<PAGE>
FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
--------------
COMMISSION FILE NUMBER 0-230 17
--------
CHOICETEL CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1649949
- --------- ----------
(State of jurisdiction or IRS Employer ID no.
incorporation of organization)
9724 10th Ave. North, Plymouth, MN 55441
- ---------------------------------- ------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 612-544-1260
N/A
---
(Former name, former address and former fiscal year if changed from last report)
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
--- ---
As of date of filing, the Company has 2,915,007 shares outstanding.
<PAGE>
CHOICETEL COMMUNICATIONS, INC.
FORM 10-QSB INDEX
MAY 17, 1999
Part I: Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet -
December 31, 1998 and March 31, 1999
Consolidated Statements of Operations -
Three months ended March 31, 1998 and 1999
Consolidated Statements of Cash Flows -
Three months ended March 31, 1998 and 1999
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis
Part II: Other Information
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
(a) Financial Data Schedule
(b) Reports on 8-K
<PAGE>
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHOICETEL COMMUNICATIONS, INC.
Date: May 17, 1999 By: /s/ Jack S. Kohler
------------------------------
Jack S. Kohler
Vice President and Chief Financial Officer
<PAGE>
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998 AND MARCH 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash ....................................................... $ 385,320 363,239
Accounts receivable ........................................ 1,220,134 1,080,794
Prepaid:
Rent ..................................................... 150,156 176,411
Other .................................................... 221,000 487,149
Deferred taxes 756,381 710,000
--------- ---------
Total current assets ..................................... 2,732,991 2,817,593
--------- ---------
Property and equipment, net ................................ 6,604,042 6,336,401
--------- ---------
Other assets:
Prepaid rents .............................................. 47,743 73,998
Rental agreements, net of accumulated amortization
of $776,333 at Dec. 1998, and $899,971 at March 1999 ......... 5,378,133 5,501,771
Deferred financing, net of accumulated amortization
of $3,000 at Dec. 1998, and $5,500 at March 1999 ............. 37,565 27,000
--------- ---------
5,463,441 5,602,769
--------- ---------
$ 14,800,474 $ 14,756,763
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Checks outstanding in excess of bank balance ............... $ 60,084 $ 74,604
Notes payable .............................................. 350,000 350,000
Current portion of long-term debt .......................... 1,300,737 1,222,559
Accounts payable ........................................... 262,993 238,944
Accrued expenses ........................................... 2,371,168 2,339,805
--------- ---------
Total current liabilities ................................ 4,344,982 4,225,912
Long-term liabilities:
Deferred taxes ............................................. 598,418 653,000
Long-term debt, net of current portion ..................... 3,969,909 3,891,732
--------- ---------
4,576,528 4,544,732
Shareholders' equity ......................................... 5,887,165 5,986,119
--------- ---------
$ 14,800,474 $ 14,756,763
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1999 1998
--------- ---------
<S> <C> <C>
Service revenue ................... $ 2,435,014 $ 1,933,135
Cost of service ................... 1,186,760 881,296
----------- -----------
Gross margin ...................... 1,248,254 1,051,839
----------- -----------
Selling, general and admin:
Service and collection ........... 421,913 228,825
Marketing ........................ 149,942 89,712
Admin, office and overhead ....... 343,077 244,908
----------- -----------
914,932 563,445
Depreciation and amortization ..... 348,252 291,487
Interest .......................... 113,803 40,485
Sales tax contingency ............. 51,184 69,709
----------- -----------
1,428,171 965,126
----------- -----------
Income (loss) before income taxes . (179,917) 86,713
Provision (credit) for income taxes (80,963) 34,685
----------- -----------
Net income (loss) ................. $ (98,954) $ 52,028
----------- -----------
Per share net income (loss) ....... $ (0.03) $ 0.02
----------- -----------
----------- -----------
Shares outstanding-weighted average 2,915,006 2,915,006
Per share diluted net income ...... $ 0.02
-----------
-----------
Shares outstanding - diluted ...... 2,943,577
</TABLE>
See notes to consolidated financial statements.
<PAGE>
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income ............................................. $ (98,954) $ 52,028
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization ................................. 348,252 291,497
Changes in operating assets and liabilities
(Increase) decrease in:
Accounts receivable ........................................ (139,340) (262,516)
Prepaid rent and other ..................................... 166,756 14,528
Deferred taxes ............................................. (80,963)
Increase (decrease) in:
Accounts payable ........................................... 24,049 (8,235)
Accrued expenses ........................................... 31,363 (111,319)
Net cash provided by (used in) operating activities ............ 251,747 (24,017)
------------ ------------
Cash flows used in investing activities:
Purchase of equipment and rental contracts .................... (395,437) (71,028)
Sales of short-term investments .............................. 513,888
------------ ------------
Net cash (used in) provided from investing activities .......... (395,437) 442,860
------------ ------------
Cash flows from financing activities:
Proceeds from
Issuance of:
Long-term debt .............................................. 450,000
Common stock
Collections of subscription receivable ....................... 10,000
Principal payments on long-term debt ......................... (293,645) (477,463)
Net change in notes payable ..................................
------------ ------------
Net cash provided by financing activities .................... 166,355 (477,463)
------------ ------------
Net increase (decrease) in cash ................................ 22,081 (58,620)
Cash, beginning balance ........................................ 363,239 343,705
------------ ------------
Cash, ending balance ........................................... $ 385,320 $ 285,085
------------ ------------
Supplemental disclosure of cash flow information:
Cash paid for interest ........................................ $ 38,663 $ 54,284
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1998 AND
THREE MONTH PERIOD ENDED MARCH 31 1999 (UNAUDITED)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of ChoiceTel
Communications, Inc (formerly Intelliphone, Inc.) and its wholly owned
subsidiaries Choicetel, Inc., and Public Internet Access Holding Corp. All
material intercompany balances have been eliminated.
NATURE OF BUSINESS:
Intelliphone, Inc. was incorporated in October 1989 and changed its name to
ChoiceTel Communications, Inc. in April 1997. The Company provides coin operated
telephone service in fourteen states and Puerto Rico, however, revenue is
generated predominately in Minnesota, Oregon, Pennsylvania and Puerto Rico.
Choicetel, Inc. was incorporated in 1995 and was dormant until June 1996 when
operations began. Choicetel is a CLEC and resells local telephone service to pay
telephone owners in Minnesota. Choicetel's largest customer is ChoiceTel
Communications.
Public Internet Access Holding Corp. was incorporated in 1998 and has not
started operations.
PROPERTY AND EQUIPMENT AND DEPRECIATION METHODS:
Property and equipment, consisting principally of coin operated telephones,
are stated at cost. Depreciation is being provided by the straight-line method
over the estimated useful lives, principally ten years, of the related assets.
In October 1998, the Company changed the estimated useful life of all phones
from 7 years to 10 years, based upon its experience. The effect of this change
resulted in $75,000 less depreciation expense in 1998 and 1999. Phone locations
are evaluated by management to determine if their carrying amounts have been
impaired. No reductions for impaired assets have occurred.
PREPAID RENTS:
Prepaid rents represent incentives paid to property owners to secure long
term phone location agreements at such sites and are being amortized as consumed
per the phone location agreement.
RENTAL AGREEMENTS:
Rental agreements consist of the purchase price paid for phone location
agreements in excess of the purchase price of the related equipment on site and
are amortized on a straight line basis over the estimated economic life of the
rental agreements, currently ranging from five to twelve years.
DEFERRED FINANCING:
Deferred financing costs are being amortized over the life of the related
notes on a straight-line basis.
INCOME TAXES:
Prior to 1997 ChoiceTel Communications, Inc. and Choicetel, Inc., were "S"
corporations under the Internal Revenue Code. Instead of paying corporate income
taxes, the shareholders of
<PAGE>
an "S" corporation are taxed individually on their proportionate share of the
Company's taxable income or loss. Effective January 1997, ChoiceTel
Communication's "S" corporation status terminated and it became subject to
federal and state income taxes.
STOCK-BASED COMPENSATION:
The Company accounts for its stock options in accordance with the provisions
of Accounting Principles Board Opinion No. 25 (APB No. 25), ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES. As such, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. The Company has also adopted SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION (SFAS No. 123), which permits entities to recognize as
expense over the vesting period the fair value of all stock-based award on the
date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply
the provisions of APB No. 25 and provide pro forma net income disclosures for
employee stock option grants as if the fair-value based method defined in SFAS
No. 123 had been applied. The Company has elected to continue to apply the
provisions of APB No. 25 and provide the pro forma disclosure provisions of SFAS
No. 123.
NET INCOME (LOSS) PER SHARE:
In 1997, the Company adopted SFAS Statement No. 128, "Earnings per share".
Basic earnings per common share are based on the weighted average number of
common shares outstanding in each year. Diluted earnings per common share assume
that outstanding common shares are increased by shares issuable upon exercise of
stock options and warrants for which market price exceeds exercise price, less
shares which could have been purchased by the Company with the related proceeds.
This calculation added 1,451 shares to the diluted weighted average shares
outstanding for 1998.
ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts of certain assets and liabilities and
disclosures. Accordingly, the actual amounts could differ from those estimates.
Any adjustments applied to estimated amounts are recognized in the year in which
such adjustments are determined. Estimates that are susceptible to significant
change are disclosed in notes 3 and 7.
2. SHAREHOLDERS' EQUITY:
In February, 1997 the shareholders of Choicetel, Inc. contributed all
outstanding shares of Choicetel, Inc. to the Company. The contribution was
recorded as an adjustment to additional paid-in capital.
In April 1997, the shareholders approved an increase in the number of authorized
shares of common stock from 2,000,000 with no par value to 15,000,000 with $0.01
par value. The shareholders also approved the authorization of 5,000,000 shares
of preferred stock with $0.01 par value. The change in par value did not affect
any existing rights of shareholders and has been recorded as an adjustment to
additional paid-in capital and common stock.
In November 1997, the Company completed an initial public offering of 800,000
Units at an offering price of $7.00 per Unit. Each Unit consisted of one share
of Common Stock and one Redeemable Warrant. The Company received net proceeds of
approximately $4,499,000 after the payment of approximately $1,101,000 in
related underwriting fees and offering costs.
<PAGE>
3. ACQUISITIONS:
Jay Telephone Vending:
On June 30, 1998, the Company purchased a route of payphones in Philadelphia,
Pennsylvania along with the trade name Jay Telephone Vending from Edward Steven
Corporation and Drake Telephone Company. The purchase price for the acquired
assets was $4,005,000, and was financed with the bank with a $3,800,000 note
payable.
The following summarized unaudited pro forma information assumes the acquisition
had occurred on January 1, 1998. The pro forma statement is presented for
illustration purposes only and is not indicative of what the Company's actual
results would have been.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 (UNAUDITED)
----------------------------------------
PRO FORMA
COMPANY JAY TELEPHONE ADJUSTMENTS COMBINED
--------- ------------- ----------- ----------
<S> <C> <C> <C> <C>
GROSS MARGIN 5,112,906 878,434 5,991,340
--------- ------- ---------
SELLING, GENERAL AND
ADMINISTRATIVE 3,021,734 617,674 -223,173 3,416,235
INTEREST EXPENSE 310,081 13,413 176,587 500,081
DEPRECIATION AND AMORTIZATION 1,317,051 0 235,539 1,552,590
SALES TAX CONTINGENCY 253,972 0 0 253,972
INCOME BEFORE INCOME TAXES 210,068 247,347 -188,953 268,462
PROVISION FOR INCOME TAXES 95,000 98,939 -75,582 118,357
------ ------ ------- -------
NET INCOME AFTER TAX 115,068 148,408 -113,471 150,105
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
4. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Phones and related equipment $ 8,683,905 $ 8,288,468
Accumulated depreciation (2,275,805) (2,163,041)
------------ ------------
6,408,100 6,125,427
Office equipment and improvements 288,656 291,093
Accumulated depreciation (92,715) (80,119)
------------ ------------
195,941 210,974
------------ ------------
$ 6,604,041 $ 6,336,401
------------ ------------
------------ ------------
</TABLE>
5. NOTES PAYABLE:
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Note payable, shareholder, interest only at 8.5%.
Convertible to shares of common stock at $5.10 per $350,000 $350,000
share.
<PAGE>
-------- --------
$350,000 $350,000
-------- --------
-------- --------
</TABLE>
6. LONG-TERM DEBT:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Note payable, Telco West, due in monthly
installments of $21,342 including interest at
10.25% through July 2001, secured by equipment. $ 515,057 $ 564,874
Note payable, Telecapital, due in monthly
installments of $4,452 including interest at
14.5% through April 2002, secured by equipment. 124,159 138,159
Note payable, bank, due in monthly installments
plus interest at 1% above prime rate. 3,343,997 3,495,998
Note payable, bank, revolving credit facility
up to $1,000,000, convertible to a term note
in October 1999. 800,000 350,000
Capital leases at 9.5% 487,433 551,156
--------- ---------
5,270,646 5,114,291
Less current portion 1,300,737 1,222,559
--------- ---------
$ 3,969,909 $ 3,891,732
--------- ---------
--------- ---------
</TABLE>
Future maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
Year ending December 31 Amount
----------------------- ------
<S> <C>
1999 $ 1,222,559
2000 1,217,961
2001 983,837
2002 910,080
2003 765,461
--------
$5,114,291
----------
----------
</TABLE>
7. COMMITMENTS AND CONTINGENCY:
Phone locations:
The Company rents phone locations from merchants and property owners under
varying lease terms, usually seven years, generally cancelable by the Company
upon 15 days notice.
Consulting agreement:
The Company paid a director/shareholder $34,800 and $7,200 for certain
consulting services in 1998 and 1999, respectively.
Leases:
Operating leases:
The Company leases its offices in Minnesota, Oregon and Puerto Rico under
operating leases expiring in May 2000. The Company also leases office space in
Pennsylvania on a month-to-month basis. The leases have renewal options and
require the Company to pay certain common area costs and real estate taxes. Rent
expense under the leases was $101,737 for the year ended December 31, 1998.
Future minimum lease payments are as follows:
<PAGE>
<TABLE>
<CAPTION>
Year ending December 31 Amount
----------------------- ------
<S> <C>
1999 $ 83,788
2000 26,795
----------
$ 110,583
----------
----------
</TABLE>
Capital leases:
The cost of equipment, included in property and equipment, acquired under
capital leases and the related accumulated depreciation at December 31, 1998, is
as follows:
<TABLE>
<S> <C>
Cost $ 934,856
Less accumulated depreciation 177,858
--------
$ 756,998
--------
--------
</TABLE>
The future minimum lease payments under capital leases, at December 31, 1998,
and their net present value are as follows:
Total future minimum lease payments, payable in:
<TABLE>
<S> <C>
1999 $ 355,158
2000 241,970
-------
597,128
Less amounts representing interest 45,972
----------
Present value of future minimum lease payments $ 551,156
----------
----------
</TABLE>
Dial-around compensation:
The Company has recognized revenue for dial-around compensation based upon
rates for such compensation set by the Federal Communications Commission (FCC).
In July, 1997 the U.S. Court of Appeals ruled that the rate set by the FCC was
inappropriate and needed to be reexamined. The FCC on October 9, 1997 issued an
order reestablishing a dial-around rate for the two year period commencing
October 6, 1997. The FCC indicated that it planned to address dial-around
compensation for the period from November 6, 1996 through October 6, 1997 in a
subsequent order. There can be no assurance when the FCC will issue another
order regarding the rate of dial-around compensation, what that order will
determine, whether such order will be appealed, and what the determination would
be upon any appeal. Accordingly, the Company has recognized revenue at the
previous rate of $6.00 per phone per month for the period of January 1, 1997
through October 6, 1997. The change in estimate resulted in an accrual of a
$351,000 liability at December 31, 1997 and is included in accrued expenses at
December 31, 1998.
Effective October 7, 1997 and January 1, 1998 the Company has recognized dial
around revenue based upon estimated dial-around calls per phone. Estimates vary
by time of year and geographic location of the phones. In 1998, The FCC adjusted
the rate retroactively from October 7, 1997 to $0.24 per call. The amount due
from dial-around compensation included in accounts receivable is approximately
$856,000 and $871,000 at December 31, 1998 and March 31, 1998, respectively. The
ultimate resolution of matters related to dial-around compensation could have a
material effect on the Company's results of operations.
Sales tax contingency:
After an original contact by ChoiceTel Communications, Inc., the Minnesota
Department of Revenue conducted and audit of the Company's revenues for
calculation of sales taxes which the
<PAGE>
department asserts are due on telephone receipts. While the Company does not
believe its coin receipts are subject to Minnesota sales tax and has notified
the Minnesota Department of Revenue of its position, it may have to assert its
position in the Minnesota courts in order to prevail. The financial statements
include an accrual management believes is sufficient to cover this contingency.
Puerto Rico line charge contingency:
In March of 1998, the Company received verbal assurances from the Puerto
Rican Telephone Company (PRTC) that payphone lines would be made available and
the charge would be a flat rate of $50.00 per month per line. However, when
phone bills were received in the Company's offices, they included additional
charges ranging from $0.13 to $0.26 per call. At that time, the PRTC and the
Company agreed that until a final decision was reached on a rate case before the
Puerto Rican Regulatory Board (PRRB), the Company would not pay the per call
charges. On May 27, 1998 the PRRB ruled on that rate case and instructed the
PRTC to reduce the per call charges to between $.01 and $.03 per call, depending
upon the routing of the call. The PRTC appealed the ruling to the Court of
Appeals, which upheld the ruling. PRTC has since appealed the ruling to the
Puerto Rico Supreme Court, which has agreed to hear the case and has issued a
stay of execution until the court renders a decision on the appeal. From April
through September 1998, the Company accrued unpaid line charges at the rate of
$0.15 per call. In October 1998, the Company reduced the rate it was accruing
line charges to $0.06 per call based upon progress of this case.
8. STOCK OPTIONS AND WARRANTS:
On April 11, 1997, the Company's Board of Directors adopted the 1997
Long-term Incentive and Stock Option Plan (the "Plan"). The Plan provides for
the issuance of incentive stock options and non-qualified stock options to key
employees and directors of the Company. The total number of shares of common
stock authorized and reserved for issuance under the Plan is 100,000 shares. The
exercise price for each incentive stock option granted under the Plan may not be
less than the fair market value of the common stock on the date of the grant,
unless, in the case of incentive stock options, the optionee owns greater than
10% of the total combined voting power of all classes of capital stock of the
Company, in which case the exercise price may not be less than 110% of the fair
market value of the common stock on the date of the grant. The exercise price
for each non-qualified option may not be less the 85% of the fair market value
of the common stock on the date of the grant. Unless otherwise determined by the
Board, incentive options granted under the Plan have a maximum duration of 10
years, non-qualified options and awards have a maximum duration of 15 years.
Vesting is based on such terms and conditions as the board shall determine. As
of December 31, 1997, no options had been granted under the plan.
During 1998 the Company granted options to employees and non-employee directors
to purchase 70,000 shares through the incentive plan.
Information with respect to options outstanding as of December 31, 1998 and
March 1999, is summarized as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
Weighted average Weighted average
Shares exercise price Shares exercise price
------ ---------------- ------ ----------------
<S> <C> <C> <C> <C>
Outstanding at the
beginning of the year 122,500 $3.37 130,000 $4.34
Granted 70,000 4.06
<PAGE>
Exercised
Forfeited 62,500 2.00
------- -----
Outstanding at end of period 130,000 $4.34 130,000 $4.34
------- ----- ------- -----
------- ----- ------- -----
Options exercisable at period end 80,000 80,000
Weighted average remaining life 3.4 years 3.1 years
</TABLE>
During 1998 the Company issued 150,000 warrants to purchase at any time one
share of common stock, 50,000 of the warrants have an exercise price of $5.00
expiring August 2000, 50,000 of the warrants have an exercise price of $6.00
expiring in August 2001, and 50,000 have an exercise price of $7.00 expiring in
August 2002.
At December 31, the Company has outstanding the following warrants:
<TABLE>
<CAPTION>
Weighted average
1998 1999 exercise price
---- ---- ----------------
<S> <C> <C> <C>
Issued in public offering 800,000 800,000 $9.50
Granted to Underwriter in public offering 160,000 160,000 $8.95
Granted to investment relations company 150,000 150,000 $6.00
Outstanding at period end 1,110,000 1,110,000 $9.40
Exercisable at period end 1,110,000 1,110,000
Weighted average remaining life 3.8 years 3.5 years
</TABLE>
The warrants granted to the Underwriter consist of one warrant for 80,000 units
at $8.40 per unit and is not exercisable until one year after the date the
registration statement is declared effective. Each unit contains a warrant that
entitles the holder to purchase at any time one share of common stock at an
exercise price of $9.50. The warrants expire November 2002.
9. INCOME TAXES:
On January 1, 1997 the Company terminated its status to be treated as an "S"
corporation. The provision for income taxes is as follows:
<TABLE>
<CAPTION>
1998
-----
<S> <C>
Current, state $ 2,000
Deferred:
Federal 80,000
State 13,000
--------
$ 95,000
</TABLE>
A reconciliation between the statutory federal income tax rates to the Company's
effective tax rate is as follows:
<TABLE>
<CAPTION>
1998
-----
<S> <C>
Statutory federal tax rate 34.0%
State taxes (net of federal tax benefit) 6.0%
Effect of nondeductible expenses 5.2%
-------
Effective tax rate 45.2%
-------
-------
</TABLE>
The deferred tax asset and deferred tax liability consists of the following:
<PAGE>
<TABLE>
<CAPTION>
December 31,
1998
<S> <C>
Deferred tax asset:
Sales tax contingency $ 545,000
Accrued expenses 25,000
Accrued dial-around compensation 140,000
---------
$ 710,000
Deferred tax liability:
Depreciation $ 839,000
Amortization (31,000)
Net operating loss carry forward (155,000)
---------
$ 653,000
---------
---------
</TABLE>
Utilization of the deferred tax asset of $710,000 disclosed above is dependent
on future taxable profits in excess of profits arising from existing taxable
temporary differences. Although there was a reportable taxable loss for the year
ended December 31, 1998 the assets have been recognized based on management's
estimate of future taxable income.
10. FINANCIAL INSTRUMENTS:
The Company's financial instruments recorded on the balance sheet
include cash and short-term investments, accounts receivable, notes and accounts
payable and debt. Because of their short maturity, the carry amount of cash,
short-term investments, accounts receivable and notes and accounts payable
approximates recorded value based on rates available to the Company for similar
terms and maturities.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company derives revenue from three principal sources: coin calls, non-coin
calls and Dial-Around calls. Coin calls represent calls paid for with coins
deposited in the telephone. The Company recognizes coin revenue in the amount
deposited net of applicable sales taxes. Non-coin calls are calls charged to a
customer credit card or billed to the called party (collect calls). These calls
are processed by the payphone's computer using "store and forward" technology
or, if a live operator is requested, the call is processed by an operator
service provider ("OSP") such as, for example, AT&T, MCI or Sprint. Compensation
for Dial-Around calls is paid by long-distance carriers in accordance with rules
set by the FCC when consumers access a long-distance carrier directly by dialing
an access number, an 800 number, or by using a non-billable calling card.
The principal costs related to ongoing operation of the Company's payphones
include telephone line charges, consisting of payments made by the Company to
telephone companies and long-distance carriers for access charges and use of
their networks and commission payments to site providers.
RECENT ACQUISITIONS
On June 30, 1998, the Company completed an acquisition from Edward Steven
Corporation and Drake Telephone Company of site contracts for 965 payphones
located principally in Philadelphia, Pennsylvania and all equipment located at
the respective sites, as well as the trade name
<PAGE>
"Jay Telephone Vending". The purchase price for the acquired assets was
$4,005,000, and was financed with a $3,800,000 note payable to the bank.
During 1998, the Company began researching the Puerto Rican payphone
market. It was determined that although the Puerto Rican Regulatory Board (PRRB)
had not required the Puerto Rican Telephone Company (PRTC) to provide
"competition neutral" service to independent payphone providers at a "cost-based
rate", the Company was confident that the Telecom Act would eventually correct
this situation. In March 1998, the Company hired a Leasing Manager for Puerto
Rico, and began contracting with local businesses to provide payphone service.
In April 1998 the Company received its first payphone line from the PRTC and
installed its first payphones. As of March 31, 1999 the Company had installed
600 payphones and had signed agreements to install an additional 1,100
payphones.
In March of 1998, the Company received verbal assurances from the PRTC,
that payphone lines would be made available, and the charge would be a flat rate
of $50.00 per month per line. However, when actually invoiced the bills included
additional charges ranging from $0.13 to $0.26 per call. At that time, the PRTC
and the Company agreed that until a final decision was reached on a rate case
before the PRRB, the Company would not pay the per call charges. On May 27, 1998
the PRRB ruled on that rate case and instructed the PRTC to reduce the per call
charges to between $0.01 and $0.03 per call, depending upon the routing of the
call. The PRTC appealed the ruling to the Court of Appeals, which upheld the
ruling in December 1998. The PRTC appealed the ruling to the Puerto Rican
Supreme Court, which on January 28, 1999 agreed to hear the case and issued a
stay of execution until the court renders a decision on the appeal. During the
second and third quarters of 1998 the Company accrued unpaid line charges at the
rate of $0.15 per call. In the fourth quarter the Company reduced the accrued
unpaid line charges to $0.06 per call. If the Puerto Rican Supreme Court
reverses the Court of Appeals, and reinstates the old rates, then the Company
estimates it would have unrecorded liabilities at December 31, 1998, and March
31, 1999 of $45,000 and $125,000 respectively.
During 1998, the Company began test marketing public internet access
terminals, which allow customers to access the internet while away from their
home or office computer. The customers have the option of paying the charges,
currently $1.00 for 5 minutes, using cash or a credit card. At March 31, 1999
the Company had contracted with site providers to install 10 terminals, of which
4 were installed. Under the terms of the contracts, the Company receives all
revenues generated by the terminals in return for a commission payment based
upon revenues generated.
Based on results of testing through December 31, 1998, management has
determined to continue public internet testing in order to determine whether
consumer demand will be sufficient to generate a return on the investment, which
investment currently is approximately $5,000 per terminal. Management is
considering strategies to develop the internet access market, including bringing
into the business joint venture partners that may benefit in owning part of a
network of public internet terminals, with the goals of lowering the Company's
investment per terminal and accelerating the growth of the network. During the
first quarter of 1999, the Company announced it is assessing its long-term
strategic plan, which may include the sale of its payphone assets and the
refocusing of the Company in the public internet access market.
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31 1998.
Total revenue for the three months ended March 31, 1999, increased
approximately $502,000, or 26.0%, compared to the three months ended March 31,
1998. This growth was due in part to the Company increasing the average number
of pay telephones in service from 3,180 during the
<PAGE>
1998 period to 4,550 during the 1999 period, an increase of 43.5%. Coin
revenue increased $338,000 or 23.5% and non coin revenues increased $88,500
or 46.0% compared to the previous year period. Dial-around compensation
increased $74,500 or 25.0%. The Company accrued dial-around compensation at
approximately $27.00 per phone per month during the 1998 period compared to
$30.00 per phone per month during the 1998 period.
Commencing in the fourth quarter of 1998, the Company experienced a
significant decrease in coin revenues in the Midwest region. The Midwest region
includes Minnesota and Wisconsin and represents approximately 48% of the phones
in service at December 31, 1998. During the fourth quarter of 1998 and first
quarter 1999 , total coin revenues in that region decreased $129,000 or 11.2%
and $210,00 or 18.9% respectively. Management attributes the reduction to
increased competition from wireless communication devices.
Telephone and long-distance charges increased $224,000 or 40.6% as compared
to the previous year period. Site Provider commissions increased $80,500 or
24.6% over the previous year period. Selling, general and administrative
("SG&A") expenses increased by $352,000 or 62.4%, due to the Company's increased
spending in Marketing and Acquisition activities, which includes $190,000 of
SG&A in Puerto Rico and $135,000 of SG&A in Pennsylvania.
Interest expense increased $73,000 or 181.1% compared to the prior year due
to the Jay Telephone acquisition. Depreciation and amortization for the 1999
period increased $57,000 or 19.5% and was reduced by approximately $75,000 as a
result of increasing the estimated useful life of payphones from 7 years to 10
years effective the fourth quarter of 1998. Management believes a 10 year useful
life is a better estimate of payphone performance. Without this change,
depreciation and amortization increased $132,000 or 45.2% over the previous
year as a result of the higher depreciation and amortization associated with the
acquired route.
SALES TAX CONTINGENCY.
The Company, based on its analysis of the published regulations of the
Minnesota Department, of Revenue, has not remitted any sales tax payments to the
State of Minnesota. In 1996, the Company learned that the position of the
Department of Revenue was that calls from payphones were subject to state sales
tax. Management is of the view that the payphone service it provides is not
subject to sales tax and the Company is challenging the imposition of the tax.
Nonetheless, the Company has established a reserve of $1.4 million to cover the
potential of an unsuccessful resolution of this matter.
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended March 31, 1999, the Company's operating
activities provided $252,000. Investments in equipment and rental agreements
used $395,000 and principal payments on long-term debt used $294,000. Activities
were funded with $450,000 drawn from the credit facility with the bank, and
collection of $10,000 of subscription receivable, resulting in a $22,000
increase in cash balances.
On June 30, 1998 the Company entered into a credit agreement with Norwest
Bank Minnesota, pursuant to which the Company borrowed $3,800,000 to purchase a
route of 965 payphones in Philadelphia, Pennsylvania. The Company has granted
the Bank a first lien on all of its assets to secure its obligations to the
Bank. The agreement provides for monthly payments of interest and principal. The
initial interest rate is 1% over the banks reference rate and is adjusted
annually based upon debt leverage. The principal balance is scheduled to be
repaid 16% in the first year, 18% in the second year, 20% in the third year, 22%
in the fourth year and 24% in the 5th year. On December 16, 1998 the agreement
was amended to provide the Company a $1,000,000 line of credit to be used to
accelerate the rate of installations in Puerto Rico. The line of credit converts
into a fully amortizing term loan on September 30, 1999 to be amortized over the
following 45 months.
<PAGE>
During the first quarter of 1999, the Company agreed in principle to sell
approximately 1000 payphones in an all cash transaction. The transaction is
subject to completion of due diligence and other customary closing conditions.
The Company anticipates the transaction will be completed in the second quarter
of 1999 and that net proceeds will be applied to the reduction of debt and the
installation of payphones in Puerto Rico. The Company expects to partially
offset loss of revenues derived from the assets to be sold with revenues from
the Puerto Rican phones and through reduced borrowing costs.
<PAGE>
Part II - Other Information
Item 1. Legal Proceedings - None
Item 6. Exhibits and Reports on Form 8-K
(a) 27 - Financial Data Schedule
(b) Reports on Form 8-K - None
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
FINANCIAL STATEMENTS FOR CHOICETEL COMMUNICATION, INC. AND SUBSIDIARIES AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 385
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<RECEIVABLES> 1,220
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