 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. Additional petitions for pricing flexibility are presently pending,
including a petition by Pacific Bell.
On May 21, 2001, the FCC's new rules governing competitive local exchange
carrier interstate access charges became effective. The rules establish an
initial maximum rate of 2.5 cents per minute for interstate access charges for
the first year. In the second year, the rate is reduced to 1.8 cents per
minute. In the third year, the rate is further reduced to 1.2 cents per minute.
At the end of the third year, the benchmark rate is reduced to the level of the
incumbent local exchange carrier. A competitive local exchange carrier may not
file tariffs for the above benchmark rates unless the incumbent local exchange
carrier in whose territory it operates charges a higher rate, in which case the
competitive local exchange carrier may charge the higher incumbent local
exchange carrier rate or the rate it had tariffed in the previous six months,
if lower than the incumbent local exchange carrier's rate. A competitive local
exchange carrier may charge a rate higher than the benchmark if the long
distance carrier, through negotiations, agrees to such a higher rate.
In addition, the FCC only allowed a competitive local exchange carrier to
charge the benchmark rates in those areas in which the competitive local
exchange carrier was actually serving customers on May 21, 2001. In new service
areas, the competitive local exchange carrier may only tariff rates as high as
the incumbent local exchange carrier. Several petitions for reconsideration of
the FCC's order were filed with the FCC, as well as appeals to the U.S. Court
of Appeals for the District of Columbia Circuit. The Court recently granted the
FCC's request to hold the appeals in abeyance until the FCC decides the motions
for reconsideration.
In the same order, the FCC determined that a long distance carrier's refusal
to serve customers of a competitive local exchange carrier that tariffs the
FCC's benchmark rates would generally violate the long distance carrier's duty
as a common carrier to provide service a reasonable decision. The manner in
which the
16
FCC continues to implement its approach to lowering access charge levels could
have a material effect on our ability to compete in providing interstate access
services.
In February 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. In March 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.
On April 27, 2001, the FCC released its Order on Remand regarding
intercarrier compensation for Internet service provider-bound traffic. The FCC
asserted exclusive jurisdiction over Internet service provider-bound traffic
and established a new interim intercarrier compensation regime for Internet
service provider-bound traffic with capped rates above a fixed traffic exchange
ratio. Traffic in excess of a ratio of 3:1 (terminating minutes to originating
minutes) is presumed to be ISP-bound traffic, and is to be compensated at rates
that decrease from $.0015 to $.0007, or the applicable state-approved rate if
lower, over three years. Traffic below the 3:1 threshold is to be compensated
at the rates in existing and future interconnection agreements. Traffic above
the 3:1 ratio is also subject to a growth ceiling with traffic in excess of the
growth ceiling subject to "bill and keep," an arrangement in which the
originating carrier pays no compensation to the terminating carrier to complete
calls. In addition, when a competitive carrier begins to provide service in a
state it has not previously served, all traffic in excess of the 3:1 ratio is
subject to bill-and-keep arrangements. In exchange for this reduction in
reciprocal compensation obligations to competitive local exchange carriers, the
incumbent local exchange carriers must offer to exchange all traffic subject to
Section 251 (b) (5) of the Telecommunications Act of 1996, as well as Internet
service provider-bound traffic, at the federal capped rates. It is not possible
to estimate the full impact of the FCC Order at this time because the federal
regime does not alter existing contracts except to the extent that they
incorporate changes of federal law, and because adoption of the federal regime
is within the discretion of the incumbent local exchange carrier exchanging
traffic with competitive local exchange carriers on a state-by-state basis. In
addition, the rules are the subject of petitions for reconsideration before the
FCC and appeals to the U.S. Court of Appeals for the District of Columbia
Circuit. In the event an incumbent local exchange carrier determines not to
adopt the federal regime, the incumbent local exchange carrier must pay the
same rate for Internet service provider-bound traffic as for calls subject to
reciprocal compensation. 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.
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 District of Columbia 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. The FCC's decision on remand is on appeal to the
U.S. Curt of Appeals for the District of Columbia Circuit.
In August 1998, the FCC determined that advanced services are
telecommunications services subject to regulation under Sections 251 and 252 of
the Telecommunications 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.
17
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. The U.S. Court of Appeals for the District of
Columbia 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. The FCC has initiated a rulemaking proceeding to consider whether
advanced services offered by incumbent local exchange carriers should be
regulated as services offered by a dominant or nondominant carrier. If the
service offerings are deemed nondominant, the incumbent local exchange carrier
would be subject to lessened regulation.
In November 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 carriers, we cannot be certain that these new rules
will be implemented by the incumbent local exchange carrier's in a favorable
manner. Moreover, these rules have been appealed. We cannot predict 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 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 slamming liability 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 slamming
liability rules have been appealed to the U.S. 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 Communications Assistance for Law Enforcement Act (CALEA) provides rules
to ensure that law enforcement agencies would be able to properly conduct
authorized electronic surveillance of digital and wireless telecommunication
services. CALEA requires telecommunications carriers to modify their equipment,
facilities, and services used to provide telecommunications services to ensure
that they are able to comply with authorized surveillance requirements. For
circuit-switched facilities, carriers were required to complete these
modifications by June 30, 2001. Carriers providing packet-switched services
were required to comply by November 19, 2001. The deadline for carrier
compliance with certain additional requirements has been extended by the FCC
until June 30, 2002.
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
18
convenience and necessity from the state regulatory agency and comply with
state requirements for telecommunications utilities, including state tariffing
requirements. We currently have such certificates to provide local exchange and
intrastate toll service in California, Nevada, Washington, Oregon, Arizona,
Colorado, Idaho, Utah and New Mexico. Most states in which we 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. In November 1998, Pacific Bell and Verizon (formerly
known as GTE) filed applications for rehearing of the October 22, 1998
decision, which were denied in July 1999. The Company, together with the
California Public Utilities Commission and several other competitive local
exchange carriers, is a defendant in a federal lawsuit by Verizon. Verizon
claims that the California Public Utilities Commission's decision violates the
federal Telecommunications Act of 1996, as interpreted by the FCC. On September
27, 2001, the district court granted summary judgment against Verizon and in
favor of the California Public Utilities Commission and the competitive local
exchange carriers. Verizon has appealed to the Ninth Circuit and has agreed to
consolidate this case with Pacific Bell's appeals (described below) regarding
the same California Public Utilities Commission order and a California Public
Utilities Commission order affirming the final arbitration decision regarding
the Company's and Pacific Bell's dispute over reciprocal compensation
obligations and with appeals concerning reciprocal compensation arising from
district court decisions in Oregon and Washington state in cases in which the
Company is not a party.
On October 6, 1999, Pacific Bell sued the California Public Utilities
Commission to challenge the legality of the California Public Utilities
Commission's October 22, 1998 decision. The Company intervened in this action
as a defendant. On September 27, 2001, the district court granted summary
judgment against Pacific Bell and in favor of the California Public Utilities
Commission and the intervening defendants (the Company was an intervening
defendant). Pacific Bell has appealed to the Ninth Circuit and has agreed to
consolidate the case with its other appeal (described below), Verizon's appeal,
and appeals concerning reciprocal compensation arising from district court
decisions in Oregon and Washington state in cases in which the Company is not a
party.
In November 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. In June 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 in October
1999, filed an appeal in federal district court in San Francisco with respect
to this decision, although until recently, they have paid the full amount of
our billings for calls since the
19
effective date of the current agreement. On September 27, 2001, the district
court granted summary judgment against Pacific Bell and in favor of the
California Public Utilities Commission and the Company. Pacific Bell has
appealed to the Ninth Circuit and has agreed to consolidate the case with its
other appeal (described above), Verizon's appeal (described above), and appeals
concerning reciprocal compensation arising from district court decisions in
Oregon and Washington state in cases in which the Company is not a party.
Towards the later half of 2001, one incumbent local exchange carrier,
Verizon, took the position that it had properly implemented the FCC's Order on
Remand, and that this unilateral action modified the current interconnection
agreement between the Company and Verizon. Accordingly, Verizon withheld
payment of portions of invoices submitted by the Company for calls after June
13, 2001. The Company disputed this assertion, and the dispute was resolved
through expedited procedures before the California PUC. On August 3, 2001,
Pac-West filed a Motion with the California Public Utilities Commission
pursuant to the dispute resolution provisions of its interconnection agreement
with Verizon requesting a ruling that Verizons' actions violated the agreement.
On September 27, 2001, the Administrative Law Judge issued a Ruling in favor of
Pac-West, ordering Verizon to cease such withholding and make all such future
payments called for under the agreement. Verizon appealed this ruling to the
full Commission. On January 23, 2002, the California Public Utilities
Commission upheld the Ruling of the Administrative Law Judge in its entirety,
and ordered Verizon to pay all disputed amounts, plus interest, within three
business days. On January 28, 2002 Verizon made payment of withheld amounts to
the Company. Pacific Bell has not implemented the FCC Order on Remand in
California, but has informed the Company that it may do so.
We cannot predict the outcome of the California Public Utilities Commission
proceedings, future appeals or additional pending cases involving related
issues, or of the applicability of such proceedings to our interconnection
agreement with other incumbent local exchange carriers. 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 or related FCC 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 is expected to decline significantly in the
future. We are currently negotiating and implementing new interconnection
agreements and the terms including reciprocal compensation. The per minute 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.
Rating and Routing of Calls. In September 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 or the California
Public Utilities Commission could require the Company to pay incumbent local
exchange carriers in addition to the charges in our current interconnection
agreements in connection with their handling of calls employing disparate
rating and routing.
Nevada, Colorado and Utah Regulatory Proceedings and Judicial Appeals
In September 1999, Nevada Bell filed suit in U.S. District Court in Reno to
overturn a Public Utilities Commission of Nevada decision requiring Nevada Bell
to pay the Company reciprocal compensation for
20
terminating traffic to Internet service providers. Nevada Bell and the Company
negotiated an interconnection agreement, but were unable to agree on the issue
of reciprocal compensation. In 1999, a commissioner from the Public Utilities
Commission of Nevada serving as arbitrator of that dispute (pursuant to the
Telecommunications Act of 1996's arbitration provisions for interconnection
agreements) ruled that Nevada Bell did not have to pay Pac-West reciprocal
compensation for this traffic. The full Public Utilities Commission of Nevada
overruled that decision and ordered Nevada Bell to pay such compensation under
the Pac-West interconnection agreement. On March 21, 2001, in ruling on
cross-motions for summary judgment, the district court vacated the Public
Utilities Commission of Nevada decision and remanded the matter to the Public
Utilities Commission of Nevada with instructions to redo its analysis regarding
reciprocal compensation. The Company has appealed to the Ninth Circuit. The
appeal is stayed until April 2002, to allow the parties time to conduct
settlement negotiations. The parties may agree to extend the stay.
In October 2000, the Colorado public utilities commission commenced
workshops in a generic proceeding to develop its prospective policy regarding
reciprocal compensation. In November 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, 2001, we had 407 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.
As described above in "--Our Company," in August 2001 the Company approved
and announced a restructuring plan that provided for, among other things, a
reduction in workforce. Primarily as a result of this reduction in workforce in
2001, our sales, customer care and service delivery forces were decreased from
410 to 202 professionals. Of these resources, our direct sales force was
decreased from 134 to 89 employees and our customer service department was
decreased from 95 to 51 employees in the same period. As a result of other
restructuring initiatives also introduced in the third quarter of 2001, which
included suspension of expansion plans in certain states and exiting of certain
low margin services, including residential resale and COAM, we believe that
this workforce reduction will not interfere in any material respect with our
commitment to provide superior customer service.
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, 2001, we had 30 premise leases. Included in
these 30 premise leases is our switching facility in Utah and five offices,
which were closed or
21
consolidated as part of our restructuring plan described above in "--Our
Company." We are currently searching for tenants to sub-lease these facilities.
The table below lists our material active facilities as of December 31, 2001:
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 October 2009 12,065
Tukwila (Seattle area), WA Switching facility December 2009 16,851
Thornton (Denver area), CO Switching facility March 2010 24,316
Phoeix, AZ Switching facility April 2010 12,321
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 may be required as our business in existing markets grow. Each of
the leases associated with our material facilities 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
On December 6, 2001, a complaint captioned Krim v Pac-West Telecomm, Inc.,
et. al., Civil Action No. 01-CV-11217, was filed in United States District
Court for the Southern District of New York against our Company, and certain
executive officers, and various underwriters in connection with our initial
public offering. The plaintiffs allege undisclosed improper underwriting
practices concerning the allocation of shares of our common stock in exchange
for excessive brokerage commissions or agreements to purchase shares at higher
prices in the aftermarket, in violation of Section 11 of the Securities Act of
1933. The complaint also includes a claim for securities fraud under Section
10(b) of the Securities Exchange Act of 1934 against underwriters only.
Substantially similar actions have been filed concerning the initial public
offerings for more than 300 different issuers, and the cases have been
coordinated as In re Initial Public Offering Securities Litigation, 21 MC 92.
The complaint against us seeks unspecified damages on behalf of a purported
class of purchasers of our common stock. We believe that the plaintiff's claims
are without merit and will defend this lawsuit vigorously.
In addition, the Company is a party to various legal proceedings, including
the Pacific Bell, Verizon 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. For more information on legal proceedings related to
reciprocal compensation payment and other interconnection agreement issues,
please refer to "Our Business--Regulation."
Item 4. Submission of Matters to a Vote of Security Holders
None.
22
Item 4a. Directors and Executive Officers
The table below sets forth certain information as of December 31, 2001 with
respect to Pac-West's current directors and executive officers:
Name Age Position(s)
---- --- -----------
Executive Officers:
Wallace W. Griffin.. 63 Chief Executive Officer, Chairman of the Board of
Directors and Acting Chief Financial Office(1)
Henry R. Carabelli.. 46 President and Chief Operating Officer
Michael B. Hawn..... 37 Vice President Customer Network Services
Wayne Bell.......... 30 Vice President Marketing
Gregory S. Miller... 38 Vice President Sales
H. Ravi Brar........ 33 Vice President Finance and Treasurer(1)
Harry W. Wilson..... 58 Vice President Human Resources
John F. Sumpter..... 53 Vice President Regulatory
Directors:
Jerry L. Johnson.... 54 Director
John K. La Rue...... 52 Founder and Director
A. Gary Ames........ 57 Director
David G. Chandler... 43 Director
Mark S. Fowler...... 60 Director
Samuel A. Plum...... 57 Director
Dr. Jagdish N. Sheth 63 Director
Robert C. Morrison.. 55 Director
- --------
(1) In February 2002, H. Ravi Brar was appointed Interim Chief Financial
Officer.
The present principal occupations and recent employment history of each of
our executive officers and directors listed above are set forth below.
Wallace W. Griffin served as the President, Chief Executive Officer and a
Director of Pac-West from September 1998 to June 2001 at which time he was
elected Chairman of the Board of Directors and Chief Executive Officer. From
September 2001 to February 2002, Mr. Griffin assumed an additional role as
Acting Chief Financial Officer of Pac-West. 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 36 years of experience in
telecommunications, cable television, publishing and advertising. Mr. Griffin
is also a director of DDx Incorporated.
Henry R. Carabelli has served as President and Chief Operating Officer of
Pac-West since he joined the Company in June 2001. Prior to joining Pac-West,
Mr. Carabelli served as President of @Link Networks, Inc. since 1999. From 1996
to 1999, Mr. Carabelli was employed by ICG Communications, a Colorado based
competitive local exchange carrier, where he held the positions of Chief
Operating Officer and Executive Vice President of Network Operations. Prior to
ICG, Mr. Carabelli spent 19 years in management with Ameritech and Michigan
Bell. Mr. Carabelli brings over 24 years of telecommunications experience to
Pac-West.
Michael B. Hawn has served as Vice President of Customer Network Services of
Pac-West since he joined the Company in August 2001. Prior to joining Pac-West,
Mr. Hawn was employed by @Link Networks, Inc.
23
since February 2000, where he held the positions of Vice President of National
Operations and Vice President of Program Management. From 1997 to 2000, he was
employed by ICG Communications, where he held various positions including; Vice
President of Planning and Engineering, Vice President of Engineering, and
Senior Director of Quality. Prior to ICG, Mr. Hawn held various managerial and
technical positions with Lucent Technologies and AT&T Bell Laboratories. Mr.
Hawn brings 15 years of telecommunications experience to Pac-West.
Wayne Bell has served as Vice President of Marketing since he joined
Pac-West in August 2001. Prior to joining Pac-West, Mr. Bell served as Vice
President of Marketing and Channel Development for @Link Networks, Inc. since
January 2000. From 1998 to 2000, he was employed by ICG Communications where he
held the position of Senior Director of Product and Process Development. Prior
to ICG, Mr. Bell served as Acting Director of Program Office for U S West
Communications, Inc. Mr. Bell brings over nine years of telecommunications
experience to Pac-West.
Gregory S. Miller has served as Vice President of Sales since he joined the
Company in August 2001. Prior to joining Pac-West, Mr. Miller was employed by
Waave Telecommunications, Inc. since August 1999, where he held the positions
of Vice President of Sales and Business Development and Vice President of Sales
and Marketing. From May 1999 to August 1999 Mr. Miller served as General
Manager for Teligent, and from April 1997 to May 1999 he served as Director of
Sales for ICG Communications. Prior to ICG, Mr. Miller held management
positions with Nextel Communications, Inc. He brings over 12 years of
telecommunications experience to Pac-West.
John K. La Rue founded Pac-West in 1980 and served as its President until
September 1998. From September 1998 until July 2001, Mr. La Rue served as our
Executive Vice President. Currently, Mr. La Rue is semi-retired and is now
employed on a part-time basis serving as an advisor to Mr. Griffin and
Mr. Carabelli. Mr. La Rue has over 34 years of industry experience.
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 26 years of management experience.
John F. Sumpter has served as our Vice President of Regulatory since July
1999. 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. He has over 29 years of experience in
the telecommunications industry.
H. Ravi Brar served as our Vice President of Finance and Treasurer since
September 2001 and was appointed our Interim Chief Financial Officer in
February 2002. Prior to such time he held the positions of Vice President of
Customer Operations and Vice President of Business Development. Mr. Brar has
been employed with Pac-West since July 1999. In addition, Mr. Brar serves as
President and is a director of Installnet Inc. and US Net Solutions, Inc., each
a 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.
Jerry L. Johnson served as our Chairman of the Board from September 1998
until June 2001. From 1995 until December 2001, Mr. Johnson was employed by
Safeguard Scientifics Inc., where he was the Executive
24
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
director of Dynegy, Inc., E-Money Advisors, and MDL Capital.
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: Gibraltar Packaging Group, Morton Grove Pharmaceuticals,
Inc., Pharma Research Corporation, Engineering Materials Corp., Pre Delivery
Services Corporation, U.S. Education Corporation, The Plastics Group 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 2000, as counsel to the firm. Mr. Fowler also serves
as a director of TalkAmerica Holdings, Inc. and Beasley Broadcast Group, Inc.
Samuel A. Plum has served as one of our Directors since September 1998. Mr.
Plum has been a Managing General Partner of the general partner of SCP Private
Equity Partners, L.P. since its commencement in August 1996 and was employed by
Safeguard from 1993 to 1996. From February 1989 to January 1993, Mr. Plum
served as President of Charterhouse, Inc. and Charterhouse North American
Securities, Inc., the U.S. investment banking and broker-dealer divisions of
Charterhouse PLC, a merchant bank located in the United Kingdom. From 1973 to
1989, Mr. Plum served in various capacities in the investment banking divisions
of Paine Webber Inc. and Blyth Eastman Dillon & Co., Inc. Mr. Plum has 22 years
of investment banking, mergers and acquisitions and private equity investment
experience. Mr. Plum also serves as a director of Index Stock Photography,
Inc., Metallurg Holdings, Inc., Pentech Financial Services Inc. and Webvision
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, AT&T--Latin America and etrieve, Inc.
Robert C. Morrison has served as one of our Directors since June 2001 and
has served as Pac-West's Corporate Secretary since January 2001. Mr. Morrison
is a senior attorney at Neumiller and Beardslee, a professional corporation.
Neumiller and Beardslee have provided legal counsel to Pac-West since its
formation and to its predecessor continuously since 1988. From 1982 to 1990,
Mr. Morrison served as Managing Director of Neumiller & Beardslee. He has been
a practicing business attorney since 1972. Mr. Morrison currently serves on the
Board of Regents of the University of California and is a director of the
Lassen Volcanic National Park Foundation and UC Davis Foundation.
25
PART II
ITEM 5. Market For Registrant's Common Equity And Related Stockholder Matters
Market Information
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 years ended December 31, 2001 and 2000 as reported by the Nasdaq stock
market.
2001 2000
----------- -------------
High Low High Low
----- ----- ------ ------
First quarter. $6.63 $3.16 $40.13 $22.13
Second quarter $3.60 $1.94 $28.50 $14.75
Third quarter. $1.86 $0.48 $22.38 $ 9.00
Fourth quarter $0.85 $0.45 $11.95 $ 2.06
As of March 1, 2002, the number of shareholders of record of the Company's
common stock was 535.
Our common stock currently trades on Nasdaq National Market System, which
has certain compliance requirements for continued listing of common stock.
Among other requirements, if the minimum closing bid price per share is less
than $1.00 for a period of 30 consecutive business days, our shares may be
delisted following a 90 day notice period during which the minimum closing bid
price must be $1.00 or above per share for a period of 10 consecutive business
days. The bid price for our common stock has not closed above $1.00 per share
since August 6, 2001. On September 27, 2001, the Nasdaq temporarily suspended
the $1.00 minimum closing bid price requirement. The suspension lasted until
January 2, 2002, at which time the original requirements were reinstated.
In February 2002, we received a letter from Nasdaq notifying us that since
January 2, 2002, our stock price has closed below the minimum closing bid price
per share requirement for continued inclusion in the Nasdaq National Market
System and that we would be provided 90 calendar days, or until May 15, 2002,
to regain compliance with this requirement. If, at anytime before May 15, 2002,
our stock price closes at $1.00 per share or more for a minimum of 10
consecutive trading days, we will again be in compliance with the minimum
closing bid price requirement. However, if our stock price does not meet this
criteria, we expect that we will receive written notification that our
securities may be delisted.
Before May 15, 2002, the Company may apply for listing on the Nasdaq
SmallCap Market and, if accepted, be afforded an additional 180 calendar days
to regain compliance with the Nasdaq's minimum closing bid price requirement
and, provided that the initial listing requirements for the Nasdaq SmallCap
Market are met within this 180 calendar day period, would permit our common
stock to be listed on such market.
If we are delisted from the Nasdaq National Market System or the Nasdaq
SmallCap Market, there may be a reduction in the liquidity of the market for
our common stock, which may cause a material adverse effect on the price of our
common stock. Delisting could reduce the ability of holders of our common stock
to purchase or sell shares as quickly and as inexpensively as they could have
done in the past. This lack of liquidity would make it more difficult for us to
raise capital in the future. Although we are working to comply with all
continued listing requirements of Nasdaq, there can be no assurance that we
will be able to satisfy such requirements.
We have not declared any cash dividends on our common stock during the
fiscal years 2001, 2000 and 1999, 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.
26
Recent sales of Unregistered Securities
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; and
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.
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
Annual Report on Form 10-K. The selected data in this section is not intended
to replace the consolidated financial statements.
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. For more information on reciprocal compensation, please
refer to Note 2 and Note 7 to the accompanying consolidated financial
statements included in Item 8 of this Annual Report on Form 10-K and "our
Business -Regulation" above. 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. For more information, please refer to Note 2 to the
accompanying consolidated financial statements included in Item 8 of this
Annual Report on 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 our restructuring; impairment of goodwill;
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
$(4,177,000), $(7,564,000), $(3,690,000), $(327,000) and $(90,000), and
(income) loss on asset dispositions, net of $(35,000), $580,000, $0, $(3,000)
and $(29,000), for the years ended December 31, 2001, 2000, 1999, 1998 and
1997, 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.
In August 2001, the Company approved and announced a restructuring plan that
contained certain business initiatives designed to respond to unfavorable
market conditions, including the suspension of our expansion plans into Idaho
and New Mexico and the closure of our switch facility in Utah, which was
completed in December 2001. The restructuring plan also provided for a
reduction in workforce and the exit from certain lower margin services,
including residential resale and COAM equipment. For additional information
regarding our restructuring plan, please refer to Note 3 to our accompanying
consolidated financial statements included in Item 8 of this Annual Report on
Form 10-K. Restructuring charges of $8.8 million were recorded in the third
quarter of 2001. In addition, as a result of the Company's modified business
plan, the Company determined its goodwill was impaired and recorded an
impairment charge of $16.8 million in the third quarter of 2001. For more
information, please refer to Note 5 to the accompanying consolidated financial
statements included in Item 8 of this Annual Report on Form 10-K.
27
Year Ended December 31,
- - ------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- --------- -------- -------
Statements of Operations Data:
Revenues....................................................................... $149,992 $139,090 $ 95,505 $ 42,211 $29,551
Costs and expenses:
Operating costs............................................................. 57,345 42,388 20,510 15,344 12,060
Selling, general and administrative:
Selling, general and administrative......................................... 66,099 54,026 22,855 10,779 7,367
Transaction bonuses and consultant's costs(1)............................... -- -- -- 3,798 --
Depreciation and amortization............................................... 34,657 20,905 8,689 4,106 2,204
Restructuring charges(2).................................................... 8,764 -- -- -- --
Impairment of goodwill(3)................................................... 16,787 -- -- -- --
-------- -------- --------- -------- -------
Income (loss) from operations............................................ (33,660) 21,771 43,451 8,184 7,920
Interest expense............................................................... 19,937 18,932 18,124 4,199 932
Gain on disposal of answering service division................................. -- -- -- -- (385)
Costs of merger and recapitalization(1)........................................ -- -- -- 3,004 --
Other (income) expense, net.................................................... (4,212) (6,984) (3,690) (330) (119)
-------- -------- --------- -------- -------
Income (loss) before provision for (benefit from) income taxes,
extraordinary item and cumulative effect of change in accounting
principle.................................................................. (49,385) 9,823 29,017 1,311 7,492
Provision for (benefit from) income taxes...................................... (14,593) 4,791 13,111 1,561 2,997
-------- -------- --------- -------- -------
Income (loss) before extraordinary item and cumulative effect of change in
accounting principle....................................................... (34,792) 5,032 15,906 (250) 4,495
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(4).................................................................... -- (1,415) -- -- --
-------- -------- --------- -------- -------
Net income (loss).............................................................. $(34,792) $ 3,617 $ 15,906 $ (667) $ 4,495
======== ======== ========= ======== =======
Income (loss) per share before extraordinary item and cumulative effect of
change in accounting principle:
Basic....................................................................... $ (0.96) $ 0.14 $ 0.59 $ (0.30) $ 32.11
Diluted..................................................................... $ (0.96) $ 0.13 $ 0.56 $ (0.30) $ 32.11
Net income (loss) per share:
Basic....................................................................... $ (0.96) $ 0.10 $ 0.59 $ (0.38) $ 32.11
Diluted..................................................................... $ (0.96) $ 0.10 $ 0.56 $ (0.38) $ 32.11
Weighted average shares outstanding:
Basic....................................................................... 36,058 35,838 20,173 5,244 140
Diluted..................................................................... 36,058 37,662 21,294 5,244 140
Other Financial Data:
Adjusted EBITDA (as defined above).......................................... $ 26,548 $ 42,676 $ 52,140 $ 16,088 $10,124
Adjusted EBITDA margin%..................................................... 17.7% 30.7% 54.6% 38.1% 34.3%
Cash provided by (used in):
Operating activities........................................................ $ 12,251 $ 41,762 $ 41,439 $ 12,033 $ 5,876
Investing activities........................................................ (9,883) (67,841) (135,966) (42,031) (6,619)
Financing activities........................................................ 4,986 66 161,979 41,631 3,658
Balance Sheet Data (as of period end):
Cash and cash equivalents................................................... $ 64,029 $ 56,675 $ 82,688 $ 15,236 $ 3,603
Short-term investments...................................................... 18,471 43,904 70,138 -- --
Restricted cash............................................................. -- -- 10,087 -- --
Working capital............................................................. 42,294 72,932 151,492 15,532 2,598
Property and equipment, net................................................. 201,036 201,514 105,189 57,294 19,079
Total assets............................................................. 314,737 360,792 290,100 82,493 27,528
Total long-term debt and capital leases.................................. 160,192 165,459 150,017 100,116 12,206
Convertible redeemable preferred stock, including accrued cumulative
dividends of $1,324 in 1998................................................... -- -- -- 46,324 --
Stockholders' equity (deficit)................................................. 85,071 119,757 106,250 (74,113) 8,672
- --------
(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) Restructuring charges relate to the Company's restructuring plan approved
and announced in August 2001. See Note 3 to the accompanying consolidated
financial statements.
(3) As a result of the Company's modified businessplan, the Company determined
its goodwill was impaired and recorede an impairment charge of $16.8
million in the third quarter of 2001. See Note 5 to the accompanying
consolidated financial statements.
(4) Reflects the 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.
28
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Pac-West is a 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 outstanding 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 is included in our results of
operations from the date of acquisition. For more information, please refer to
Note 5 to the accompanying consolidated financial statements included in Item 8
of this Annual Report on Form 10-K.
For the years ended December 31, 2001, 2000 and 1999, 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 $150.0 million, $139.1 million and $95.5 million, respectively,
and adjusted EBITDA (earnings before interest, net, income taxes, depreciation
and amortization, restructuring charges, goodwill impairment, income or loss on
asset dispositions and cumulative effect of change in accounting principle) of
approximately $26.5 million, $42.7 million and $52.1 million, respectively.
As of December 31, 2001, we had 235,244 total DSO equivalent lines in
service, a 22% increase from December 31, 2000. Total DSO equivalent lines in
service include wholesale and on-network retail DSO line equivalents. In
response to technology and network design evolution toward increased data and
VoIP standards, the Company has retroactively adjusted its line counting
methodology to adopt industry standard bandwidth based measurement of lines in
DSO equivalents. The Company has also segregated small to medium-size lines
into on-network and off-network components as related to the Company's decision
to exit a number of off-network lines of business. For the year ended December
31, 2001, our minutes of use were 26.6 billion, an increase of 12% over 2000.
In August 2001, the Company approved and announced a restructuring plan that
contained certain business initiatives designed to respond to unfavorable
market conditions, including the suspension of our expansion plans into Idaho
and New Mexico and the closure of our switch facility in Utah, which was
completed in December 2001. The restructuring plan also provided for a
reduction in workforce and the exit from certain lower margin services,
including residential resale and COAM equipment. For additional information
regarding our restructuring plan, please refer to Note 3 to our accompanying
consolidated financial statements included in Item 8 of this Annual Report on
Form 10-K.
As a result of implementing this restructuring plan, the Company recorded an
$8.8 million restructuring charge in the third quarter of 2001, of which $5.0
million was related to the write-off of leasehold improvements and other
equipment in Utah that cannot be redeployed to other locations. In connection
with the restructuring charge, the Company expensed a total of $2.4 million
related to future rent payments due (net of estimated sublease payments) for
abandoned premises, primarily in Utah and San Diego, which will be paid over
the respective lease terms through various dates ending in fiscal year 2010. In
order to estimate rent expense, the Company made certain assumptions related to
these abandoned premises including: (1) the time period over
29
which the premises would remain vacant, (2) sublease terms, and (3) estimated
sublease rents. In the case of the Utah switch facility, no sublease income has
been estimated due to the specialized nature of this facility. As of December
31, 2001, the workforce reduction contemplated by the restructuring plan was
complete and all severance payments arising as a result of such workforce
reduction have had been paid. The cost savings realized in the quarter ended
December 31, 2001 as a result of implementing the restructuring plan exceeded
the Company's target cost savings of $2.0 to $3.0 million per quarter. The
Company's operating and selling, general and administrative expenses for the
quarter ended December 31, 2001 improved $4.4 million from the previous
quarter. We expect to maintain these cost savings, however no assurance can be
made that implementation of the restructuring plan will continue to improve our
financial results in the future.
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," the Company periodically evaluates the
carrying amount of its property and equipment when events or changes in
business circumstances have occurred which indicate the carrying amount of such
assets may not be fully recoverable. Determination of impairment is based on an
estimate of undiscounted future cash flows resulting from the use of the assets
and their eventual disposition. If the Company determines an asset has been
impaired, the impairment charge is recorded based on a comparison of the net
book value of the fixed asset and the discounted future cash flows resulting
from the use of the asset over its average remaining useful life.
In connection with the implementation of the restructuring plan as discussed
above, the Company evaluated the carrying amount of its property and equipment
in accordance with SFAS 121 and determined, based on management's best
estimate, that no impairment charge was required for these assets as of
December 31, 2001. This analysis required significant judgments and estimates
related to, among other factors, demand for and the pricing of our services. To
the extent actual market conditions differ significantly from management's
estimates, the estimated fair market value of our long-lived assets could
change which may result in a future impairment charge and such charge, if any,
may be material.
In accordance with Accounting Principles Board Opinion No. 17 (APB 17),
"Intangible Assets," the Company periodically evaluates the carrying amount of
its enterprise-level costs in excess of net assets of acquired businesses
(goodwill) when events or changes in business circumstances have occurred which
indicate the carrying amount of enterprise-level goodwill may be impaired.
Determination of impairment is based on an estimate of the fair value of the
goodwill using estimated discounted future cash flows. As a result of the
Company's modified business plan, the Company determined its goodwill was no
longer realizable and recorded an impairment charge of $16.8 million in the
third quarter of 2001. As of August 1, 2001, when the Company determined the
goodwill was impaired, the Company discontinued amortizing the related
goodwill. Goodwill amortization was $2.0 million and $2.8 million for the years
ended December 31, 2001 and 2000, respectively.
Factors Affecting Operations
Critical Accounting Policies. 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, disclosure of contingent assets and liabilities, and reported
amounts of revenues and expenses for the reporting period. We consider certain
accounting policies related to revenue recognition, provision for doubtful
accounts receivable, impairment provisions for long-lived assets and goodwill,
accruals related to abandoned properties identified in our restructuring plan,
and the outcomes of litigation and regulatory proceedings discussed in Note 7
to the consolidated financial statements in Item 8 of this Form 10-K to be
critical policies due to the estimation processes involved in each. By their
nature, these judgments are subject to an inherent degree of uncertainty. Thus,
actual results could differ from estimates made and such differences could be
material. See Note 2 to the accompanying consolidated financial statements
included in this Form 10-K for a summary of significant accounting policies.
Revenues. We derive our revenues from monthly recurring charges, usage
charges and amortization of initial non-recurring charges. Monthly recurring
charges include the fees paid by customers for lines in service
30
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 originated or 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, effective as of January 1, 2000, changed the
timing of when revenue is recognized for non-refundable up-front payments
received for installation services. Prior to 2000, these amounts had 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.
We derive a substantial portion of our revenues from reciprocal compensation
paid by incumbent local exchange carriers with which we have interconnection
agreements. For the years ended December 31, 2001, 2000 and 1999, recorded
reciprocal compensation accounted for approximately 42%, 45% and 58%,
respectively, of our revenues. From 1997 through 1999, two incumbent local
exchange carriers with which we have interconnection agreements, Pacific Bell
and Verizon, 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. The total
reciprocal compensation withheld by Pacific Bell and Verizon and not included
in revenues was $32.6 million for the year ended December 31, 1998. Pacific
Bell discontinued withholding amounts in June 1999 and Verizon discontinued
withholdings in October 1999. The amounts withheld in 1999 prior to these dates
aggregated $29.9 million. In September 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, Verizon paid all amounts withheld totaling $6.3 million.
In June 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 in June 1999. Until the third quarter of 2001, Pacific Bell has paid
the full amount of our billings for calls since the effective date of the new
agreement. In August 1999, we, along with the commissioners of the California
Public Utilities Commission and others, were named as a defendant in an action
filed by Verizon California. The action challenged the legality of the
California Public Utilities Commission's decision regarding reciprocal
compensation as discussed above. In September 2001, the action was dismissed by
the District Court. The dismissal has been appealed by Verizon and Pacific Bell
to the U.S. Court of Appeals for the Ninth Circuit. The obligation of Verizon
or other local exchange carriers to pay this reciprocal compensation under its
current agreement is currently under review by both state and federal
regulators.
From June through December of 2001, Verizon California withheld certain
reciprocal compensation payments on the basis that the amounts invoiced by the
Company exceeded the amounts permissible under an order of the FCC which
permitted incumbent local exchange carriers to adopt a plan, on a statewide
basis, containing such reduced rates. The Company contested Verizon's
withholdings before the California Public Utilities Commission, and on January
23, 2002, the California Public Utilities Commission ordered Verizon to pay all
such withheld amounts plus interest. While, until the third quarter of 2001,
the incumbent local exchange carriers have otherwise 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.
31
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 switches and to connect to the incumbent local
exchange carrier and other competitive local exchange carriers to our networks.
Our strategy of leasing rather than building our own transport facilities
results in our operating costs being a significant component of total costs.
Selling, General and Administrative Expenses. Our recurring selling,
general and administrative expenses include network development, administration
and maintenance costs, selling and marketing, customer service, provision for
doubtful accounts, information technology, billing, corporate administration
and personnel.
Provision for doubtful accounts receivable. Provisions for allowances for
doubtful accounts are estimated based upon historical collection experience,
customer delinquencies and bankruptcies, information provided by our customers,
observance of trends in the industry and other current economic conditions. If
this information does not properly reflect future collections, our accounts
receivable could be overstated or understated.
Accruals related to abandoned properties. In August 2001, the Company
approved and announced a restructuring plan, which included, among other things
discussed below in Note 3, closing our switch facility in Utah and
consolidation of six sales offices. In order to estimate rent expense related
to these abandoned premises, the Company made certain assumptions including;
(1) the time period over which the premises would remain vacant, (2) sublease
terms, and (3) estimated sublease rents. In the case of the Utah switching
facility, no sublease income was estimated due to the specialized nature of
this facility. If the Company is unable to sublet the abandoned premises within
the estimated timeframe and at estimated terms, the restructuring charge could
be understated.
Provisions for long-lived assets and goodwill. The Company periodically
evaluates the carrying amount of its long-lived assets and goodwill when events
or changes in business circumstances have occurred which indicate the remaining
estimated useful lives of such assets may not be fully recoverable. In
assessing the recoverability of these assets, the Company must make assumptions
regarding, among other things, estimated future cash flows to determine the
fair value of the respective assets. If these estimates and the related
assumptions change in the future, the Company may be required to record an
impairment charge for these assets in the future, which charge, if any, may be
material.
32
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, 2001, 2000 and 1999.
Income (loss) from operations for 2001 includes restructuring and impairment
charges totaling $25.6 million recognized in the quarter ended September 30,
2001 in response to current market conditions. Net income for 2000 includes a
charge related to a change in accounting principle incurred upon the Company's
adoption of SAB 101 of $1.4 million, net of income tax benefit of $0.9 million.
Revenues for 1999 include a settlement received in connection with previously
withheld reciprocal compensation of $26.3 million.
Year Ended December 31,
----------------------
2001 2000 1999
----- ----- -----
Statements of Operations Data:
Revenues.................................... 100.0% 100.0% 100.0%
Operating costs............................. 38.2 30.5 21.5
Selling, general and administrative expenses 44.1 38.8 23.9
Depreciation and amortization expense....... 23.1 15.0 9.1
Income (loss) from operations............... (22.4) 15.7 45.5
Net income (loss)........................... (23.2) 2.6 16.7
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Consolidated revenues for the year ended December 31, 2001 increased $10.9
million to $150.0 million from $139.1 million for the same period ended in
2000. The increase in revenues is primarily attributed to an increase of $0.2
million in paid local interconnection revenues, an increase of $10.1 million
and $3.7 million in recurring charges and installation charges billed directly
to Internet service providers and business customers, respectively, a decrease
of $1.7 million in local and long distance usage revenues, an increase of $2.1
million in dedicated transport revenues, and a decrease of $2.7 million in
product and service revenues related to exiting the COAM business.
In 2000, we increased the capacity of our switching facilities in Los
Angeles, Oakland and Stockton, California and completed new switching
facilities in, or near, Phoenix, Arizona, Denver, Colorado and Salt Lake City,
Utah (our restructuring plan provided for the closure of our Utah switch
facility, which was closed in December 2001). As a result of additional
switching facilities, increased utilization of expanded switch capacities and
acquisitions completed during 2000, our revenues for the year ended December
31, 2001 increased $10.9 million, or 8%, from the same period ended in 2000.
The total DSO equivalent lines in service increased 22% to 235,244 as of
December 31, 2001 from 193,397 lines as of December 31, 2000. Billable minutes
of use were 26.6 billion for the twelve months ended December 31, 2001, up 12%
from 23.7 billion billed during the same period in 2000. As discussed above, in
response to technology and network design evolution toward increased data and
Voice over IP (VoIP) standards, the Company has retroactively adjusted its line
counting methodology to adopt industry standard bandwidth based measurement of
lines in DSO equivalents. The Company has also segregated small to medium-size
lines into on-network and off-network components as related to the Company's
decision to exit a number of off-network lines of business.
The number of inbound local calls and the minutes subject to reciprocal
compensation revenues in accordance with interconnection agreements increased
6% and 12%, respectively, for the year ended December 31, 2001 over the same
period ended 2000. However, favorable revenues from increased inbound local
calls and minutes was almost entirely offset as one incumbent local exchange
carrier with which we have an interconnection agreement, refused to pay that
portion of reciprocal compensation due under their interconnection agreement
that they estimated was in excess of the payments required if the rate structure
33
pursuant to the FCC Order on Remand was applicable to our interconnection
agreement with them. For more information, please refer to Note 7 to the
accompanying consolidated financial statements included in Item 8 of this
Annual Report on Form 10-K. The net effect resulted in a $0.2 million increase
in paid interconnection revenues for the year ended December 31, 2001 over the
corresponding period in 2000. Revenues from switched access charges for the
year ended December 31, 2001 remained substantially unchanged from those
recorded in the previous year.
Direct billings to wholesale market customers increased during the year
ended December 31, 2001 from the same period in 2000 by $10.1 million, or 35%.
Lines in service to this market increased from 164,527 lines at December 31,
2000 to 193,266 lines in service at December 31, 2001, an increase of 17%.
Direct billings to small and medium-sized business customers increased
significantly from the year ended December 31, 2000, resulting in increased
revenues of $3.7 million for the year ended December 31, 2001, a 52% increase.
As of December 31, 2001, we had 41,978 on-network lines in service compared to
28,870 lines at December 31, 2000, an increase of 45%.
Outbound local and long distance revenues, including 800, 888, and 877
numbers and travel card calls, decreased $1.7 million during the year ended
December 31, 2001 from the same period ended in 2000. Although total minutes
billed to customers increased between periods, the average rate per minute
charged to customers declined as the mix between local and long distance calls
made by customers changed during these periods. During the year ended December
31, 2001, approximately 43% of minutes billed to customers were charges for
local minutes compared to approximately 32% in the same period ended 2000.
The $2.1 million, or 27%, increase in dedicated transport revenues primarily
relates to increased data networking services for private networks.
As a result of comprehensive product reviews intended to identify
opportunities to improve profitability undertaken in connection with the
development of the restructuring plan, we decided to exit certain low-margin
businesses such as COAM equipment and residential resale and concentrate our
efforts in developing next generation offerings. This decision to exit the COAM
equipment business in the quarter ended September 30, 2001 contributed to
decreased revenues from product and service offerings of $2.7 million, or 27%,
for the year ended 2001 compared to the same period ended 2000.
Our consolidated operating costs for the year ended December 31, 2001
increased $14.9 million to $57.3 million from $42.4 million for the
corresponding period in 2000. The increase in operating costs was primarily due
to an increase in network operations associated with an anticipated higher
level of telecommunications activity and to achieve geographic coverage. In
addition, we continued to make significant investments in our network
infrastructure during 2000 and the first part of 2001 to accommodate
anticipated growth of our communications services. In the quarter ended
September 30, 2001, we recorded a provision against operating costs to write
down excess inventory of approximately $0.6 million as a result of exiting the
COAM equipment business.
Our consolidated selling, general and administrative expenses for the year
ended December 31, 2001 increased $12.1 million to $66.1 million from $54.0
million for the corresponding period in 2000. As expected, we incurred
significant selling and marketing costs in connection with our efforts to
expand our operations and establish ourselves in markets before switches became
operational and generated revenues. In August 2001, in response to a weakening
economy, we approved and announced a restructuring plan that included, among
other things, a workforce reduction designed to reduce our expenses. As a
result of normal attrition and the workforce reduction, our headcount was
reduced to 407 employees as of December 31, 2001 from 693 employees at December
31, 2000. In addition, selling, general and administrative expenses for the
year ended December 31, 2001 include approximately $3.2 million of provision
for doubtful accounts reflective of the softening economy and increased
delinquencies and bankruptcies, an increase of $2.2 million from the same
period ended 2000. Selling, general and administrative expenses were 44% and
39% of revenues for the years ended December 31, 2001 and 2000, respectively.
34
Our consolidated depreciation and amortization expense for the year ended
December 31, 2001 increased $13.8 million to $34.7 million from $20.9 million
for the same period in 2000. Depreciation and amortization as a percentage of
revenues increased to 23% for the year ended December 31, 2001 from 15% from
the same period ended 2000. The increase in depreciation and amortization
expense was primarily due to additional depreciation expense incurred related
to significant capital purchases between years. During the year ended December
2001, including $2.0 million of purchases financed under a capital lease
facility, the Company purchased an additional $37.2 million of property and
equipment.
In August 2001, in response to current market conditions, we approved and
announced a restructuring plan that included, among other things, various
business initiatives designed to prioritize the Company's sales efforts around
high-growth areas of business, focus on products with higher profit
contributions, improve capital utilization and decrease expenses. These
initiatives resulted in restructuring and goodwill impairment charges of $8.8
million and $16.8 million, respectively, in the quarter ended September 30,
2001. As expected, with the workforce reduction, which was substantially
complete as of August 31, 2001, the implementation of our restructuring plan
resulted in a selling, general and administrative savings of approximately $1.0
million per month.
Our consolidated interest expense for the year ended December 31, 2001
increased $1.0 million to $19.9 million from $18.9 million in 2000. Interest
expense over these two periods is primarily related to the $150 million Senior
Notes issued on January 29, 1999, including amortization of related deferred
financing costs associated with the offering over a period of ten years.
Interest expense is net of amounts capitalized of $1.7 million and $2.5 million
for the twelve months ended December 31, 2001 and 2000, respectively.
Our consolidated interest income for the year ended December 31, 2001
decreased $3.4 million to $4.2 million from $7.6 million for the same period in
2000. This decrease is primarily related to lower cash balances between periods
and lower interest rates. Interest income includes realized gains and losses on
investments.
The Company's effective income tax rates reflect the applicable federal and
state statutory income tax rates applied to pretax income (loss) adjusted for
the tax impact of the non-deductibility of certain acquisition related goodwill
amortization and impairment charges. For the years ended December 31, 2001 and
2000, the Company's effective income tax rate was (30%) and 49%, respectively.
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 was 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 and 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 (our restructuring
plan initiated in the third quarter of 2001 provided for the closure of our
Utah switch facility which was closed in December 2001). 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
35
the same period ended 1999. Additionally, we increased the number of access
lines to small and medium-sized businesses to 28,870 (as adjusted to adopt
industry standard bandwidth based measurement of lines in DSO equivalents
described above) as of December 31, 2000, an increase of 75% 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 52% to 193,397 (as
adjusted) as of December 31, 2000 from 127,088 (as adjusted) 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 year
ended December 31, 2000 by $8.5 million, or 46%, from the same period in 1999.
Lines in service to wholesale market customers increased from 104,058 lines at
December 31, 1999 to 164,527 lines at December 31, 2000, an increase of 58%.
Direct billings to small and medium-sized business customers increased
during the year ended December 31, 2000 by $3.5 million, or 177%, from the same
period in 1999. On-network lines in service to these customers increased from
16,488 lines at December 31, 1999 to 28,870 lines at December 31, 2000, an
increase of 75%.
The $7.6 million increase in outbound local and long distance revenues,
including 800 number and travel card calls, represented a 96% increase in the
year ended December 31, 2000 over 1999. This increase was 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 was
primarily related to increased data networking services for private networks.
Our consolidated operating costs for the year ended December 31, 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 anticipated growth of our communications services. Excluding
the reciprocal compensation settlement of $26.3 million in the year ended
December 31, 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 $31.1 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 included
36
$989,000 of provision for doubtful accounts, an increase of $494,000 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
years. During the year 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 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 years 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.
Quarterly Operating and Statistical Data
The following table sets forth unaudited operating and statistical data for
each of the specified quarters of 2000 and 2001. The operating and statistical
data for any quarter are not necessarily indicative of results for any future
period. Lines sold to date and lines in service to date for all quarters in the
table below have been adjusted as discussed under "--Overview" above.
Quarter Ended
------------------------------------------------------------------------------
2000 2001
-------------------------------------- --------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
-------- -------- -------- -------- -------- -------- -------- --------
Ports equipped (see Note 1
below)...................... 460,800 518,400 576,000 672,000 672,000 672,000 672,000 652,800
Lines sold to date........... 157,826 187,593 190,204 206,853 245,061 249,368 253,434 240,053
Lines in service to date..... 147,023 174,750 178,209 193,397 233,839 236,193 242,451 235,244
Estimated data lines (% of
installed lines)............ 82% 82% 87% 86% 87% 86% 85% 84%
Lines on switch %............ 95% 96% 94% 93% 93% 93% 93% 94%
Internet service provider and
enhanced communications
service provider customer
lines collocated %.......... 87% 90% 80% 81% 84% 84% 83% 82%
Quarterly minutes of use
switched (in millions)...... 5,387 5,653 6,140 6,487 6,583 6,290 6,436 7,286
Capital expenditures
(in thousands).............. $ 11,610 $ 43,518 $ 16,292 $ 42,228 $ 20,149 $ 9,504 $ 5,092 $ 2,406
Employees.................... 482 551 629 693 689 645 428 407
- --------
(1) The decline in ports equipped from September 30, 2001 to December 31, 2001
is a result of ports in transit from our Utah switch facility to our
Stockton switch facility.
37
Liquidity and Capital Resources
Net cash provided by operating activities was $12.3 million for the year
ended December 31, 2001 as compared to $41.8 million for the same period ended
in 2000. One of the primary differences between periods was attributable to a
decrease in operating income (excluding depreciation, amortization,
restructuring and impairment charges). Our operating income was lower than last
year as we increased our operating and selling, general and administrative
expenses to accommodate network expansion and anticipated revenue growth.
Additionally, our accounts payable balances decreased between years which was
partially offset by income tax refunds totaling $3.1 million received in the
first and fourth quarters of 2001, and a decrease in accounts receivable and
inventory balances. On June 30, 2000 the Company entered into an Indefeasible
Right of Use (IRU) agreement to acquire dedicated fiber optics circuits at a
price of approximately $23 million. Of this amount, $5.8 million was paid on
July 28, 2000, and the balance of $17.3 million, which was recorded in other
current liabilities, was included in the $41.8 million of net cash provided by
operating activities for the year ended December 31, 2000. For more
information, please refer to Note 7 in the accompanying consolidated financial
statements included in Item 8 to this Annual Report on Form 10-K.
Net cash used in investing activities was $9.9 million for the year ended
December 31, 2001 compared to $67.8 million for the same period ended 2000.
During the year ended 2001, the Company invested $35.2 million, excluding $2.0
million of equipment being financed under a capital lease, in new switching and
related equipment, as compared to $92.3 million during the same period ended in
2000. Investments in equipment in 2000 include the $23 million for the IRU
agreement. Cash used to purchase equipment during the years ended December 31,
2001 and 2000 were partially offset by net redemptions of short-term
investments to cover capital and other operating requirements. Additionally,
during the year ended December 31, 2000 the Company paid $12.2 million to
acquire Napa Telecom, Installnet, Baron Telecommunications and Communications
Specialists, Inc.
Net cash provided by financing activities was $5.0 million for the year
ended December 31, 2001 as compared to $0.1 million for the same period ended
in 2000. In June 2001, we borrowed $10.0 million against our senior credit
facility. These proceeds were partially offset by principal payments on our
capital leases of $5.2 million.
The local telecommunications service business is capital intensive. Our
operations have required substantial capital investment for the design,
acquisition, construction and implementation of our network. Capital
expenditures, including amounts financed under capital leases, were $37.2
million, $113.6 million and $56.4 million for the years ending December 31,
2001, 2000 and 1999, respectively. Approximately $32.8 million of capital
expenditures made during 2000 and 2001 are included in projects in progress as
of December 31, 2001 and therefore are not being depreciated until they are
placed in service in 2002. In response to a weakening economy, we have
undertaken various initiatives intended to not only maximize our performance
during this economic downturn, but to take advantage of emerging opportunities.
Our business plan, as currently contemplated, anticipates capital expenditures,
excluding acquisitions, of approximately $30.0 million in 2002. However, the
actual cost of these additional capital expenditures will depend on a variety
of factors. Accordingly, our actual capital requirements may exceed, or fall
below, the amounts described above.
Our senior credit facility, which expires June 15, 2002, provides for
maximum borrowings of up to $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,
2001, there was $10.0 million outstanding under this facility at a borrowing
rate of approximately 4.12%. Borrowings under our senior credit facility are
secured by substantially all of our assets. We are currently reviewing our debt
obligations, including the senior credit facility, and are considering various
alternatives to reduce our outstanding obligations and borrowing costs.
38
In 2000 and 2001, the Company had a lease facility used exclusively for the
acquisition of networking products and related services manufactured by Cisco
Systems, Inc. The Company purchased approximately $23.3 million of networking
products under this facility, which is being accounted for as a capital lease.
Our principal sources of funds for 2002 are anticipated to be current cash
and short-term investment balances, cash flows from operating activities, and
if necessary and available, 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. As currently contemplated, we
expect to fund, among other things, our semi-annual interest payments of $10.1
million each, anticipated capital expenditures of approximately $30.0 million,
capital lease payments of $8.1 million, repayment of the $10.0 senior debt
borrowing and our Fiber IRU obligation of $17.2 million for which we are
currently negotiating extended payment terms. 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, among other things, 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. Key
factors which could affect our liquidity include: future demand of our
services; financial stability of our customers; outcomes of regulatory
proceedings involving reciprocal compensation; capital expenditures; and, debt
payments.
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. 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. The Company is in compliance with its financial covenants.
Inflation
We do not believe that inflation has had any material effect on our business
over the past three years.
Recent Developments
During the first quarter of 2002, we purchased from holders of our Senior
Notes an aggregate of approximately $21 million principal amount of Senior
Notes at a substantial discount to par value. Although we are currently no
longer in the market seeking to purchase additional Senior Notes, we are
reviewing all of our debt obligations and are considering various alternatives
to continue to reduce such obligations, including, among other things, the
purchase of additional Senior Notes. The manner, volume and timing of any such
purchases, if any, would depend on then current market conditions for our
Senior Notes.
Our independent auditor, Arthur Andersen LLP, has informed us that on March
14, 2002, it was indicted on federal obstruction of justice charges arising
from the government's investigation of Enron Corp. We have been carefully
monitoring these developments. In a release, dated March 18, 2002, the SEC has
said that it will continue to accept financial statements audited, and interim
financial statements reviewed by, Arthur Andersen so long as it is able to make
certain representations to us. Our ability to raise capital and make timely
filings with the SEC could be impaired if the SEC ceases accepting financial
statements audited by Arthur Andersen, if Arthur Andersen becomes unable to
make the required representations to us or if, for any other reason, Arthur
Andersen is unable to perform required audit-related services for us. In such
event, we would promptly seek to engage a new independent auditor or take such
other actions as may be necessary to enable us to raise capital and make timely
filings.
39
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, 2001, we had
$150 million principal amount 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 which may, at our option, have
a variable interest rate tied to LIBOR. As of December 31, 2001 we have drawn
$10 million against our line of credit and at December 31, 2001, our rate was
4.12% based upon LIBOR. Additionally, we are 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 $82.5 million of cash and
cash equivalents and short-term investments at December 31, 2001 by
approximately $0.8 million.
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 5, 2002, are set forth on pages F-1 through F-23 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 5, 2002, are set forth on pages F-24 and F-25 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.
Items 10, 11, 12, and 13.
Information required by Items 10, 11, 12 and 13 of Part III of this Annual
Report on Form 10-K is incorporated by reference from Pac-West Telecomm, Inc.'s
Proxy Statement, to be delivered to its shareholders in connection with its
Annual Meeting of Shareholders to be held June 11, 2002, which will be filed
with the Securities Exchange Commission, pursuant to Regulation 14A, not later
than 120 days after the end of the fiscal year, all of which information is
hereby incorporated by reference, in and made part of, this Annual Report on
Form 10-K.
40
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, 2001, 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, 2001, 2000 and 1999 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 Telecomm, 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. La Rue, 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)).
41
Exhibit
Number Description
------ -----------
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)).
42
Exhibit
Number Description
------ -----------
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)).
10.23(c) Loan and Security Agreement dated June 15, 1999, as amended, between Pac-West Telecomm,
Inc., Union Bank of California and other lenders as designated (Incorporated by reference to
Exhibit 10.23(c) to the Company's Quarterly Report on Form 10-Q for the period ended
June 30, 2001).
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)).
43
Exhibit
Number Description
- ------ -----------
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 Communications, 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 U S 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 U S 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).
44
Exhibit
Number Description
------ -----------
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 U S 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(a) 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).
10.43(b) Amendment No 1 to IRU Agreement dated May 15, 2001, between Pac-West Telecomm, Inc.
and Qwest Communications Corporation (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 (Incorporated
by reference to Exhibit 10.48 to the Company's Annual Report on Form 10-K for the period
ended December 31, 2000).
+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. (Incorporated by reference to
exhibit 10.49 to the Company's Annual Report on Form 10-K for the period ended
December 31, 2000).
+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. (Incorporated by reference to
Exhibit 10.50 to the Company's Annual Report on Form 10-K for the period ended
December 31, 2000).
45
Exhibit
Number Description
- ------ -----------
+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. (Incorporated by reference to
Exhibit 10.51 to the Company's Annual Report on Form 10-K for the period ended December 31,
2000).
+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. (Incorporated by reference to exhibit
10.52 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000).
+10.53 Interconnection Agreement Between Roseville Telephone Company and Pac-West Telecomm, Inc.
for the State of California dated September 18, 2000 (Incorporated by reference to exhibit 10.53
to the Company's Annual Report on Form 10-K for the period ended December 31, 2000).
+10.54 Mutual Settlement Agreement, dated November 16, 2000, by and between Mr. Brian K. Johnson
and Pac-West Telecomm, Inc. (Incorporated by reference to exhibit 10.54 to the Company's
Annual Report on Form 10-K for the period ended December 31, 2000).
10.55 Agreement for Local Wireline Network Interconnection and Service Resale Between AT&T Corp.
and U S West Communications, Inc. for the State of Idaho dated July 27, 1998 (Incorporated by
reference to Exhibit 10.23(c) to the Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2001).
10.56 Letter Agreement between Qwest Corporation (f/k/a U S West Communications, Inc.) and Pac-
West Telecomm, Inc. for the State of Idaho, dated October 2, 2000 (Incorporated by reference to
Exhibit 10.23(c) to the Company's Quarterly Report on Form 10-Q for the period ended June 30,
2001).
10.57 Agreement for Local Wireline Network Interconnection and Service Resale Between AT&T
Communications of the Mountain States, Inc. and U S West Communications, Inc for the State of
Utah,dated June 28, 1998 (Incorporated by reference to Exhibit 10.23(c) to the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2001).
10.58 Letter Agreement between Qwest Corporation (f/k/a U S West Communications, Inc.) and
Pac-West Telecomm, Inc. for the State of Utah, dated October 2, 2000 (Incorporated by reference
to Exhibit 10.23(c) to the Company's Quarterly Report on Form 10-Q for the period ended
June 30, 2001).
*+10.59 Severance Agreement, dated September 27, 2001, by and between Mr. Richard Bryson and
Pac-West Telecomm, Inc.
*+10.60 Employment Agreement, dated June 11, 2001, by and between Mr. Henry R. Carabelli and
Pac-West Telecomm, Inc.
*+10.61 Agreement Regarding Change in Employment Status, dated August 1, 2001, by and between John
K. La Rue and Pac-West Telecomm, Inc.
*+10.62 Employment Agreement, dated December 1, 2001, by and between Mr. Wallace W. Griffin and
Pac-West Telecomm, Inc.
*+10.63 Agreement Regarding Compensation in Change of Control, dated December 1, 2000 by and
between Mr. H. Ravi Brar and Pac-West Telecomm, Inc.
*+10.64 Agreement Regarding Compensation in Change of Control, dated December 1, 2000 by and
between Mr. John F. Sumpter and Pac-West Telecomm, Inc.
46
Exhibit
Number Description
- ------ -----------
*+10.65 Agreement Regarding Compensation in Change of Control, dated December 1, 2000 by and
between Mr. Gregory Joksch and Pac-West Telecomm, Inc.
*21.1 Subsidiaries of the Company.
*23.1 Consent of Arthur Andersen LLP.
*99.1 Letter by the Company addressed to the SEC regarding certain representations made to the
Company by Arthur Andersen LLP.
- --------
* Newly filed with this report
+ Management contract or compensatory plan or arrangement
(b) Reports on Form 8-K
None
47
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 29,
2002.
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 Chairman and Chief Executive
- ----------------------------- Officer (Principal
Wallace W. Griffin Executive Officer)
/s/ H. RAVI BRAR Interim Chief Financial
- ----------------------------- Officer (Principal
H. Ravi Brar Financial and Accounting
Officer)
/s/ JERRY L. JOHNSON Director
- -----------------------------
Jerry L. Johnson
/s/ JOHN K. LA RUE Director
- -----------------------------
John K. La Rue
/s/ DAVID G. CHANDLER Director
- -----------------------------
David G. Chandler
/s/ MARK S. FOWLER Director
- -----------------------------
Mark S. Fowler
- ----------------------------- Director
Samuel A. Plum
/s/ DR. JAGDISH N. SHETH Director
- -----------------------------
Dr. Jagdish N. Sheth
/s/ A. GARY AMES Director
- -----------------------------
A. Gary Ames
/s/ ROBERT C. MORRISON Director
- -----------------------------
Robert C. Morrison
48
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants............................. F-2
Consolidated Balance Sheets.......................................... F-3
Consolidated Statements of Operations and Comprehensive Income (Loss) 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,
2001 and 2000, and the related consolidated statements of operations and
comprehensive income (loss), changes in stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 2001. 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 of America. 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, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
ARTHUR ANDERSEN LLP
San Jose, California
February 5, 2002
F-2
PAC-WEST TELECOMM, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2001 and 2000
ASSETS
2001 2000
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 64,029,000 $ 56,675,000
Short-term investments.................................................... 18,471,000 43,904,000
Trade accounts receivable, net of allowances of $2,630,000 and $3,003,000
as of December 31, 2001 and 2000, respectively.......................... 13,621,000 19,106,000
Accounts receivable from related parties.................................. 80,000 34,000
Income tax receivable..................................................... 291,000 2,257,000
Inventories............................................................... 2,939,000 4,272,000
Prepaid expenses and other current assets................................. 3,134,000 3,482,000
Deferred financing costs, net............................................. 785,000 853,000
Deferred tax assets....................................................... 4,491,000 2,475,000
------------ ------------
Total current assets.................................................. 107,841,000 133,058,000
------------ ------------
PROPERTY AND EQUIPMENT:
Network and other communication equipment................................. 146,703,000 114,325,000
Equipment under capital leases............................................ 23,273,000 21,311,000
Office furniture.......................................................... 2,624,000 2,046,000
Business software and computer equipment.................................. 25,346,000 19,586,000
Vehicles.................................................................. 2,004,000 2,053,000
Leasehold improvements.................................................... 30,149,000 23,971,000
Projects in progress...................................................... 32,775,000 49,065,000
------------ ------------
262,874,000 232,357,000
Less: Accumulated depreciation and amortization.............................. (61,838,000) (30,843,000)
------------ ------------
Property and equipment, net............................................... 201,036,000 201,514,000
------------ ------------
COSTS IN EXCESS OF NET ASSETS OF ACQUIRED BUSINESSES, net.................... -- 18,756,000
OTHER ASSETS, net............................................................ 5,860,000 7,464,000
------------ ------------
Total assets.......................................................... $314,737,000 $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, 2001 and 2000
2001 2000
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of notes payable.................................... $ -- $ 16,000
Current obligations under capital leases............................ 7,881,000 5,852,000
Borrowings under senior credit facility............................. 10,000,000 --
Accounts payable.................................................... 11,536,000 18,681,000
Accrued payroll and related expenses................................ 2,884,000 3,872,000
Accrued interest on Senior Notes.................................... 8,438,000 8,437,000
Other accrued liabilities........................................... 6,604,000 4,209,000
Fiber IRU liability................................................. 17,240,000 17,240,000
Deferred revenues................................................... 964,000 1,819,000
------------ ------------
Total current liabilities.................................... 65,547,000 60,126,000
------------ ------------
SENIOR NOTES........................................................... 150,000,000 150,000,000
CAPITAL LEASES, less current portion................................... 10,192,000 15,459,000
------------ ------------
Total long-term debt......................................... 160,192,000 165,459,000
------------ ------------
DEFERRED REVENUES, less current portion................................ 644,000 735,000
------------ ------------
DEFERRED INCOME TAXES.................................................. 3,283,000 14,715,000
------------ ------------
Total liabilities............................................ 229,666,000 241,035,000
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 7)
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value:
Authorized shares--100,000,000
Issued and outstanding shares--36,148,487 and 35,948,549 at
December 31, 2001 and 2000, respectively...................... 36,000 36,000
Additional paid-in capital............................................. 183,550,000 183,568,000
Note receivable from stockholder....................................... (200,000) (200,000)
Retained deficit....................................................... (98,072,000) (63,280,000)
Accumulated other comprehensive income (loss).......................... (53,000) 277,000
Deferred stock compensation............................................ (190,000) (644,000)
------------ ------------
Total stockholders' equity................................... 85,071,000 119,757,000
------------ ------------
Total liabilities and stockholders' equity................... $314,737,000 $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 AND COMPREHENSIVE INCOME (LOSS)
For the Years Ended December 31, 2001, 2000 AND 1999
2001 2000 1999
------------ ------------ -----------
REVENUES....................................................................... $149,992,000 $139,090,000 $95,505,000
COSTS AND EXPENSES:
Operating.................................................................. 57,345,000 42,388,000 20,510,000
Selling, general and administrative........................................ 66,099,000 54,026,000 22,855,000
Depreciation and amortization.............................................. 34,657,000 20,905,000 8,689,000
Restructuring charges...................................................... 8,764,000 -- --
Impairment of goodwill..................................................... 16,787,000 -- --
------------ ------------ -----------
Income (loss) from operations........................................... (33,660,000) 21,771,000 43,451,000
------------ ------------ -----------
OTHER EXPENSE (INCOME):
Interest expense........................................................... 19,937,000 18,932,000 18,124,000
Interest income............................................................ (4,177,000) (7,564,000) (3,690,000)
(Income) loss on asset dispositions, net................................... (35,000) 580,000 --
------------ ------------ -----------
Total other expense, net................................................ 15,725,000 11,948,000 14,434,000
------------ ------------ -----------
Income (loss) before provision for (benefit from) income taxes and
cumulative effect of change in accounting principle.................... (49,385,000) 9,823,000 29,017,000
PROVISION FOR (BENEFIT FROM) INCOME TAXES...................................... (14,593,000) 4,791,000 13,111,000
------------ ------------ -----------
Income (loss) before cumulative effect of change in accounting
principle.............................................................. (34,792,000) 5,032,000 15,906,000
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE,
net of income tax benefit of $943,000......................................... -- (1,415,000) --
------------ ------------ -----------
Net income (loss)....................................................... (34,792,000) 3,617,000 15,906,000
ACCRUED PREFERRED STOCK DIVIDENDS.............................................. -- -- (4,085,000)
------------ ------------ -----------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS............................. $(34,792,000) $ 3,617,000 $11,821,000
============ ============ ===========
INCOME (LOSS) PER SHARE BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE:
Basic...................................................................... $ (0.96) $ 0.14 $ 0.59
Diluted.................................................................... $ (0.96) $ 0.13 $ 0.56
LOSS PER SHARE FROM CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE:
Basic...................................................................... $ -- $ (0.04) $ --
Diluted.................................................................... $ -- $ (0.03) $ --
NET INCOME (LOSS) PER SHARE:
Basic...................................................................... $ (0.96) $ 0.10 $ 0.59
Diluted.................................................................... $ (0.96) $ 0.10 $ 0.56
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic...................................................................... 36,057,941 35,837,552 20,172,968
Diluted.................................................................... 36,057,941 37,661,717 21,293,828
COMPREHENSIVE INCOME (LOSS):
Net income (loss).......................................................... $(34,792,000) $ 3,617,000 $11,821,000
Change in accumulated other comprehensive income (loss).................... (330,000) 277,000 --
------------ ------------ -----------
Comprehensive income (loss)................................................ $(35,122,000) $ 3,894,000 $11,821,000
============ ============ ===========
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, 1999, 2000 and 2001
Notes Accumulated
Receivable Other Deferred Total
Common Stock Additional From Comprehen- Stock Stockholders'
------------------ Paid-in Stock Retained sive Income Compensa- Equity
Shares Amount Capital holders Deficit (Loss) tion (Deficit)
---------- ------- ------------ ---------- ------------ ----------- --------- -------------
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 preferred stock
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
Exercise of stock options..... 45,125 -- 94,000 -- -- -- -- 94,000
Issuance of shares under
Employee Stock Purchase
Plan......................... 154,813 -- 258,000 -- -- -- -- 258,000
Unrealized loss on investments -- -- -- -- -- (330,000) -- (330,000)
Reversal of deferred stock
compensation for
forfeitures.................. -- -- (370,000) -- -- -- 370,000 --
Amortization of deferred stock
compensation................. -- -- -- -- -- -- 84,000 84,000
Net loss...................... -- -- -- -- (34,792,000) -- -- (34,792,000)
---------- ------- ------------ --------- ------------ --------- --------- ------------
Balance, December 31, 2001.... 36,148,487 $36,000 $183,550,000 $(200,000) $(98,072,000) $ (53,000) $(190,000) $ 85,071,000
========== ======= ============ ========= ============ ========= ========= ============
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, 2001, 2000 and 1999
2001 2000
------------ ------------
OPERATING ACTIVITIES:
Income (loss) before cumulative effect of change in accounting principle................. $(34,792,000) $ 5,032,000
Adjustments to reconcile income (loss) before cumulative effect of change in
accounting principle to net cash provided by operating activities:
Depreciation and amortization........................................................... 34,657,000 20,905,000
Amortization of deferred financing costs................................................ 878,000 853,000
Amortization of deferred stock compensation............................................. 84,000 264,000
Impairment of goodwill.................................................................. 16,787,000 --
Non-cash restructuring charges.......................................................... 5,000,000 --
Net (gain) loss on asset dispositions................................................... (35,000) 580,000
Interest earned on restricted cash...................................................... -- (38,000)
Provision for doubtful accounts......................................................... 3,214,000 989,000
Provision for inventory................................................................. 550,000 --
Deferred income tax provision (benefit)................................................. (14,593,000) 4,787,000
Changes in operating assets and liabilities, net of acquisitions:
(Increase) decrease in trade accounts receivable...................................... 2,271,000 (9,254,000)
(Increase) decrease in accounts receivable from related parties....................... (46,000) 29,000
(Increase) decrease in income tax receivable.......................................... 3,111,000 (2,062,000)
(Increase) decrease in inventories.................................................... 783,000 (1,761,000)
(Increase) decrease in prepaid expenses and other current assets...................... 348,000 (489,000)
(Increase) decrease in other assets................................................... 716,000 (253,000)
Increase (decrease) in accounts payable............................................... (7,145,000) 401,000
Increase in accrued interest on Senior Notes.......................................... 1,000 2,000
Increase (decrease) in income taxes payable........................................... -- (537,000)
Increase (decrease) in accrued payroll and related expenses and other liabilities..... 462,000 22,314,000
------------ ------------
Net cash provided by operating activities.......................................... 12,251,000 41,762,000
------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment...................................................... (35,189,000) (92,337,000)
(Purchases) redemptions of short-term investments, net................................... 25,103,000 26,511,000
Proceeds from disposal of equipment...................................................... 193,000 46,000
Purchase of restricted cash investments, net of redemptions of $10,125,000 and
$10,238,000 in 2000 and 1999, respectively.............................................. -- 10,125,000
Costs of acquisitions, net of cash received.............................................. 10,000 (12,186,000)
------------ ------------
Net cash used in investing activities.............................................. (9,883,000) (67,841,000)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from issuance of Senior Notes................................................... -- --
Net proceeds from initial public offering of common stock................................ -- --
Repayment of senior secured borrowings................................................... -- --
Proceeds from borrowing under senior credit facility..................................... 10,000,000 --
Proceeds from repayment of note receivable from stockholder.............................. -- 33,000
Repayments on notes payable.............................................................. (16,000) (100,000)
Principal payments on capital leases..................................................... (5,200,000) --
Payments for deferred financing costs.................................................... (150,000) (2,000)
Proceeds from the issuance of common stock............................................... 352,000 135,000
------------ ------------
Net cash provided by financing activities.......................................... 4,986,000 66,000
------------ ------------
Net increase (decrease) in cash and cash equivalents............................... 7,354,000 (26,013,000)
CASH AND CASH EQUIVALENTS:
Beginning of year........................................................................ 56,675,000 82,688,000
------------ ------------
End of year.............................................................................. $ 64,029,000 $ 56,675,000
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Non cash investing activities:
Issuance of common stock for acquisitions............................................... $ -- $ 9,147,000
Non cash financing activities:
Equipment purchased under capital lease obligations..................................... $ 1,962,000 $ 21,311,000
Cash paid during the year for:
Interest................................................................................ $ 20,782,000 $ 20,250,000
Income taxes............................................................................ $ -- $ 2,253,000
1999
-------------
OPERATING ACTIVITIES:
Income (loss) before cumulative effect of change in accounting principle................. $ 15,906,000
Adjustments to reconcile income (loss) before cumulative effect of change in
accounting principle to net cash provided by operating activities:
Depreciation and amortization........................................................... 8,689,000
Amortization of deferred financing costs................................................ 1,162,000
Amortization of deferred stock compensation............................................. --
Impairment of goodwill.................................................................. --
Non-cash restructuring charges.......................................................... --
Net (gain) loss on asset dispositions................................................... --
Interest earned on restricted cash...................................................... (629,000)
Provision for doubtful accounts......................................................... 495,000
Provision for inventory................................................................. --
Deferred income tax provision (benefit)................................................. 6,316,000
Changes in operating assets and liabilities, net of acquisitions:
(Increase) decrease in trade accounts receivable...................................... (4,211,000)
(Increase) decrease in accounts receivable from related parties....................... 1,000
(Increase) decrease in income tax receivable.......................................... 1,776,000
(Increase) decrease in inventories.................................................... (505,000)
(Increase) decrease in prepaid expenses and other current assets...................... (1,975,000)
(Increase) decrease in other assets................................................... (2,541,000)
Increase (decrease) in accounts payable............................................... 8,011,000
Increase in accrued interest on Senior Notes.......................................... 8,435,000
Increase (decrease) in income taxes payable........................................... 520,000
Increase (decrease) in accrued payroll and related expenses and other liabilities..... (11,000)
-------------
Net cash provided by operating activities.......................................... 41,439,000
-------------
INVESTING ACTIVITIES:
Purchases of property and equipment...................................................... (56,370,000)
(Purchases) redemptions of short-term investments, net................................... (70,138,000)
Proceeds from disposal of equipment...................................................... --
Purchase of restricted cash investments, net of redemptions of $10,125,000 and
$10,238,000 in 2000 and 1999, respectively.............................................. (9,458,000)
Costs of acquisitions, net of cash received.............................................. --
-------------
Net cash used in investing activities.............................................. (135,966,000)
-------------
FINANCING ACTIVITIES:
Proceeds from issuance of Senior Notes................................................... 150,000,000
Net proceeds from initial public offering of common stock................................ 118,133,000
Repayment of senior secured borrowings................................................... (100,000,000)
Proceeds from borrowing under senior credit facility..................................... --
Proceeds from repayment of note receivable from stockholder.............................. --
Repayments on notes payable.............................................................. (132,000)
Principal payments on capital leases..................................................... --
Payments for deferred financing costs.................................................... (6,022,000)
Proceeds from the issuance of common stock............................................... --
-------------
Net cash provided by financing activities.......................................... 161,979,000
-------------
Net increase (decrease) in cash and cash equivalents............................... 67,452,000
CASH AND CASH EQUIVALENTS:
Beginning of year........................................................................ 15,236,000
-------------
End of year.............................................................................. $ 82,688,000
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Non cash investing activities:
Issuance of common stock for acquisitions............................................... $ --
Non cash financing activities:
Equipment purchased under capital lease obligations..................................... $ --
Cash paid during the year for:
Interest................................................................................ $ 8,723,000
Income taxes............................................................................ $ 4,499,000
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, 2001
1. ORGANIZATION:
Pac-West Telecomm, Inc. (the Company) is a 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 maintain and attract new customers, manage and
adequately finance network growth and technological change within the
telecommunications industry, maintain high quality, market driven services at
prices generally equal to or below those charged by our competitors, obtain
positive and timely responses regarding governmental regulations and adequately
manage working capital and cash flows.
In September 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 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
was 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. These acquisitions
were accounted for using the purchase method of accounting (see Note 5.)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries since the date of acquisition. All
intercompany accounts and transactions have been eliminated. Installnet, Inc.,
and U.S. Net Solutions, Inc. are subsidiaries of Pac-West Telecomm, Inc. and
are included in the respective consolidated financial statements. In addition,
D.B.D Consulting, Inc was a subsidiary of the Company until October 31, 2001,
at which time it was disposed of for its net book value of approximately
$28,000.
F-8
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentration of Customers and Suppliers
The concentrations of customers and suppliers of the Company for the years
ended December 31, 2001, 2000 and 1999 are:
2001 2000 1999
---- ---- ----
Revenues (percent of revenues): Incumbent Local Exchange Carriers (ILECs, see
Note 7).................................................................... 42% 45% 58%
Expenses (percent of operating costs): largest supplier...................... 35% 35% 49%
In 2001, 2000 and 1999, the Company's largest source of operating costs was
also the largest incumbent local exchange carrier (ILEC).
For the years ended December 31, 2001, 2000 and 1999, revenue from our ISPs
accounted for approximately 22%, 19% and 19%, respectively, of our total
revenues, and accounted for approximately 15% and 17% of our accounts
receivable as of December 31, 2001 and 2000, respectively. This ISP revenue
does not include reciprocal compensation related to terminating calls to ISPs,
long distance services and dedicated transport services. 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 2001 and 2000, respectively, the
Company recognized a $3.2 million and $1.0 million provision for doubtful
accounts included in selling, general and administrative expense in the
accompanying consolidated statements of operations. This provision reflects
increased accounts receivable write-offs as a result of an increase in customer
delinquencies and bankruptcies.
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,
disclosure of contingent assets and liabilities, and reported amounts of
revenues and expenses during the reporting period. Significant estimates made
by the Company include provision for doubtful accounts receivable, impairment
provisions for long-lived assets and goodwill, accruals related to abandoned
properties identified in our restructuring plan, and the outcomes of litigation
and regulatory proceedings discussed in Note 7. By their nature, these
judgments are subject to an inherent degree of uncertainty. Thus, actual
results could differ from estimates made and such differences could be material.
Provision for doubtful accounts receivable. Provisions for allowances for
doubtful accounts receivable are estimated based upon historical collection
experience, customer delinquencies and bankruptcies, information provided by
our customers, observance of trends in the industry and other current economic
conditions. If this information does not properly reflect future collections,
our accounts receivable could be overstated or understated.
Provisions for long-lived assets and goodwill. The Company periodically
evaluates the carrying amount of its long-lived assets and goodwill when events
or changes in business circumstances have occurred which indicate the remaining
estimated useful lives of such assets may not be fully recoverable. In
assessing the recoverability of these assets, the Company must make assumptions
regarding, among other things, estimated future cash flows to determine the
fair value of the respective assets. If these estimates and the related
assumptions change in the future, the Company may be required to record an
impairment charge for these assets in the future.
Accruals related to abandoned properties. In August 2001, the Company
approved and announced a restructuring plan, which included, among other things
(see Note 3), closing our switch facility in Utah and consolidation of six
sales offices. In order to estimate rent expense related to these abandoned
premises, the
F-9
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company made certain assumptions including; (1) the time period over which the
premises would remain vacant, (2) sublease terms, and (3) estimated sublease
rents. In the case of the Utah switching facility, no sublease income was
estimated due to the specialized nature of this facility. If the Company is
unable to sublet the abandoned premises within the estimated timeframe and at
estimated terms, the restructuring charge could be understated.
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, 2001 and 2000,
$1,608,000 and $2,554,000, respectively, of installation payments received and
$1,049,000 and $999,000, respectively, 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 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.
F-10
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, 2001 and 2000 were classified
as available-for-sale and appropriately carried at fair value. Realized gains
and losses are included in interest income in the accompanying consolidated
statements of operations. Differences between cost and fair value (unrealized
gains and losses) are recorded as other comprehensive income (loss), a separate
component of stockholders' equity. For the years ended December 31, 2001 and
2000, the change in other comprehensive income (loss) was a (decrease) increase
of $(330,000) and $277,000, respectively (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. In the third quarter of 2001, the Company recorded a
provision of approximately $0.6 million as a result of exiting the COAM
business (see Note 3).
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 improvements 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 2001, 2000 and 1999, the Company capitalized $1,724,000,
$2,462,000 and $2,346,000, respectively, of interest related to capital
projects.
Depreciation and amortization of property and equipment was $32,471,000,
$17,651,000 and $8,475,000 for the years ended December 31, 2001, 2000 and
1999, respectively.
In August 2001, the Company approved and announced a restructuring plan that
included closing our switch facility near Salt Lake City, Utah. Accordingly,
the Company wrote-off leasehold improvements and other equipment at this switch
facility that could not be redeployed to other locations. As a result of this
write-off, the Company recorded a charge of $5.0 million, which is included in
the $8.8 million restructuring charge recorded in the third quarter of 2001.
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.
F-11
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Approximately 22% and 19% of property and equipment capitalized during the
year ended December 31, 2000 was acquired by the Company from two vendors.
During 2001, the Company acquired approximately 38% and 5% of property and
equipment from these same two vendors.
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of", the Company periodically evaluates the
carrying amount of its property and equipment when events or changes in
business circumstances have occurred which indicate the remaining estimated
useful lives of such assets may not be fully recoverable. Determination of
impairment is based on an estimate of undiscounted future cash flows resulting
from the use of the assets and their eventual disposition. If the Company
determines an asset has been impaired, the impairment charge is recorded based
on a comparison of the net book value of the fixed asset and the discounted
future cash flows resulting from the use of the asset over the average
remaining useful life.
The Company evaluated the carrying amount of its property and equipment in
accordance with SFAS 121 and determined, based on management's best estimate,
that no impairment charge was required for these assets as of December 31,
2001. This analysis required significant judgments and estimates related to,
among other factors, demand and the pricing of the Company's services. To the
extent actual market conditions differ significantly from management's
estimates, the estimated fair market value of our long-lived assets could
change which may result in a future impairment charge and such charge, if any,
may be material.
During the fourth quarter of 2000, it was determined that certain
internal-use computer software purchased externally did not meet management's
expectations. Under the provisions of SFAS 121 the Company recorded an
impairment charge 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.
Other Assets
At December 31, other assets consist of the following:
2001 2000
---------- ----------
Deferred financing costs.................... $4,148,000 $4,808,000
Acquisition of lease rights................. 1,026,000 1,254,000
Long-term portion of deferred installation
costs..................................... 448,000 516,000
Long-term portion of prepaid expenses
and deposits.............................. 133,000 781,000
Employee receivable......................... 105,000 105,000
---------- ----------
$5,860,000 $7,464,000
========== ==========
Deferred financing costs 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 of deferred financing costs
for the years ended December 31, 2001, 2000 and 1999, was $878,000, $853,000
and $1,162,000, respectively, and is included in interest expense in the
accompanying consolidated statements of operations.
During 1999, the Company acquired lease rights of additional space in its
Los Angeles facility. This amount is being amortized on a straight-line basis
over the life of the lease, which is 81 months. Amortization expense for this
facility was $228,000, $260,000 and $0 for the years ended 2001, 2000 and 1999,
respectively, and is included in amortization expense in the accompanying
consolidated statements of operations.
F-12
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Other Accrued Liabilities
At December 31, other accrued liabilities consist of the following:
2001 2000
---------- ----------
Accrued restructuring charges (See Note 3)..... $2,460,000 $ --
Taxes payable, collected from customers........ 361,000 582,000
Acquisition holdbacks.......................... 608,000 1,060,000
Accrued warranty and maintenance............... 102,000 402,000
Other.......................................... 3,073,000 2,165,000
---------- ----------
$6,604,000 $4,209,000
========== ==========
Income Taxes
The Company provides for income taxes in accordance with SFAS No. 109 (SFAS
109), "Accounting for Income Taxes." 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 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 (Loss)
In September 1997, the FASB issued SFAS No. 130 (SFAS 130), "Reporting
Comprehensive Income." SFAS 130 establishes the disclosure requirements for
comprehensive income (loss) and its components within the financial statements.
For the year ended December 31, 2001 and 2000 there was $(330,000) and
$277,000, respectively, of other comprehensive (loss) income pertaining to the
net unrealized investment gains and losses. The Company had no items of other
comprehensive income (loss) for the years ended December 31, 1999; therefore,
comprehensive income (loss) was the same as net income (loss) for this year.
Segment Reporting
The Company has adopted SFAS No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information." 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 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
accompanying consolidated financial statements.
F-13
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Specifically, the following table presents revenues by service type for the
years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
------------ ------------ -----------
Local services....... $116,609,000 $102,970,000 $79,071,000
Long-distance
services........... 14,393,000 16,128,000 7,974,000
Dedicated transport
services........... 9,747,000 7,663,000 5,162,000
Products and services 7,226,000 9,942,000 1,485,000
Other................ 2,017,000 2,387,000 1,813,000
------------ ------------ -----------
$149,992,000 $139,090,000 $95,505,000
============ ============ ===========
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, (SFAS 133) "Accounting for Derivative
Instruments and for Hedging Activities" and SFAS No. 138, (SFAS 138)
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an amendment of FASB Statement No. 133", 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 and is effective January 1, 2001. The adoption of SFAS
133 did not impact the Company's financial statements as the Company does not
invest in derivatives or participate in hedging activities.
In June 2001, the FASB issued SFAS No. 141 (SFAS 141), "Business
Combinations" and SFAS No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets". Major provisions of these statements are as follows: all business
combinations initiated after June 30, 2001 must use the purchase method of
accounting; the pooling of interest method of accounting is prohibited except
for transactions initiated before July 1, 2001; intangible assets acquired in a
business combination must be recorded separately from goodwill if they arise
from contractual or other legal rights or are separable from the acquired
entity and can be sold, transferred, licensed, rented or exchanged, either
individually or as part of a related contract, asset or liability; goodwill and
intangible assets with indefinite lives are not amortized but are tested for
impairment at least annually using a fair value approach, except in certain
circumstances, and whenever there is an impairment indicator; other intangible
assets will continue to be valued and amortized over their estimated lives;
in-process research and development will continue to be written off
immediately; all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting; effective January 1,
2002, existing goodwill will no longer be subject to amortization; goodwill
arising between June 29, 2001 and December 31, 2001 will not be subject to
amortization. As discussed in Note 5, the Company wrote-off its unamortized
goodwill in the third quarter of 2001. Therefore, the adoption of SFAS 142 will
have no effect on the Company's financial statements at this time.
In October 2001, the FASB issued SFAS No. 143 (SFAS 143), "Accounting for
Asset Retirement Obligations" to be effective for all fiscal years beginning
after June 15, 2002, with early adoption permitted. SFAS 143 establishes
accounting standards for the recognition and measurement of an asset retirement
obligation and its associated asset retirement cost. It also provides
accounting guidance for legal obligations associated with the retirement of
tangible long-lived assets. The Company does not believe the adoption of SFAS
143 will have a material impact on the Company's financial position or results
of operations.
F-14
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In October 2001, the FASB issued SFAS No. 144 (SFAS 144), "Accounting for
the Impairment or Disposal of Long-Lived Assets". SFAS 144 supercedes SFAS 121
and requires that one accounting model be used for long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired and by
broadening the presentation of discontinued operations to include more disposal
transactions. SFAS 144 will be effective for fiscal years beginning after
December 15, 2001. The Company will adopt SFAS 144 in the first quarter of
fiscal year 2002. The Company does not believe the adoption of SFAS 144 will
have a material impact on the Company's financial position or results of
operations.
Income (Loss) Per Share
Income (loss) per share has been calculated under SFAS No. 128 (SFAS 128),
"Earnings per Share." 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 such as stock options,
using the treasury stock method, and other securities convertible into common
stock using the if-converted basis. For the year ended December 31, 2001,
dilutive securities were antidilutive, as they decreased the loss per share for
this period. Accordingly, options to purchase 582,644 shares were excluded from
the diluted net loss per share calculation for this period.
Diluted net income (loss) per share information considers the effect of
dilutive securities as follows:
For the Year Ended December 31, 2001
-----------------------------------
Income Shares Per Share
------------ ---------- ---------
Basic net loss per share:
Net loss available to common stockholders.................... $(34,792,000) 36,057,941 $(0.96)
Effect of dilutive securities:
Stock options................................................ --
----------
Diluted net loss per share:
Net loss available to common stockholders and dilutive stock
options.................................................... $(34,792,000) 36,057,941 $(0.96)
============ ========== ======
For the Year Ended December 31, 2000
-----------------------------------
Income Shares Per Share
----------- ---------- ---------
Basic net income per share:
Income applicable to common stockholders before cumulative effect
of change in accounting principle, net........................... $ 5,032,000 35,837,552 $ 0.14
Cumulative effect of change in accounting principle, net........... (1,415,000) 35,837,552 (0.04)
----------- ---------- ------
Net income available 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 dilutive stock options
before cumulative effect of change in accounting principle, net.. $ 5,032,000 37,661,717 $ 0.13
Cumulative effect of change in accounting principle, net........... (1,415,000) 37,661,717 (0.03)
----------- ------
Net income available to common stockholders and dilutive stock
options.......................................................... $ 3,617,000 37,661,717 $ 0.10
=========== ========== ======
F-15
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Year Ended December 31, 1999
------------------------------------
Income Shares Per Share
----------- ---------- ---------
Basic net income per share:
Net income available 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
=========== ========== =====
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). This conversion of the convertible
redeemable preferred stock in 1999 was antidilutive and has been excluded from
the calculation of diluted income per share.
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. RESTRUCTURING CHARGES:
In August 2001, the Company approved and announced a restructuring plan
which contained certain business initiatives in response to current unfavorable
market conditions including suspension of our expansion plans in certain
states, exiting of certain lower margin services, including residential resale
and customer owned and maintained (COAM) equipment, and undertaking certain
cost reduction initiatives. In addition to restructuring certain product
offerings, this restructuring program included closing our switch facility in
Utah, consolidation of six sales offices, and a workforce reduction of
approximately 200 employees. As a result of these restructuring activities, the
Company recorded an $8.8 million restructuring charge in the third quarter of
2001 of which $5.0 million was related to the write-off of leasehold
improvements and other equipment in Utah, which cannot be redeployed to other
locations. Amounts expensed totaling $2.4 million relate to future rent
payments due (net of estimated sublease payments) for abandoned premises,
primarily in Utah and San Diego, which will be paid over the respective lease
terms through various dates ending in fiscal year 2010. In order to estimate
rent expense for these abandoned premises, the Company made certain assumptions
including; (1) the time period over which the premises would remain vacant, (2)
sublease terms, and (3) estimated sublease rents. In the case of the Utah
switching facility, no sublease income has been estimated due to the
specialized nature of this facility. As of September 30, 2001 the workforce
reduction was substantially complete with all severance payments being made as
of December 31, 2001. A remaining restructuring liability of $2.5 million is
included in other accrued liabilities in the accompanying consolidated balance
sheet as of December 31, 2001.
F-16
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the restructuring expenses and the associated remaining
liability consist of the following:
Restructuring
Liability as of
Total Non-Cash Cash December 31,
Charge Charges Payments 2001
---------- ---------- ---------- ---------------
Write-off of leasehold improvements
and equipment...................... $5,171,000 $5,000,000 $ -- $ 171,000
Rent expense for vacated premises.... 2,377,000 -- 230,000 2,147,000
Workforce reduction.................. 921,000 -- 921,000 --
Other charges........................ 295,000 -- 153,000 142,000
---------- ---------- ---------- ----------
$8,764,000 $5,000,000 $1,304,000 $2,460,000
========== ========== ========== ==========
4. INVESTMENTS:
The following tables summarize the Company's investments in securities as of
December 31, 2001:
Unrealized Fair Market
Cost Losses, net Value
----------- ----------- -----------
Cash equivalents....................... $45,136,000 $ -- $45,136,000
U.S. government agencies............... 6,278,000 (10,000) 6,268,000
Municipals............................. 6,600,000 -- 6,600,000
Commercial paper....................... 998,000 -- 998,000
Corporate bonds........................ 11,672,000 (41,000) 11,631,000
Asset backed securities................ 3,427,000 (2,000) 3,425,000
Other income........................... 375,000 -- 375,000
----------- -------- -----------
Total investments in securities..... $74,486,000 $(53,000) $74,433,000
Cash................................... 8,067,000
-----------
Total cash and investments.......... $82,500,000
===========
Reported as:
Cash and cash equivalents........... $64,029,000
Short-term investments.............. $18,471,000
As of December 31, 2001, $12,473,000 of our short-term investments had
maturity dates which exceeded one year.
F-17
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following tables summarize the Company's investments in securities as of
December 31, 2000:
Unrealized Fair Market
Cost Gains, net Value
----------- ---------- ------------
Cash equivalents....................... $27,570,000 $ -- $ 27,570,000
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
Asset backed securities................ 9,282,000 86,000 9,368,000
----------- -------- ------------
Total investments in securities..... $94,380,000 $277,000 $ 94,657,000
Cash................................... 5,922,000
------------
Total cash and investments.......... $100,579,000
============
Reported as:
Cash and cash equivalents........... $ 56,675,000
Short-term investments.............. 43,904,000
============
As of December 31, 2000, $39,044,000 of our short-term investments had
maturity dates which exceeded one year.
5. COSTS IN EXCESS OF NET ASSETS OF ACQUIRED BUSINESSES:
At December 31, 2000, costs in excess of net assets of acquired businesses
(goodwill) primarily related to the acquisitions of Napa Telecom, Installnet,
Baron Telecommunications and CSI. In accordance with Accounting Principles
Board Opinion No. 17 (APB 17), "Intangible Assets," the Company periodically
evaluates the carrying amount of its enterprise-level goodwill when events or
changes in business circumstances have occurred that indicate the carrying
amount of the enterprise-level goodwill may be impaired. Determination of
impairment is based on an estimate of the fair value of the goodwill using
estimated discounted future cash flows. As a result of the Company's modified
business plan, the Company determined its goodwill was impaired and recorded an
impairment charge of $16.8 million in the third quarter of 2001. As of August
1, 2001, when the Company determined the goodwill was impaired, the Company
discontinued amortizing the related goodwill. Goodwill amortization was $2.0
million and $2.8 million for the years ended December 31, 2001 and 2000,
respectively.
F-18
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, 2000, costs in excess of net assets of acquired businesses,
net, consisted of the following:
Napa Baron
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
Common stock........... -- 8,400,000 587,000 160,000 -- 9,147,000
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
========== =========== ========== ========== ======== ===========
As of August 1, 2001, costs in excess of net assets of acquired businesses,
net, for which an impairment charge was recorded as noted above, consisted of
the following:
Unamortized balance at December 31,
2000............................. $2,981,000 $12,884,000 $1,705,000 $1,027,000 $159,000 $18,756,000
2001 costs......................... -- 20,000 9,000 6,000 35,000
2001 adjustment to purchase price.. -- -- (45,000) -- -- (45,000)
2001 amortization.................. (434,000) (1,236,000) (149,000) (116,000) (24,000) (1,959,000)
---------- ----------- ---------- ---------- -------- -----------
Impairment charge.................. $2,547,000 $11,668,000 $1,520,000 $ 917,000 $135,000 $16,787,000
========== =========== ========== ========== ======== ===========
- --------
* Cash was paid prior to January 2000 for "other" acquisitions.
Costs in excess of net assets acquired for Napa Telecom were 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 were
amortized on a straight-line basis over 84 months beginning February 1,
September 1, and November 1, 2000, respectively.
6. DEBT AND CAPITAL LEASE OBLIGATIONS:
At December 31, long-term debt and capital lease obligations consisted of
the following:
2001 2000
------------ ------------
Senior Notes........................... $150,000,000 $150,000,000
Borrowings under senior credit facility 10,000,000 --
Capital lease obligation............... 18,073,000 21,311,000
Less current portion of borrowing under
senior credit facility............... (10,000,000) --
Less current portion of capital lease.. (7,881,000) (5,852,000)
------------ ------------
$160,192,000 $165,459,000
============ ============
F-19
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, 2001, the Company was 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 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. In June 2001, the
Company borrowed $10.0 million under the senior credit facility. This amount is
classified in current liabilities in the accompanying consolidated balance
sheet. As of December 31, 2001 the Company's effective borrowing rate was
4.12%. Prior to June 2001, there were no amounts outstanding under this
facility. The credit facility requires the Company to meet certain financial
covenants including, maximum levels of debt as a ratio of earnings before
interest, taxes, depreciation and amortization (as defined), minimum interest
coverage and a maximum amount of capital expenditures. The credit facility also
contains 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.
F-20
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 2001 and 2000, the Company had a lease facility used exclusively for
networking products and services manufactured by Cisco Systems, Inc. Equipment
financed under this facility is leased for a term of 36 months at which time
the Company may purchase the equipment at fair market value. Purchases of
networking products under this facility of $23.3 million have been accounted
for as a capital lease. Upon acceptance of the networking products the Company
makes recurring monthly lease payments and begins depreciating the equipment
over a period of three years. Lease payments and depreciation commenced during
the second quarter of 2001. During the year ended December 31, 2001 the Company
made principal lease payments and recorded depreciation expense of $5.2
million. As of December 31, 2001, future obligations related to capital leases
are as follows:
Capital Leases
--------------
2002.................................. $ 8,055,000
2003.................................. 8,055,000
2004.................................. 2,362,000
-----------
18,472,000
Less: portion representing interest... 399,000
-----------
Capital lease obligations, current and
long-term........................... $18,073,000
===========
7. COMMITMENTS AND CONTINGENCIES:
Operating Leases
The Company leases and operates eight 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 and Denver, CO. The leases are pursuant to non-cancelable
operating leases that expire in June 2002, September 2007, November 2003,
September 2006, October 2009, December 2009, April 2010 and March 2010,
respectively. The lease expiring in June 2002 contains five two-year renewal
options and the other seven 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 non-cancelable leases. Management of the
Company expects that these leases will be renewed or replaced, as necessary, by
other leases in the normal course of business.
F-21
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company's restructuring program, which was announced in the third
quarter of 2001 (see Note 3), included closing our switch facility in Utah and
the consolidation of six sales offices. In order to estimate rent expense to
these abandoned premises, the Company made certain assumptions including; (1)
the time period over which the premises would remain vacant, (2) sublease
terms, and (3) estimated sublease rents. In the case of the Utah switching
facility, no sublease income has been estimated due to the specialized nature
of this facility. As of December 31, 2001 future minimum lease payments for
these properties is approximately $3.9 million. As of December 31, 2001 the
Company has an estimated remaining liability of $2.1 million, net of estimated
sublease payments, to provide for future lease payments related to these
facilities. The Company is actively searching for tenants to sublease these
properties. Including abandoned premises, the Company's future minimum lease
payments with initial terms in excess of one year as of December 31, 2001, are
as follows:
Operating Leases
------------------------
Telephone
Circuits and
Space Equipment
----------- ------------
2002................................... $ 4,252,000 $10,618,000
2003................................... 4,041,000 8,296,000
2004................................... 3,715,000 5,410,000
2005................................... 3,342,000 2,507,000
2006................................... 2,643,000 784,000
2007 and thereafter.................... 11,480,000 --
----------- -----------
$29,473,000 $27,615,000
=========== ===========
Rental expense charged to operations for the years ended December 31, 2001,
2000 and 1999, for operating leases for space, excluding amounts charged
against the restructuring liability, was $4,389,000, $3,244,000 and $1,260,000,
respectively. Rent expense 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
$40,576,000, $24,530,000 and $12,729,000 for the years ended December 31, 2001,
2000 and 1999, respectively, is included in operating costs in the accompanying
consolidated statements of operations. Rental expense paid to related parties
was approximately $171,000, $158,000 and $157,000 and for the years ended
December 31, 2001, 2000 and 1999, respectively.
Purchase Commitments
In 1999, the Company began implementing new billing and operations support
systems. Total estimated costs for these systems aggregated approximately $15
million, of which approximately $9 million was incurred in 1999, $4 million was
incurred in 2000 and $2 million was incurred in 2001. As of December 31, 2001
these systems were substantially complete. The majority of the $15 million
incurred as of December 31, 2001 is included in business software and computer
equipment in the accompanying consolidated balance sheets.
In 1999, the Company also began implementing a new enterprise and financial
software system. Total estimated costs for this system are $5 million, of which
approximately $4.7 million has been incurred through December 31, 2001. The
majority of the $4.7 million incurred as of December 31, 2001 is recorded in
business software and computer equipment in the accompanying consolidated
balance sheets.
On June 30, 2000, the Company entered into an Indefeasible Right of Use
(IRU) agreement with Qwest Communications relating to 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
F-22
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. Effective June 2001, the Company
amended the IRU Agreement with Qwest Communications and extended the payment
due date for the balance from June 30, 2001 to May 15, 2002. The purchase price
of approximately $23.0 million is included in projects in progress and the
balance of $17.2 million is classified as Fiber IRU liability in current
liabilities in the accompanying consolidated balance sheets as of December 31,
2001 and 2000. The Company is currently negotiating a further amendment to the
payment term. The circuits are expected to be placed in use by the middle of
fiscal year 2002.
Employment Agreements
The Company entered into employment agreements in 2001 with two key
executives that provide for, among other things, minimum annual base salaries,
bonus entitlements upon the achievement of certain objectives, and the issuance
of stock options. Also in 2001, the Company entered into an agreement with a
previous executive officer to work on a part time basis as a result of his
partial retirement. All other agreements entered into with executive officers,
except those discussed below, expired or terminated in 2000 and 2001.
On November 27, 2000, the Company's Board of Directors approved an Agreement
Regarding Compensation on Change of Control with eight officers. Six of these
agreements remain in effect as of December 31, 2001. 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. In 2001, this agreement was
entered into with two additional officers. 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 vested 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 calls
terminated to an ISP are not local calls, and as such are not covered by the
interconnection agreements.
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. The Declaratory Ruling was appealed and, on appeal,
was remanded to the FCC.
F-23
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In June 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 calls to ISPs under the new interconnection
agreement with Pacific Bell which became effective in June 1999. This
interconnection agreement was in effect throughout 2001, and remains in effect
pursuant to its terms until it is superceded by a negotiated or arbitrated
replacement or interconnection agreement. The Company expects such a
replacement agreement to become effective in the latter half of 2002.
In September 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.
In September 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, and the Company has appealed this decision to the Ninth
Circuit. The appeal has been stayed until April 2002 to allow the parties time
to conduct settlement negotiations. The parties may agree to extend the stay.
In August 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 Verizon (formerly GTE). The action challenges the legality of the
California Public Utilities Commission's decision regarding requiring
reciprocal compensation for traffic termination to ISPs. Verizon 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. On September
27, 2001, the district court granted summary judgment against Verizon and in
favor of the California Public Utilities Commission and the competitive local
exchange carriers. Verizon has appealed to the Ninth Circuit and has agreed to
consolidate this case with Pacific Bell's appeals (described below) regarding
the same California Public Utilities Commission order and the California Public
Utilities Commission order affirming the final arbitration decision regarding
the Company's and Pacific Bell's dispute over reciprocal compensation
obligations and with appeals concerning reciprocal compensation arising from
district court decisions in Oregon and Washington state in cases in which the
Company is not a party. In October 1999, Verizon paid, and the Company recorded
as revenue, $6,308,000 of reciprocal compensation that GTE had previously
withheld. Verizon 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.
On April 27, 2001, the FCC released its Order on Remand regarding
intercarrier compensation for ISP-bound traffic. The FCC asserted exclusive
jurisdiction over ISP-bound traffic and established a new interim intercarrier
compensation regime for ISP-bound traffic with capped rates above a fixed
traffic exchange ratio. Traffic in excess of a ratio of 3:1 (terminating
minutes to originating minutes) is presumed to be ISP-bound traffic, and is to
be compensated at rates that decrease from $.0015 to $.0007, or the applicable
state-approved rate if lower, over three years. Traffic below the 3:1 threshold
is to be compensated at the rates in existing and future interconnection
agreements. Traffic above the 3:1 ratio is subject to a growth ceiling with
traffic in excess of the growth ceiling subject to "bill and keep," an
arrangement in which the originating carrier pays no
F-24
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
compensation to the terminating carrier to complete calls. In addition, when a
competitive carrier begins to provide service in a state it has not previously
served, all traffic in excess of the 3:1 ratio is subject to bill-and-keep
arrangements. In exchange for this reduction in reciprocal compensation
obligations to CLECs, the ILECs must offer to exchange all traffic subject to
Section 251(b)(5) of the Telecommunications Act of 1996, as well as ISP-bound
traffic, at the federal capped rates. It is not possible to estimate the full
impact of the FCC Order at this time because the federal regime does not alter
existing contracts except to the extent that they incorporate changes of
federal law, and because adoption of the federal regime is within the
discretion of the ILEC exchanging traffic with CLECs on a state-by-state basis.
In the event an ILEC determines not to adopt the federal regime, the ILEC must
pay the same rate for ISP bound traffic as for calls subject to reciprocal
compensation. In addition, this decision is on appeal.
Towards the later half of 2001, Verizon took the position that it had
properly implemented the FCC's Order on Remand, and that this unilateral action
modified the current interconnection agreement between the Company and Verizon.
Accordingly, Verizon withheld payment of portions of invoices submitted by the
Company for calls after June 13, 2001. The Company disputed this assertion. On
August 3, 2001, Pac-West filed a motion with the CPUC pursuant to the dispute
resolution provisions of its interconnection agreement with Verizon requesting
a ruling that Verizon's actions violated the agreement. On September 27, 2001
the administrative law judge issued a ruling in favor of Pac-West, ordering
Verizon to cease such withholding and make all payments called for under the
agreement. Verizon appealed this ruling to the full California Public Utilities
Commission. On January 23, 2002, the full Commission upheld the Ruling of the
Administrative Law Judge in its entirety, and ordered Verizon to pay all
disputed amounts, plus interest, within three business days. On January 28,
2002, Verizon made payment of withheld amounts to the Company. Pacific Bell has
not implemented the FCC Order on Remand in California, but has informed the
Company that it may do so.
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 and payments withheld by
ILECs during each of the three years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
------------ ----------- ------------
Total amount billed to ILECs during the year.......... $ 75,339,000 $62,194,000 $ 58,866,000
Amount withheld by ILECs and not recorded as revenue
in the Company's statements of operations........... (12,946,000) -- (29,855,000)
Amounts received for prior withholding and recorded as
revenue............................................. -- -- 26,308,000
------------ ----------- ------------
Net amount recorded as revenue from the ILECs during
the year............................................ $ 62,393,000 $62,194,000 $ 55,319,000
============ =========== ============
Other Legal Proceedings
On December 6, 2001, a complaint captioned Krim v Pac-West Telecomm, Inc.,
et. al., Civil Action No. 01-CV-11217, was filed in United States District
Court for the Southern District of New York against our Company, and certain
executive officers, and various underwriters in connection with our initial
public offering.
F-25
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The plaintiffs allege undisclosed improper underwriting practices concerning
the allocation of shares of our common stock in exchange for excessive
brokerage commissions or agreements to purchase shares at higher prices in the
aftermarket, in violation of Section 11 of the Securities Act of 1933. The
complaint also includes a claim for securities fraud under Section 10(b) of the
Securities Exchange Act of 1934 against underwriters only. Substantially
similar actions have been filed concerning the initial public offerings for
more than 300 different issuers, and the cases have been coordinated as In re
Initial Public Offering Securities Litigation, 21 MC 92. The complaint against
us seeks unspecified damages on behalf of a purported class of purchasers of
our common stock. We believe that the plaintiff's claims are without merit and
will defend this lawsuit vigorously.
From time to time, Pac-West Telecomm, Inc. is a party to litigation that
arises in the ordinary course of business. The Company believes that the
resolution of this litigation will not materially harm its business, financial
condition or results of operations.
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. 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
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, 2001.
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 (one of whom is no longer an officer) 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.
F-26
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Subject to the terms and conditions of an Offer to Exchange (Offer) dated
November 14, 2001, the Company will grant options to purchase an aggregate of
831,638 shares of its common stock at the fair market value at the date of
issuance in exchange for such tendered options. The tendered options
represented out of the money options at the date the tender offer commenced.
Effective December 19, 2001, in accordance with the offer, the Company canceled
831,638 options and plans to reissue these options to eligible employees no
earlier than 185 days from the cancellation date.
A summary of the status of the Company's stock option plans at December 31,
2001 and changes during the years ended December 31, 1999, 2000 and 2001 are
presented in the table below:
Weighted Average
Qualifying Non-qualifying Total Exercise Price
---------- -------------- ---------- ----------------
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
Granted................ 964,484 952,913 1,917,397 1.61
Exercised.............. (45,125) -- (45,125) 2.14
Cancelled.............. (1,770,143) (148,609) (1,918,752) 11.73
---------- --------- ----------
Balance, December 31, 2001 1,808,318 2,071,027 3,879,345 $ 3.06
========== ========= ==========
Options outstanding, exercisable and vested by price range at December 31,
2001, are as follows:
Weighted Average
Weighted Average Weighted Number Exercise Price of
Number Remaining Contractual Average Exercise Vested and Options
Range of Exercise Price Outstanding Life Price Exercisable Exercisable
- ----------------------- ----------- --------------------- ---------------- ----------- -----------------
$ 0.48--0.56 604,000 6.9 $0.48 568,750 $0.48
0.71--35.00 3,275,345 8.8 3.53 773,357 6.19
--------- ---------
$ 0.48--35.00 3,879,345 8.5 $3.06 1,342,107 $3.77
========= =========
As of December 31, 2000, the number of options outstanding that were vested
and exercisable was 1,096,785. These options had a weighted average exercise
price of $3.45. As of December 31, 1999, the number of options outstanding that
were vested and exercisable was 646,917. These options had a weighted average
exercise price of $3.93.
F-27
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has adopted the disclosure-only provisions of SFAS No. 123 (SFAS
123), "Accounting for Stock-Based Compensation", 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 for the years ended December 31, 2001, 2000 and 1999 would
have been as follows:
2001 2000 1999
------------ ---------- -----------
Net income (loss) available to common stockholders:
As reported..................................... $(34,792,000) $3,617,000 $11,821,000
Pro forma....................................... $(34,546,000) $ 915,000 $10,831,000
Basic earnings (loss) per common share
As reported..................................... $ (0.96) $ 0.10 $ 0.59
Pro forma....................................... $ (0.96) $ 0.03 $ 0.54
Diluted earrings (loss) per common share:
As reported..................................... $ (0.96) $ 0.10 $ 0.56
Pro forma....................................... $ (0.96) $ 0.02 $ 0.51
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 100%, 100% and 74% for 2001, 2000 and 1999, respectively;
weighted average risk-free interest rates ranging from 3.48 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. On June 30, 2001
and December 31, 2001 the Company issued another 66,378 shares and 43,646
shares, respectively, to employees for amounts withheld during 2001 under this
plan.
F-28
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. INCOME TAXES:
The provision for (benefit from) income taxes for the years ended December
31, 2001, 2000 and 1999 consists of the following:
2001 2000 1999
------------ ---------- -----------
Current:
Federal............................. $ -- $ 4,000 $ 6,795,000
State............................... -- -- --
Deferred:
Federal............................. (12,507,000) 4,457,000 5,595,000
State............................... (2,086,000) 330,000 721,000
------------ ---------- -----------
$(14,593,000) $4,791,000 $13,111,000
============ ========== ===========
The Company's provision for income tax differed from the amount computed by
applying the statutory federal income tax rate to income before income taxes
and cumulative effect of change in accounting principle, as follows:
2001 Rate 2000 Rate 1999 Rate
------------ ----- ---------- ---- ----------- ----
Income tax determined by applying the statutory
federal income tax rate to income before income
taxes and cumulative effect of change in
accounting principle........................... $(17,285,000) (35.0)% $3,438,000 35.0% $10,156,000 35.0%
State income taxes, net of federal income tax
benefit........................................ (1,356,000) (2.8) 215,000 2.2 470,000 1.6
Non-deductible amortization of costs in excess of
net assets of acquired businesses.............. 432,000 1.0 680,000 6.9 -- --
Nondeductible goodwill impairment................ 4,084,000 8.3 -- -- -- --
Reciprocal compensation settlement............... -- -- -- -- 1,500,000 5.2
Changes in reserves.............................. (549,000) (1.2) 313,000 3.2 936,000 3.2
Other............................................ 81,000 0.2 145,000 0.6 49,000 0.2
------------ ----- ---------- ---- ----------- ----
Provision for (benefit from) income taxes........ $(14,593,000) (29.5)% $4,791,000 48.8% $13,111,000 45.2%
============ ===== ========== ==== =========== ====
F-29
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The cumulative balance sheet effects of deferred tax items are:
2001 2000
------------ ------------
Trade accounts receivable allowances................. $ 892,000 $ 1,054,000
Deferred revenue..................................... 442,000 768,000
Vacation and other accrued expenses.................. 665,000 289,000
Restructuring and other reserves..................... 1,199,000 --
Inventory reserves................................... 218,000 145,000
Tax credits and loss carryforwards................... 14,329,000 232,000
State taxes.......................................... 2,744,000 2,197,000
------------ ------------
Deferred tax asset................................ 20,489,000 4,685,000
------------ ------------
Depreciation and amortization........................ (10,101,000) (9,742,000)
Capitalized interest................................. (1,626,000) (1,324,000)
Software development costs........................... (5,977,000) (4,445,000)
Prepaid expenses..................................... (95,000) --
IRU rentals.......................................... (617,000) --
Other reserves....................................... (865,000) (1,414,000)
------------ ------------
Deferred tax liability............................ (19,281,000) (16,925,000)
------------ ------------
Net deferred tax asset (liability)................... 1,208,000 (12,240,000)
Less: Amount classified as current deferred tax asset 4,491,000 2,475,000
------------ ------------
Net noncurrent deferred tax liability............. $ (3,283,000) $(14,715,000)
============ ============
The Company intends to realize its net deferred tax asset of approximately
$1.2 million through the filing of a carryback claim against taxes paid in 1999.
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 $2,750,000, $2,540,000 and
$2,667,000, or 2%, 2% and 3%, of the Company's revenues for the years ended
December 31, 2001, 2000 and 1999, respectively. The Company also had amounts
due from Bay Alarm at December 31, 2001 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 approximately $78,000,
$69,000 and $60,000 for these services for the years ended December 31, 2001,
2000 and 1999, respectively. As outlined in Note 7, the Company leases a
facility in Oakland from Bay Alarm. Rents paid under this lease were
approximately $171,000, $158,000 and $157,000 for the years ended 2001, 2000
and 1999, respectively. All expenses paid to Bay Alarm are included in selling,
general and administrative expenses in the accompanying consolidated statements
of operations.
Notes Receivable from Stockholders
In connection with the Transaction described in Note 1, 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
F-30
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$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 sheets 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 full-recourse notes receivable with another officer of the Company for
$105,000, which is included in other assets in the accompanying consolidated
balance sheets. 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 six 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's matching contributions were $442,000, $247,000
and $134,000 for the years ended December 31, 2001, 2000 and 1999,
respectively. These amounts are included in selling, general and administrative
expenses in the accompanying consolidated statements of operations.
F-31
PAC-WEST TELECOMM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA
The following is a summary of quarterly consolidated financial results for
each of the two fiscal years ending 2001. In fiscal year 2000, the amounts were
restated in the fourth quarter of 2000 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
----------- ----------- ------------ -----------
2001:
Revenue...................................... $40,061,000 $38,162,000 $ 35,521,000 $36,248,000
Gross margin................................. $27,445,000 $23,944,000 $ 19,050,000 $22,208,000
Net loss..................................... $ (485,000) $(3,624,000) $(26,784,000) $(3,899,000)
Net loss per share:
Basic and Diluted........................ $ (0.01) $ (0.10) $ (0.74) $ (0.11)
2000:
Revenue...................................... $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
principle (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
F-32
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 of America the consolidated financial statements of Pac-West
Telecomm, Inc. included in this Form 10-K, and have issued our report thereon
dated February 5, 2002. 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 5, 2002
F-33
PAC-WEST TELECOMM, INC. :
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 2001
Balance at Charged to Charged
Beginning of Costs and to Other Balance at
Description Year Expenses Accounts Deductions End of Year
----------- ------------ ---------- -------- ---------- -----------
Allowance for doubtful accounts............. $3,003,000 $3,214,000 $ -- $3,587,000(1) $2,630,000
FOR THE YEAR ENDED DECEMBER 31, 2000
Charged
Balance at to Costs Charged to
Beginning and Other Balance at
Description of Year Expenses Accounts Deductions End of Year
----------- ---------- -------- ---------- ---------- -----------
Allowance for doubtful accounts............. $675,000 $989,000 $1,981,000 $642,000(1) $3,003,000
FOR THE YEAR ENDED DECEMBER 31, 1999
Charged
Balance at to Costs Charged Balance at
Beginning and to Other End of
Description of Year Expenses Accounts Deductions Year
----------- ---------- -------- -------- ---------- ----------
Allowance for doubtful accounts............. $400,000 $495,000 $ -- $220,000(1) $675,000
- --------
(1) Deductions represent write-offs.
F-34
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 Telecomm, 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. La Rue,
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)).
Exhibit
Number Description
- ------ -----------
+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)).
2
Exhibit
Number Description
------ -----------
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 Communications, 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 endng 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 U S 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).
3
Exhibit
Number Description
------ -----------
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 U S 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 U S 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(a) 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).
10.43(b) Amendment No. 1 to IRU Agreement dated May 15, 2001, between Pac-West Telecomm, Inc.
and Qwest Communications Corporation (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).
4
Exhibit
Number Description
- ------ -----------
+10.46 2000 Napa Valley Non-Qualified 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 (Incorporated by
reference to exhibit 10.48 to the Company's Annual Report on Form 10-K for the period ended
December 31, 2000).
+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. (Incorporated by reference to
exhibit 10.49 to the Company's Annual Report on Form 10-K for the period ended December 31,
2000).
+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. (Incorporated by reference to exhibit
10.50 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000).
+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. (Incorporated by reference to
exhibit 10.51 to the Company's Annual Report on Form 10-K for the period ended December 31,
2000).
+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. (Incorporated by reference to exhibit
10.52 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000).
+10.53 Interconnection Agreement Between Roseville Telephone Company and Pac-West Telecomm, Inc.
for the State of California dated September 18, 2000 (Incorporated by reference to exhibit 10.53
to the Company's Annual Report on Form 10-K for the period ended December 31, 2000).
+10.54 Mutual Settlement Agreement, dated November 16, 2000, by and between Mr. Brian K. Johnson
and Pac-West Telecomm, Inc. (Incorporated by reference to exhibit 10.54 to the Company's
Annual Report on Form 10-K for the period ended December 31, 2000).
10.55 Agreement for Local Wireline Network Interconnection and Service Resale Between AT&T Corp.
and U S West Communications, Inc. for the State of Idaho dated July 27, 1998 (Incorporated by
reference to Exhibit 10.55 to the Company's Quarterly Report on Form 10-Q for the period ended
June 30, 2001).
10.56 Letter Agreement between Qwest Corporation (f/k/a U S West Communications, Inc.) and Pac-
West Telecomm, Inc. for the State of Idaho, dated October 2, 2000 (Incorporated by reference to
Exhibit 10.56 to the Company's Quarterly Report on Form 10-Q for the period ended June 30,
2001).
10.57 Agreement for Local Wireline Network Interconnection and Service Resale Between AT&T
Communications of the Mountain States, Inc. and U S West Communications, Inc for the State of
Utah, dated June 28, 1998 (Incorporated by reference to Exhibit 10.57 to the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2001).
10.58 Letter Agreement between Qwest Corporation (f/k/a U S West Communications, Inc.) and Pac-
West Telecomm, Inc. for the State of Utah, dated October 2, 2000 (Incorporated by reference to
Exhibit 10.58 to the Company's Quarterly Report on Form 10-Q for the period ended June 30,
2001).
5
Exhibit
Number Description
- ------ -----------
*+10.59 Severance Agreement, dated September 27, 2001, by and between Mr. Richard Bryson and
Pac-West Telecomm, Inc.
*+10.60 Employment Agreement, dated June 11, 2001, by and between Mr. Henry R. Carabelli and
Pac-West Telecomm, Inc.
*+10.61 Agreement Regarding Change in Employment Status, dated August 1, 2001, by and between John
K. La Rue and Pac-West Telecomm, Inc.
*+10.62 Employment Agreement, dated December 1, 2001, by and between Mr. Wallace W. Griffin and
Pac-West Telecomm, Inc.
*+10.63 Agreement Regarding Compensation in change of Control, dated December 1, 2000 by and between
Mr. H. Ravi Brar and Pac-West Telecomm, Inc.
*+10.64 Agreement Regarding Compensation in change of Control, dated December 1, 2000 by and between
Mr. John F. Sumpter and Pac-West Telecomm, Inc.
*+10.65 Agreement Regarding Compensation in change of Control, dated December 1, 2000 by and between
Mr. Gregory Joksch and Pac-West Telecomm, Inc.
*21.1 Subsidiaries of the Company.
*23.1 Consent of Arthur Andersen LLP.
* 99.1 Letter by the Company addressed to the SEC regarding certain representations made to the
Company by Arthur Andersen LLP.
- --------
* Newly filed with this report
+ Management contract or compensatory plan or arrangement
6