PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2004
The terms "the Company," "Pac-West," "we," "our," "us," and similar terms
used in this Form 10-Q, refer to Pac-West Telecomm, Inc.
- Organization and Basis of Presentation:
The Company is a high-value independent broadband provider of
integrated business solutions within its target markets. The Company's customers
include Internet service providers and enhanced communications service
providers, collectively referred to as service providers (SPs), and the business
enterprise market, many of which are communications-intensive users.
These accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted for interim financial information in the United States of America
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). Accordingly, they do not include all of the information and notes
required by accounting principles generally accepted in the United States of
America (US GAAP) for complete financial statements. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
considered necessary for a fair presentation for the periods indicated, have
been included. Operating results for the three month period ended March 31, 2004
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2004. The condensed consolidated balance sheet at December
31, 2003 has been derived from the audited consolidated balance sheet at that
date, but does not include all of the information and notes required by US GAAP
for complete financial statements. These unaudited condensed consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and the notes thereto of the Company as of and for the year
ended December 31, 2003, included in the Company's Annual Report on Form 10-K
filed with the SEC on March 30, 2004.
These unaudited condensed consolidated financial statements
include the results of operations of the Company and its subsidiaries. All
intercompany accounts and transactions have been eliminated. Certain prior
period amounts have been reclassified to conform to current period
presentations.
- Stock Based Compensation:
The Company follows Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issues to Employees" for its stock based
compensation plans. 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. If
compensation expense for our stock-based compensation plans had been determined
in accordance with the fair value as prescribed in SFAS 123, the Company's net
loss per share for the quarters ended March 31, 2004 and 2003, respectively
would have been as follows (in thousands except per share amounts):
2004 2003
--------- ---------
Net loss as reported........................... $ (7,165)$ (10,324)
Total stock-based employee compensation included in
reported net loss, net of tax.................. 46 --
Total stock-based employee compensation determined
under the fair value based method.............. (711) (663)
--------- ---------
Pro forma...................................... $ (7,830)$ (10,987)
Basic net loss per common share
As reported.................................... $ (0.20)$ (0.28)
Pro forma...................................... $ (0.21)$ (0.30)
Diluted net loss per common share
As reported.................................... $ (0.20)$ (0.28)
Pro forma...................................... $ (0.21)$ (0.30)
The Company uses the Black-Scholes option-pricing model to
derive the theoretical fair value of employee stock option grants. The Black-
Scholes model pro forma fair value information should be interpreted solely as
an approximation, as opposed to a representation, of what pro forma net loss
would have been if the Company had expensed the fair value of options issued to
employees. The fair value of each option was estimated on the date of grant
using the Black-Scholes option pricing model with the following assumptions in
the quarters ended March 31, 2004 and 2003, respectively:
2004 2003
--------- ---------
Risk-free interest rate........ 2.59 % 2.55 %
Expected volatility............ 115 % 100 %
Expected dividend yield........ -- --
Expected life.................. 4 years 4 years
Fair value of options granted.. $ 1.73 $ 0.38
- Concentration of Customers and Suppliers:
During the quarter ended March 31, 2004 revenues from
three customers accounted for 17.9%, 7.3% and 20.5% of revenues, respectively.
During the quarter ended March 31, 2003 these same three customers accounted for
18.2%, 10.8% and 15.8% of revenues, respectively. During each of the quarters
ended March 31, 2004 and 2003 no other customer accounted for more than 10.0% of
total revenues. As of March 31, 2004 accounts receivable from two customers
represented 17.3% and 14.1% of trade accounts receivable. At December 31, 2003
accounts receivable from no customer represented more than 10% of trade accounts
receivable. In the quarters ended March 31, 2004 and 2003, the Company's largest
source of operating costs was from one incumbent local exchange carrier, which
represented 39.7% and 44.2% of the Company's network expenses, respectively.
- Restructuring Charges:
A summary of the restructuring expenses and the
associated remaining liability pertaining to the Company's 2001 and 2002
restructurings, which is included in other accrued liabilities in the
accompanying condensed consolidated balance sheet as of March 31, 2004, consist
of the following (in thousands):
Remaining Balance of
Restructuring Additional Restructuring
Liability Restructuring Liability
as of Expense Non-Cash Cash as of
Dec. 31, 2003 Incurred Charges Payments Mar. 31, 2004
------------ ------------ ----------- ----------- -------------
Rent expense for vacated premises....... $ 2,989 $ -- $ -- $ (172) $ 2,817
Circuit obligations..................... 1,547 -- -- (310) 1,237
Other charges........................... 6 -- -- -- 6
------------ ------------ ----------- ----------- -------------
$ 4,542 $ -- $ -- $ (482) $ 4,060
============ ============ =========== =========== =============
The amount of the reserve for vacated premises is equal to
the monthly lease payment of the unoccupied space multiplied by the remaining
months on the lease. The final cash payment to be recorded against the
restructuring reserve is currently expected to occur in March 2010.
- Income Taxes:
The Company's effective income tax rate for the quarters
ended March 31, 2004 and 2003 was 0.0% and 15.7%, respectively.
- Comprehensive Loss:
For the quarters ended March 31, 2004 and 2003, there was
$0 and $92,000, respectively, of other comprehensive loss pertaining to net
unrealized investment losses on available-for-sale marketable securities.
- Property and Equipment:
During the quarter ended March 31, 2003, the Company changed
its accounting estimates related to depreciation. The Company reduced the
useful life for phone equipment provided to customers and computer hardware from
5 years to 3 years and extended the useful life of some leasehold improvements
from 10 years to up to 20 years. As a result of the change, the Company incurred
additional depreciation in the first quarter, which increased pretax loss for
the quarter ended March 31, 2003 by $1.6 million or $0.04 per diluted share.
The Company reclassified $0.3 million related to a technology
lease from depreciation expense to selling, general and administrative expenses
for the quarter ended March 31, 2003. In management's opinion, the present
classification more accurately presents the nature of the related expense in the
Company's income statement based on the underlying transaction.
- Commitments and Contingencies:
During the quarter ended March 31, 2004 the Company
continued to make the required modifications to its network as required under
the terms of an interconnection agreement with SBC California (SBC), which was
modified by the California Public Utilities Commission on May 8, 2003.
There have been no material developments in the litigation
previously reported in the Company's Annual Report on Form 10-K for the period
ended December 31, 2003 as filed with the SEC on March 30, 2004. From time to
time, the Company is a party to litigation that arises in the ordinary course of
business. The Company believes that the resolution of this litigation, and any
other litigation the Company may be involved with in the ordinary course of
business, will not materially harm its business, financial condition or results
of operations.
- Related Party Transactions:
Bay Alarm (a significant stockholder of the Company) and
its subsidiary, InReach Internet, LLC, are collectively a customer of the
Company, comprising approximately 1.3%, or $394,000 and $398,000 of the
Company's total revenues for the quarters ended March 31, 2004 and 2003,
respectively. As of both March 31, 2004 and December 31, 2003 the Company had
amounts receivable from Bay Alarm of $8,000. These amounts are included in trade
accounts receivable, net, in the accompanying condensed consolidated balance
sheets.
Bay Alarm provides the Company with security monitoring
services at its normal commercial rates. The Company has recorded approximately
$10,000 and $20,000 of expenses for these services for the quarters ended March
31, 2004 and 2003, respectively. The Company also leases a facility in Oakland
from Bay Alarm. Rents paid under this lease were approximately $97,000 and
$81,000 for the quarters ended March 31 2004 and 2003, respectively. All
expenses paid to Bay Alarm are included in selling, general and administrative
expenses in the accompanying condensed consolidated statements of operations.
- Debt and interest expense, net:
At March 31, 2004 and December 31, 2003 long-term debt
and capital lease obligations consist of the following (in thousands):
2004 2003
--------- ---------
Senior Notes.........................$ 36,102 $ 36,102
Senior Secured Note................... 19,791 18,369
Capital lease obligation.............. 1,266 2,780
Notes Payable......................... 33 52
Less current portion of capital lease. (1,173) (2,589)
--------- ---------
$ 56,019 $ 54,714
========= =========
The Senior Notes of which there is $36.1 million in principal
amount outstanding at March 31, 2004, mature on February 1, 2009 and bear
interest at 13.5% per annum payable in semiannual installments, with all
principal due in full on February 1, 2009.
The Senior Secured Note, which was initially issued in the
principal amount of $40.0 million accrues interest at a rate of LIBOR plus 0.5%
(1.6% at March 31, 2004), and matures in December 2006. Accrued interest on the
Senior Secured Note is payable quarterly in cash, or at the Company's option,
may be capitalized and added to outstanding principal. The maturity date of the
Senior Secured Note will be automatically extended to coincide with any
extension of the expiration date of the warrants, which is extendable for up to
an additional 18 months at the option of Deutsche Bank. Under the terms of
the guaranty and security agreement related to the Senior Secured Note, the
Company granted Deutsche Bank a security interest in substantially all of its
assets and agreed to certain covenants including limitations on its ability to
incur additional indebtedness, incur liens, sell assets and pay dividends. In
accordance with the terms of the Senior Secured Note, during the quarter ended
March 31, 2004 the Company elected to capitalize and add to principal interest
of approximately $0.2 million.
Interest expense, net for the quarters ended March 31, 2004
and 2003 was as follows (in thousands):
2004 2003
--------- ---------
Interest on Senior Notes......................$ 1,232 $ 3,210
Accreted discount on Senior Secured Note....... 1,255 --
Amortization of deferred financing costs....... 168 105
Other interest expense......................... 167 43
Less Interest income........................... (41) (368)
--------- ---------
$ 2,781 $ 2,990
========= =========
- Acquisition of Sentient Group, Inc.:
During the first quarter of 2004 the Company completed
its acquisition of the assets and certain of the liabilities of Sentient Group,
Inc., a small provider of fully hosted, managed voice and data services for
business communications. The acquisition has been accounted for as a purchase
and, accordingly, the total estimated purchase price has been allocated to the
tangible and intangible assets acquired based on their respective fair values on
the acquisition date. The excess of the estimated cash purchase price of
$576,000 over the fair value of tangible and intangible net assets acquired was
recorded as Goodwill and is included in Other assets, net in the condensed
consolidated balance sheet.
- Subsequent Events:
In May 2004 the Company completed financing agreements for various network equipment with Cisco Systems, Inc.
These financing agreements total $3.1 million for equipment and maintenance up to a 36-month period.
Additionally the Company announced in April 2004 the selection of its new soft switch provider, Tekelec.
The estimated installation date of the new switch is no later than the first quarter of 2005.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein,
this report contains forward-looking statements, subject to uncertainties and
risks. In this Quarterly Report on Form 10-Q, our use of the words "outlook,"
"expect," "anticipate," "estimate," "forecast," "project," "likely,"
"objective," "plan," "designed," "goal," "target," and similar expressions is
intended to identify forward-looking statements. While these statements
represent our current judgment on what the future may hold, and we believe these
judgments are reasonable, actual results may differ materially due to numerous
important risk factors that are described in our Annual Report on Form 10-K for
the period ended December 31, 2003, as filed with the SEC on March 30, 2004,
which may be revised or supplemented in subsequent reports filed by us with the
SEC. Such risk factors include, but are not limited to: our substantial
indebtedness; an inability to generate sufficient cash to service our
indebtedness; regulatory and legal uncertainty with respect to intercarrier
compensation payments received by us; the declining rate at which intercarrier
compensation payments are determined; the inability to expand our business as a
result of the unavailability of funds to do so; adverse affects on our
operations as a result of covenants in agreements related to our borrowings; the
loss of key executive officers could negatively impact our business prospects;
and our principal competitors for local services and potential additional
competitors have advantages that may adversely affect our ability to compete
with them.
Introduction
We are a high-value, independent broadband provider of
integrated communications services within our target markets. Our customers
include Internet service providers and enhanced communications service
providers, collectively referred to as service providers, or SPs, and the
business enterprise market (enterprise), many of which are communications-
intensive users.
We built our facilities-based network to capitalize on the
significant growth in Internet usage and in the related demand for local
telephone service by SPs, as well as the increasing demand of enterprises for
customized and integrated voice and data communications services. We believe the
statewide footprint of our network, which encompasses all of the major
metropolitan areas of California, provides us with a competitive advantage over
incumbent local exchange carriers (ILECs), and other competitive local exchange
carriers (CLECs), particularly for SPs. Our ubiquitous network in California
enables SPs to provide their business and residential customers with access to
Internet, paging and other data and voice services from almost any point in the
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 and
strong gross profit margins.
For the quarters ended March 31, 2004 and 2003, we had net
revenues of approximately $29.4 million and $30.5 million, respectively.
Operating expenses for the quarters ended March 31, 2004 and 2003 were $33.8
million and $39.8 million, respectively. Net loss for the quarters ended March
31, 2004 and 2003 was $(7.2) million and $(10.3) million, respectively.
Earnings before interest, net, income taxes, depreciation and
amortization (EBITDA) for the quarters ended March 31, 2004 and 2003 was $4.7
million and $4.6 million, respectively. Although EBITDA is not a measure of
financial performance under generally accepted accounting principles, we believe
EBITDA is a common measure used by analysts and investors to evaluate our
capacity to meet our obligations. We also use EBITDA as an internal measurement
tool and accordingly, we believe that the presentation of EBITDA provides useful
and relevant information. The tables below reconcile EBITDA to net cash provided
by (used in) operating activities for the quarters ended March 31, 2004 and 2003
(in thousands):
2004 2003
------------ ------------
(unaudited) (unaudited)
EBITDA $ 4,704 $ 4,604
Change in operating assets and liabilities.............. (1,970) (3,827)
Interest expense, net................................... (2,781) (2,990)
Allowance for doubtful accounts receivable.............. 48 11
Amortization of deferred stock compensation............. 46 --
------------ ------------
Net cash provided by (used in) operating activities... $ 47 $ (2,202)
============ ============
In December 2003, we successfully completed an important
financing transaction which permitted us to reduce our debt level and cash
interest expense. In particular, on December 19, 2003, we sold to Deutsche Bank
AG - New York, acting through DB Advisors, LLC, as investment advisor, (Deutsche
Bank), a Senior Secured Note in the principal amount of $40.0 million, which we
refer to as the Senior Secured Note, and warrants to purchase up to 26,666,667
shares of our common stock at an exercise price of $1.50 per share. Under the
terms of the guaranty and security agreement related to the Senior Secured Note,
we granted Deutsche Bank a security interest in substantially all of our assets
and agreed to certain covenants including limitations on our ability to incur
additional indebtedness, incur liens, sell assets and pay dividends.
We derive our revenues from monthly recurring charges, usage
charges and amortization of initial non-recurring charges. We provide services
to both retail and wholesale customers. Monthly recurring charges include the
fees paid by customers for lines in service and additional features on those
lines, as well as equipment collocation services. Usage charges consist of fees
paid by end users for each call made, fees paid by our customers as intercarrier
compensation for completion of their customers' calls through our network, and
access charges paid by carriers for long distance traffic terminated on our
network. Initial non-recurring charges consist of fees paid by end users for the
installation of our service. 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, which is generally 24 to 36 months. We recognize revenue when
there is persuasive evidence of an arrangement, delivery of the product or
performance of the service has occurred, the selling price is fixed or
determinable and collectibility is reasonably assured.
We have carrier customers who pay us to terminate their
originating call traffic on our network. These carrier customers are renting the
use of our network to complete calls for their own customers. These payments
consist of transit traffic and other intercarrier compensation payments,
collectively referred to as intercarrier compensation and meet point, which we
refer to as switched access. Intercarrier compensation payments are a function
of the number of calls we terminate, the minutes of use associated with such
calls and the rates we are compensated at by the ILECs. Intercarrier
compensation payments have historically been a significant portion of our
revenues, as they are for most other local carriers. In particular, intercarrier
compensation payments accounted for 27.2%, and 30.8% of our total revenues for
the quarters ended March 31, 2004 and 2003, respectively. As a result, the
failure, for any reason, of one or more ILECs from which we ordinarily receive
intercarrier compensation payments to make all or a significant portion of such
payments would adversely affect our financial results.
Our right to receive intercarrier compensation payments from
ILECs, as well as the right of other CLECs to receive such payments is the
subject of numerous regulatory and legal challenges. For example, in 2003,
Verizon and SBC attempted to adopt the Federal Communications Commission's, or
FCC's, Intercarrier ISP Compensation Order. The FCC ISP order introduced a
series of declining intercarrier compensation pricing tiers for certain locally-
dialed minutes of use, at rates starting below the rates previously negotiated
in our interconnection agreements (ICAs) with both carriers. The lowest pricing
tier specified by the FCC ISP order was reached on June 15, 2003, will remain in
effect until such time that a replacement FCC order may become effective.
Additionally, the FCC ISP order introduced arbitrary annual growth limits on
compensable minutes of use subject to the FCC's plan based on the composition
and balance of traffic between carriers. During the later months of 2003,
Verizon and SBC commenced withholding of intercarrier compensation payments
based on their interpretation of the growth cap formula. We expect that SBC and
Verizon may also withhold intercarrier compensation payments in 2004 and beyond
once we have exceeded their calculation of the growth cap. We do not believe
that there will be any direct impact on us in the foreseeable future from a
March 2004 U.S. Court of Appeals ruling overturning portions of an FCC Order
relating to the telephone competition policy rules on UNE-P.
As technology continues to evolve with the corresponding
development of new products and services, there is no guarantee we will retain
our customers with our existing product and service offerings or with any new
products or services we may develop in the future. While the demand for Internet
access in our target markets continues to grow, the demand for dial-up Internet
access has slowed in recent years and may decline in the future. The
introduction of broadband and Voice over Internet Protocol (VoIP) could further
affect the growth of our existing dial-up access to the Internet and our
switched local and long-distance voice products. VoIP utilizes high-speed data
networks rather than traditional phone lines to complete calls, offering
customers enhanced functionality and potential cost savings over traditional
carrier networks. VoIP services are rapidly gaining momentum in the enterprise
market as the quality and reliability continue to improve and broadband becomes
more affordable. In this regard, in the fourth quarter of 2003, we entered into
a joint operating agreement with Sentient Group, Inc. (Sentient) to jointly
develop opportunities for the application of VoIP services to the enterprise
market, and in the first quarter of 2004 we acquired substantially all of the
assets, and assumed certain specified liabilities of Sentient. We also
announced in May 2004, a partnership with Level 3 Communications, Inc. We are
hopeful that this partnership may further accelerate our ability to deliver VoIP
services to customers both within and outside of our western U.S. footprint. Our
VoIP solution, called VoIPpro, offers a complete suite of Internet applications
and enhanced functionality with circuit-switched technology. We believe that
VoIPpro enables geographically dispersed companies to cost-effectively connect
multiple locations and teleworkers.
Regulatory uncertainty and competition in the communication
services market has resulted in the consolidation of CLECs, a trend we expect to
continue. In order to grow our business and better serve our customers, we
continue to consider new business models and strategies, including potential
acquisitions or new business lines. We believe that our ubiquitous network will
enable us to successfully compete in the future, but we cannot guarantee that we
will be able to sustain continued growth.
Results of Operations
Quarter Ended March 31, 2004 Compared to the Quarter Ended March 31,
2003
The following tables summarize the unaudited results of
operations as a percentage of revenues for the quarters ended March 31, 2004 and
2003. The following data should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto included elsewhere
in this report:
2004 2003
------------ ------------
(unaudited) (unaudited)
Consolidated Statements of Operations Data:
Revenue........................................... 100.0 % 100.0 %
Network expenses.................................. 35.7 % 35.1 %
Selling, general and administrative expenses...... 48.4 % 49.8 %
Depreciation and amortization expenses............ 30.9 % 45.4 %
Loss from operations.............................. (14.9)% (30.3)%
Net loss.......................................... (24.4)% (33.8)%
Our significant revenue components and operational metrics
for the quarters ended March 31, 2004 and 2003 are as follows:
Revenues (millions): 2004 2003 % Change
------------ ------------ ------------
(unaudited) (unaudited)
Intercarrier compensation......................... $ 8.0 $ 9.4 (14.9)%
Direct billings to SP customers................... 11.1 10.3 7.8
Direct billings to enterprise customers........... 4.7 3.6 30.6
Outbound local and long distance.................. 2.9 3.2 (9.4)
Dedicated transport............................... 1.0 1.8 (44.4)
Switched access................................... 1.5 1.7 (11.8)
Other............................................. 0.2 0.5 (60.0)
------------ ------------
Total revenues.................................... $ 29.4 $ 30.5 (3.6)%
============ ============
Operational metrics:
DS-0 equivalent lines in service ................. 407,394 337,294 20.8 %
Minutes of use (in billions) ..................... 11.3 9.4 20.2 %
Consolidated revenues decreased 3.6% to $29.4 million in
the quarter ended March 31, 2004 from $30.5 million during the same period in
2003. This decrease in revenues is primarily the result of a decrease of $1.4
million in intercarrier compensation revenue and a decrease of $0.8 million in
dedicated transport revenues, partially offset by increases in direct billings
to enterprise and SP customers.
The total lines in service increased by 70,100 or 20.8% to
407,394 at March 31, 2004 from 337,294 lines as of March 31, 2003. Billable
minutes of use increased 20.2% to 11.3 billion in the quarter ended March 31,
2004 from 9.4 billion during the same period in 2003.
The following table describes the main components of our
intercarrier compensation revenue for the quarters ended March 31. 2004 and 2003
(in thousands except minutes of use):
2004 2003 % change
--------- --------- ---------
(unaudited) (unaudited)
Minutes of use subject to intercarrier compensation revenue (billions) 11.0 9.2 19.6 %
Average intercarrier compensation per minute of use................... $ 0.0007 $ 0.0010 (28.8)
--------- --------- ---------
Intercarrier compensation revenue..................................... $ 8,009 $ 9,402 (14.8)%
========= ========= =========
Direct billings to SP customers increased 7.8% to $11.1
million in the quarter ended March 31, 2004 from $10.3 million during the same
period in 2003. While lines in service to this market increased to 340,765 lines
at March 31, 2004 from 278,405 at March 31, 2003, an increase in lines of
62,360, or 22.4%, revenue per line decreased in response to on-going competitive
pressure on pricing.
Direct billings to enterprise customers increased 30.6% to
$4.7 million in the quarter ended March 31, 2004 from $3.6 million during the
same period in 2003. This increase was primarily due to a change in the mix of
products sold combined with an increase in lines in service to 66,629 lines at
March 31, 2004 from 58,889 at March 31, 2003, an increase of 7,740, or
13.1%.
Outbound local and long distance revenues, including 800,
888, and 877 numbers and travel card calls, decreased 9.4% to $2.9 million in
the quarter ended March 31, 2004 from $3.2 million during the same period in
2003. This decline in revenue was principally due to a 19.6% rate per minute
decreases resulting from the highly competitive nature of this market.
Dedicated transport revenues decreased 44.4% to $1.0 million
in the quarter ended March 31, 2004 from $1.8 during the same period in 2003
primarily because of reduced service levels. Switched access revenues decreased
11.8% to $1.5 million in the quarter ended March 31, 2004 from $1.7 million
during the same period in 2003 primarily due to lower rates per minute of
use.
The significant costs and expenses for the quarters ended March 31, 2004 and
2003 are as follows:
Costs and expenses (in millions): 2004 2003 % Change
------------ ------------ ------------
(unaudited) (unaudited)
Network expenses.................................. $ 10.5 $ 10.7 (1.9)%
Selling, general and administrative............... 14.2 15.2 (6.6)
Depreciation and amortization..................... 9.1 13.9 (34.5)
------------ ------------
Total costs and expenses.......................... $ 33.8 $ 39.8 (15.1)%
============ ============
Consolidated network expenses remained relatively constant
with a decrease of 1.9% to $10.5 million in the quarter ended March 31, 2004
from $10.7 million during the same period in 2003. This decrease was achieved in
spite of a 20.2% increase in minutes of use largely due to increased network
efficiency. Although we continue to look for ways to optimize our network, we
cannot guarantee that our network expenses will continue to decline in the
future as we experience growth in network operations associated with a higher
level of telecommunications activity.
Consolidated selling, general and administrative expenses
decreased 6.6% to $14.2 million in the quarter ended March 31, 2004 from $15.2
million during the same period in 2003. The decrease is primarily the result of
decreases in maintenance expenses incurred on our network equipment and
personnel costs incurred in the quarter ended March 31, 2003 that were not
repeated in 2004. Selling, general and administrative expenses were 48.4% and
49.8% of revenues for the quarters ended March 31, 2004 and 2003, respectively.
Estimates and assumptions are used in setting depreciable
lives. Assumptions are based on internal studies of use, industry data on
average asset lives, recognition of technological advancements and understanding
of business strategy. Consolidated depreciation and amortization expense
decreased 34.5% to $9.1 million in the quarter ended March 31, 2004 from $13.9
million during the same period in 2003. The decrease in depreciation and
amortization expense is primarily due to the change in estimated useful lives of
certain assets, which we made in January 2003. This adjustment resulted in
additional depreciation expense of approximately $2.5 million in the quarter
ended March 31, 2003.
Consolidated loss from operations improved 52.7% to $(4.4)
million in the quarter ended March 31, 2004 from $(9.3) million during the same
period in 2003 primarily due to the factors discussed in the preceding
paragraphs.
Consolidated interest expense, net decreased 6.7% to $2.8
million in the quarter ended March 31, 2004 from $3.0 million during the same
period in 2003. In December 2003, we successfully completed a financing
transaction, which permitted us to reduce our debt level. The resulting decrease
in interest expense of $0.6 million in the quarter ended March 31, 2004 compared
to the same period in 2003 was partially offset by decreased interest income. We
incurred interest expense of approximately $1.3 million related to the accretion
of the discount on our Senior Secured Note during the quarter ended March 31,
2004. Amortization of deferred financing costs included in interest expense was
$0.2 million and $0.1 million in the quarters ended March 31, 2004 and 2003,
respectively.
For the quarters ended March 31, 2004 and 2003, our
effective income tax rate was 0.0% and 15.7%, respectively.
Consolidated net loss improved 30.1% to $(7.2) million in the
quarter ended March 31, 2004 from $(10.3) million during the same period in 2003
primarily due to the factors discussed in the preceding paragraphs.
Quarterly Operating and Statistical Data:
The following table sets forth unaudited statistical data for
each of the specified quarters of 2004 and 2003. The operating and statistical
data for any quarter are not necessarily indicative of results for any future
period.
Quarter Ended
-----------------------------------------------------
2004 2003
-----------------------------------------------------
March 31, Dec 31, Sept. 30, June 30, March 31,
--------- --------- --------- --------- ---------
(unaudited)
Ports equipped..................... 998,400 998,400 998,400 998,400 940,800
Lines in service to date........... 407,394 428,192 425,070 403,751 337,294
Quarterly minutes of use
switched (in millions)............ 11,263 11,077 11,189 10,030 9,394
Capital expenditures
(in thousands).................... $ 689 $ 1,046 $ 1,504 $ 1,713 $ 1,482
Employees.......................... 389 372 371 402 402
Liquidity and Capital Resources:
Sources and use of cash. At March 31, 2004 cash
and short term investments decreased $2.7 million to $32.0 million from $34.7
million at December 31, 2003. The decrease was primarily due to the payment of
the semi-annual interest payments on our 13.5% Senior Notes and the acquisition
of the assets and certain of the liabilities of Sentient.
Net cash used in operating activities was $0.0 million for
the quarter ended March 31, 2004 as compared to $2.2 million for the same period
ended in 2003. This improvement was primarily because of the improvements in
loss from operations in 2004 as described in "Results of Operations"
above.
Net cash used in investing activities was $1.2 million for
the quarter ended March 31, 2004 compared to net cash provided by investing
activities of $23.7 million during the same period in 2003. We did not redeem
any short-term investments in the quarter ended March 31, 2004 whereas we
redeemed $25.2 million of short-term investments in the same period in 2003.
Purchases of property and equipment decreased to $0.7 million during the quarter
ended March 31, 2004 as compared to $1.5 million during the same period in 2003.
Net cash used in financing activities was $1.6 million in
both the quarters ended March 31, 2004 and 2003. The primary financing activity
was capital lease payments of $1.5 million and $1.7 million in the quarters
ended March 31, 2004 and 2003, respectively.
Cash requirements. The telecommunications service
business is capital intensive. Our operations have required substantial capital
investment for the design, acquisition, construction and implementation of our
network. With the recent advancements in switch technology, we are currently
investigating our options for the deployment of our first next generation
network switch, which represents the latest technological improvements in switch
capacity and configuration, sometime during 2004. In April 2004, we announced
that we had selected Tekelec, a leading developer of telecommunications products
for next-generation fixed, mobile, and packet networks, as our switching and
signaling supplier. In addition we completed a modem replacement program in the
first quarter of 2004, which we expect will provide us with increased
operational efficiencies. We continue to seek further ways to enhance our
infrastructure in 2004 and beyond. These projects and our business plan, as
currently contemplated, anticipates capital expenditures, excluding
acquisitions, of approximately $12 million in 2004. However, the actual cost of
capital expenditures during 2004 will depend on a variety of factors.
Accordingly, our actual capital requirements may exceed, or fall below, the
amount described above.
During the normal course of business, we may enter into
agreements with some suppliers, which allow these suppliers to have equipment or
inventory available for purchase based upon criteria as defined by us. As of
March 31, 2004, we did not have any material future purchase commitments to
purchase equipment from any of our vendors.
Debt outstanding. At March 31, 2004 and December 31,
2003 long-term debt and capital lease obligations consist of the following (in
thousands):
2004 2003
--------- ---------
Senior Notes..................................$ 36,102 $ 36,102
Senior Secured Note............................ 19,791 18,369
Capital lease obligation....................... 1,266 2,780
Notes Payable.................................. 33 52
Less current portion of capital lease.......... (1,173) (2,589)
--------- ---------
$ 56,019 $ 54,714
========= =========
The Senior Notes of which there is $36.1
million in principal amount outstanding at March 31, 2004 of bear interest at
13.5% per annum payable in semiannual installments, with all principal due in
full on February 1, 2009.
The Senior Secured Note, which was initially issued in the
principal amount of $40.0 million accrues interest at a rate of LIBOR plus 0.5%
(1.6% at March 31, 2004), and matures in December 2006. Accrued interest on the
Senior Secured Note is payable quarterly in cash, or at the Company's option,
may be capitalized and added to outstanding principal. The maturity date of the
Senior Secured Note will be automatically extended to coincide with any
extension of the expiration date of the warrants, which is extendable for up to
an additional 18 months at the option of Deutsche Bank. Under the terms of
the guaranty and security agreement related to the Senior Secured Note, the
Company granted Deutsche Bank a security interest in substantially all of its
assets and agreed to certain covenants including limitations on its ability to
incur additional indebtedness, incur liens, sell assets and pay dividends. In
accordance with the terms of the Senior Secured Note, during the quarter ended
March 31, 2004 the Company elected to capitalize and add to principal interest
of approximately $0.2 million.
Future uses and sources of cash. Our principal sources
of funds for 2004 are anticipated to be current cash and short-term investment
balances and cash flows from operating activities. We may also obtain one or
more lease or lines of credit in 2004. However there can be no assurance that we
will obtain these additional lines of credit or leases or that such lines of
credit or leases will be entered into at favorable interest rates
