<PAGE> 1
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 September 30, 1999
Commission file number 0-230 17
CHOICETEL COMMUNICATIONS, INC.
(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 2,915,907 shares outstanding.
<PAGE> 2
CHOICETEL COMMUNICATIONS, INC.
Form 10-QSB Index
November 15, 1999
Part I: Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet -
December 31, 1998 and September 30, 1999
Consolidated Statements of Operations -
Three months ended September 30, 1998 and 1999
Nine months ended September 30, 1998 and 1999
Consolidated Statements of Cash Flows -
Nine months ended September 30, 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> 3
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: November 15, 1999 By: /s/ Jack S. Kohler
------------------------------
Jack S. Kohler
Vice President and Chief Financial Officer
<PAGE> 4
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 1998 and September 30, 1999 (unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash.................................................. $ 505,203 $ 363,239
Accounts receivable................................... 1,256,864 1,080,794
Prepaid:
Rent................................................ 69,635 176,411
Other............................................... 241,991 487,149
Deferred taxes.......................................... 782,000 710,000
----------- -----------
Total current assets............................... 2,855,693 2,817,593
----------- -----------
Property and equipment, net............................. 6,131,897 6,336,401
----------- -----------
Other assets:
Prepaid rents......................................... 61,300 73,998
Rental agreements, net of accumulated amortization of
$776,333 at Dec. 1998, and $1,159,605 at Sept. 1999.. 4,809,166 5,501,771
Deferred financing, net of accumulated amortization of
$3,000 at Dec. 1998, and $18,568 at Sept. 1999....... 24,497 27,000
----------- -----------
4,894,963 5,602,769
----------- -----------
$13,882,553 $14,756,763
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Checks outstanding in excess of bank balance $ $ 74,604
Notes payable......................................... 350,000 350,000
Current portion of long-term debt..................... 1,467,079 1,222,559
Accounts payable...................................... 34,449 238,944
Accrued expenses...................................... 2,619,184 2,339,805
----------- -----------
Total current liabilities........................... 4,470,712 4,225,912
----------- -----------
Long-term liabilities:
Deferred taxes........................................ 698,321 653,000
Long-term debt, net of current portion................ 2,760,008 3,891,732
----------- -----------
3,458,329 4,544,732
----------- -----------
Shareholders' equity.................................... 5,953,512 5,986,119
----------- -----------
$13,882,553 $14,756,763
=========== ===========
</TABLE>
See notes to consolidated financial statements.
<PAGE> 5
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended September 30, 1998 and 1999 (unaudited)
Nine Months Ended September 30, 1998 and 1999 (unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Service revenue............................ $8,089,994 $6,776,757 $2,936,092 $2,863,429
Cost of service............................ 3,704,344 2,885,526 1,266,375 1,280,220
---------- ---------- ---------- ----------
Gross margin............................... 4,385,650 3,891,231 1,669,717 1,583,209
---------- ---------- ---------- ----------
Selling, general and admin:
Service and collection................... 1,305,430 1,072,905 473,508 459,413
Marketing................................ 362,907 401,466 116,751 170,134
Admin, office and overhead............... 1,196,207 859,846 498,617 309,529
---------- ---------- ---------- ----------
2,864,544 2,334,217 1,088,876 939,076
Depreciation and amortization.............. 1,053,109 1,000,918 344,955 419,774
Interest................................... 367,794 199,168 132,695 126,024
Sales tax contingency...................... 159,490 191,444 55,154 57,894
---------- ---------- ---------- ----------
4,444,937 3,725,747 1,621,680 1,542,768
---------- ---------- ---------- ----------
Income (loss) before income taxes.......... (59,287) 165,484 48,037 40,471
Provision (credit) for income taxes........ (26,679) 66,194 21,617 16,188
---------- ---------- ---------- ----------
Net income (loss).......................... $ (32,608) $ 99,290 $ 26,420 $ 24,283
========== ========== ========== ==========
Per share net income (loss)................ $ (0.01) $ 0.03 $ 0.01 $ 0.01
========== ========== ========== ==========
Shares outstanding-weighted average........ 2,915,006 2,915,006 2,915,006 2,915,006
Per share diluted net income............... $ $ 0.03 $ 0.01 $ 0.01
========== ========== ========== ==========
Share outstanding-diluted.................. 2,958,682 2,915,006 2,958,682
</TABLE>
See notes to consolidated financial statements.
<PAGE> 6
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 1998 and 1999 (unaudited)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
------------ ------------
Cash flows from operating activities:
Net (loss) income.......................... $ (32,608) $ 99,291
Adjustments to reconcile net (loss) income
to net cash provided by operating
activities:
Depreciation and amortization.............. 1,053,109 1,000,918
Changes in operating assets and liabilities
(Increase) decrease in:
Accounts receivable...................... (176,070) (122,391)
Prepaid rent and other................... 364,632 131,646
Deferred taxes........................... (26,679) 21,486
Increase (decrease) in:
Accounts payable......................... (204,495) 45,030
Accrued expenses......................... 279,379 (248,365)
----------- -----------
Net cash provided by operating activities.... 1,257,268 927,615
----------- -----------
Cash flows used in investing activities:
Purchase of equipment and rental contracts. (958,537) (5,461,251)
Sales of assets............................ 750,000
Sales of short-term investments............ 1,151,215
----------- -----------
Net cash (used in) investing activities...... (208,537) (4,310,036)
----------- -----------
Cash flows from financing activities:
Proceeds from
Issuance of:
Long-term debt......................... 450,000 4,300,000
Collections of subscription receivable... 10,000 8,571
Principal payments on long-term debt..... (1,366,767) (862,659)
----------- -----------
Net cash provided by (used in) financing
activities............................... (906,767) 3,445,912
----------- -----------
Net increase in cash......................... 141,964 63,491
Cash, beginning balance...................... 363,239 343,705
----------- -----------
Cash, ending balance......................... $ 505,203 $ 407,196
=========== ===========
Supplemental disclosure of cash flow
information:
Cash paid for interest..................... $ 367,794 $ 199,168
=========== ===========
See notes to consolidated financial statements.
<PAGE> 7
CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year ended December 31, 1998 and
Nine Month Period ended September 30, 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 ten states and Puerto Rico, however, revenue is generated
predominately in Minnesota, Puerto Rico, Pennsylvania and Oregon.
Choicetel, Inc. was incorporated in 1995 and was dormant until June 1996
when operations began. Choicetel is a Competitive local exchange carrier (CLEC)
which 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 changed
it's name to Advants, Inc.
PROPERTY AND EQUIPMENT AND DEPRECIATIONS 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 $225,000 less
depreciation expense in 1999, on the property in service at the time of the
change. 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.
STOCK-BASED COMPENSATION:
<PAGE> 8
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 note 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> 9
3. ACQUISITION:
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.
YEAR ENDED DECEMBER 31, 1998 (unaudited)
------------------------------------------------------
Pro forma
Company Jay Telephone Adjustments Combined
--------- ------------- ----------- ---------
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
========= ======= ======== =========
4. PROPERTY AND EQUIPMENT:
1999 1998
----------- ----------
Phones and related equipment $ 8,387,409 $ 8,288,468
Accumulated depreciation (2,426,390) (2,163,041)
----------- -----------
5,961,019 6,125,427
Office equipment and improvements 292,948 291,093
Accumulated depreciation (122,070) (80,119)
----------- -----------
170,878 210,974
----------- -----------
$ 6,131,897 $ 6,336,401
=========== ===========
5. NOTES PAYABLES:
1999 1998
---------- ----------
Note payable, shareholder, interest only at 8.5%. $350,000 $350,000
Convertible to shares of common stock at $5.10
per share. $350,000 $350,000
========== ==========
<PAGE> 10
6. LONG-TERM DEBT:
1999 1998
---------- ----------
Note payable, Telco West, due in monthly
installments of $21,342 including interest
at 10.25% through July 2001, secured
by equipment. $ 409,452 $ 564,874
Note payable, Telecapital, due in monthly
installments of $4,452 including interest
at 14.5% through April 2002, secured
by equipment. 111,902 138,159
Note payable, bank, due in monthly installments
plus interest at 2% above prime rate. 3,378,370 3,495,998
Note payable, bank, revolving credit facility
up to $800,000, convertible to a term note in
September 1999. 350,000
Capital leases at 9.5% 327,363 551,156
---------- ----------
4,227,087 5,114,291
Less current portion 1,467,079 1,222,559
---------- ----------
$2,760,008 $3,891,732
========== ==========
Future maturities of long-term debt are as follows:
At At
Year ending December 31, 9/30/99 12/31/98
------------------------ ---------- ----------
1999 $ 381,749 $1,222,559
2000 1,408,331 1,232,354
2001 1,072,665 983,837
2002 913,893 910,080
2003 450,449 765,461
---------- ----------
$4,227,087 $5,114,291
========== ==========
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 $21,600 for certain
consulting services in 1998 and 1999, respectively.
Leases:
Operating leases:
The Company leases its offices in Minnesota, Oregon, Pennsylvania and
Puerto Rico under operating leases expiring from May through November 2000. The
Company also leases warehouse 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:
YEAR ENDING DECEMBER 31, Amount
- ------------------------ --------
1999 $ 83,788
2000 26,795
--------
$110,583
========
<PAGE> 11
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>
<CAPTION>
<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:
<TABLE>
<CAPTION>
<S> <C>
Total future minimum lease payments, payable in:
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 accrued
refund liability of $351,000 at December 31, 1997.
Effective October 7, 1997 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 per
call dial-around rate to $0.24 retroactive to October 7, 1997. The amount due
from dial-around compensation included in accounts receivable is approximately
$856,000 and $899,000 at December 31, 1998 and September 30, 1999,
respectively. The ultimate resolution of matters related to dial-around
compensation could have a material effect on the Company's results of operation.
Sales tax contingency:
After an original contact by ChoiceTel Communications, Inc., the Minnesota
Department of Revenue conducted an audit of the Company's revenues for
calculation of sales taxes which the 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.
<PAGE> 12
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.
Since January 1, 1999 the Company has paid to the PRTC $0.03 per call in
additional charges while accruing as an unpaid expense an additional $0.03 per
call.
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 than 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.
During 1998 the Company granted options to employees and non-employee
directors to purchase 70,000 shares through the incentive plan. No additional
options were granted during the quarter ended September 1999.
Information with respect to options outstanding as of December 31, 1998 and
September 1999, is summarized as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
WEIGHTED AVG WEIGHTED AVG
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 4.06 136,666 2.25
Exercised
Forfeited 62,500 2.00 12,667 3.50
------- ----- ------- -----
Outstanding at end of period 130,000 $4.34 253,999 $3.11
======= ===== ======= =====
Options exercisable at period end 80,000 234,999
</TABLE>
<PAGE> 13
Weighed average remaining life 3.4 years 3.0 years
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.
The Company has outstanding the following warrants:
<TABLE>
WEIGHTED AVERAGE
12/31/98 9/30/99 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 3.0 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.
A reconciliation between the statutory federal income tax rates to the
Company's effective tax rate is as follows:
<TABLE>
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:
<TABLE>
DECEMBER 31, 1998 SEPTEMBER 30, 1999
----------------- ------------------
<S> <C> <C>
Deferred tax asset:
Sales tax contingency $ 545,000 $ 617,000
Accrued expenses 25,000 25,000
Accrued dial-around compensation 140,000 140,000
--------- ---------
$ 710,000 $ 782,000
Deferred tax liability:
Depreciation $ 839,000 $1,101,000
Amortization (31,000) (56,000)
Net operating loss carry forward (155,000) (347,000)
--------- ---------
$ 653,000 $ 698,000
========= ==========
</TABLE>
<PAGE> 14
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.
11. SUBSEQUENT EVENTS:
During the first quarter of 1999, the Company agreed in principle to sell
approximately 1,000 payphones in an all cash transaction to be completed by
November 30, 1999. When completed the Company estimates the gain on the sale of
assets will not be significant. The purchaser has made advances totaling
$750,000 as of September 30, 1999 and $1,370,000 as of filing. The Company has
delivered title to 357 payphones located in Idaho, Wyoming, Nevada and Colorado
as of September 30, 1999 and an additional 208 phones located in Oregon and
Washington as of filing. The Company has recognized no gain on the sale pending
final closing. Proceeds have been used to reduce bank debt by $445,000 as of
closing and $1,095,000 as of filing, with the balance of proceeds used to
install payphones in Puerto Rico.
<PAGE> 15
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 either by the payphone's computer using "store and forward"
technology or by an operator service provided ("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 "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 September 30, 1999 the Company had
installed 885 payphones and had signed agreements that will allow for continued
growth in Puerto Rico.
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,
<PAGE> 16
1998, and September 30, 1999 of $45,000 and $325,000 respectively. If the
Puerto Rican Supreme Court upholds the court of Appeals decision, then the
Company would have overaccrued expenses by $200,000 as of September 30, 1999.
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. At September 30, 1999 the Company has 7 installed and
operating terminals. 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 to date, management has decided to expand the
public internet access business, through Advants, Inc. a wholly owned
subsidiary. Management has developed strategies to develop this business. These
strategies include bringing in business partners that will benefit in owning a
part of this network. During the third quarter the Company hired consultants to
develop a strategic plan and to raise up to $500,000 in a private placement of
Advants stock to initially fund this venture.
STRATEGIC PLAN
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. During the
third quarter the Company identified several companies it believes are
interested in purchasing some or all of the Company's payphone assets. No
definitive agreements have been reached to date, however discussions are
ongoing.
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS
ENDED SEPTEMBER 30 1998.
Total revenue for the three months ended September 30, 1999, increased
approximately $73,000, or 2.5%, compared to the three months ended September 30,
1998. This increase occurred in part due to an 8.0% increase in the average
number of pay telephones in service from 4,350 during the 1998 period to 4,700
during the 1999 period. Coin revenue decreased $36,000 or 1.8% and non coin
revenues decreased $49,000 or 11.0% compared to the previous year period.
Dial-around compensation increase $158,000 or 42.3%.
Telephone and long-distance charges decreased $26,000 or 3.2% as compared
to the previous year period, due to increased competition for local dial tone.
Site Provider commissions were about the same as the previous year period.
Selling, general and administrative ("SG&A") expenses increased by $150,000 or
16.0%, this includes approximately $110,000 spent to develop and fund an
internet access terminal business plan.
Interest expense was about the same as the prior year. Depreciation and
amortization for the 1999 period decreased $75,000 or 17.8% primarily as a
result of increasing the estimated useful
<PAGE> 17
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.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30
1998.
Total revenue for the nine months ended September 30, 1999, increased
approximately $1,313,000, or 19.4%, compared to the nine months ended
September 30, 1998. This growth was due primarily to the Company increasing the
average number of pay telephones in service from 4,250 during the 1998 period to
4,700 during the 1999 period, an increase of 10.1%. Coin revenue increased
$788,000 or 15.9% and non coin revenues increased $229,000 or 29.1% compared to
the previous year period. Dial-around compensation increased $297,000 or 28.9%.
The Company recognized dial-around compensation at approximately $31.00 per
phone per month during the 1999 period compared to $27.00 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 44% of the phones
in service at June 30, 1999. During the fourth quarter of 1998, first quarter
1999, and second quarter 1999, total coin revenues in that region decreased
$129,000 or 11.2%, $210,000 or 18.9%, and $209,000 or 18.7% respectively.
Management attributes the reduction to increased competition from wireless
communication devices.
Telephone and long-distance charges increased $618,000 or 34.76% as
compared to the previous year period. Site Provider commissions increased
$201,000 or 18.2% over the previous year period. Selling, general and
administrative ("SG&A") expenses increased by $530,000 or 22.7%, due to the
Company's increased spending to maintain offices in Puerto Rico and
Pennsylvania, and approximately $125,000 spent to develop and fund an internet
access terminal business plan.
Interest expense increased $169,000 or 84.7% compared to the prior year due
to the Jay Telephone acquisition and route expansion in Puerto Rico.
Depreciation and amortization for the 1999 period increased $52,000 or 5.2% and
was reduced by approximately $225,000 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 $277,000 or 27.7% 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 $1.5 million to cover the
potential of an unsuccessful resolution of this matter.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 1999, the Company's operating
activities provided $1,257,000. Investments in equipment and rental agreements
used $959,537 and principal payments on long-term debt used $1,367,000.
Activities were funded with $450,000 drawn from the credit facility with the
bank, a $750,000 from the sale of payphones, and collection of $10,000 of
subscription receivable, resulting in a $141,000 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
<PAGE> 18
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 of which $800,000 was drawn and
used to accelerate the rate of installations in Puerto Rico. The line of credit
converted into a fully amortizing term loan on September 30, 1999 to be
amortized over the following 45 months.
On June 30, 1999 and continuing as of the date of filing, the Company was
not in compliance with several financial covenants under its Credit Agreement
dated June 30, 1998 as amended, (the "Agreement") with Norwest Bank Minnesota,
N.A. (the "Bank"). The Company has borrowed approximately $4 million under the
Agreement and is current in all respects in its payments of principal and
interest to the Bank. On July 29, 1999, the Bank notified the Company that it
was in default for failure to meet the debt service coverage ratio, fixed
charge coverage ratio and operating cash flow requirement. The Bank also
indicated that it had no present intention to exercise its rights to accelerate
the maturity of the indebtedness or to foreclose on its security interest.
Certain officers and directors of the Company are guarantors of a portion of the
Company's obligations under the Agreement. In light of the Company's
noncompliance, on November 9, 1999 the bank notified the Company that intends to
institute the default interest rate and exclerated the due date of the note to
May 15, 2000.
In addition, the Bank advised the Company that the Bank believes the
Company's undertaking to incorporate Public Internet Access Holdings Corporation
("PIAHC") as a vehicle to continue to test and develop a public Internet access
business through the use of terminals in public facilities, violates a covenant
in the Agreement which prohibits certain investments by the Company.
During the first quarter of 1999, the Company agreed in principle to sell
approximately 1,000 payphones in an all cash transaction to be completed by
November 30, 1999. When completed the Company estimates the gain on the sale of
assets will not be significant. The purchaser has made advances totaling
$750,000 as of September 30, 1999 and $1,370,000 as of filing. The Company has
delivered title to 357 payphones located in Idaho, Wyoming, Nevada and Colorado
as of September 30, 1999 and an additional 208 phones located in Oregan and
Washington as of filing. The Company has recognized no gain on the sale pending
final closing. Proceeds have been used to reduce bank debt by $445,000 as of
closing and $1,095,000 as of filing, with the balance of proceeds used to
install additional payphones in Puerto Rico. The Company expects to partially
offset the loss of revenues derived from the assets being sold with revenues
from the Puerto Rican phones and through reduced borrowing costs.
<PAGE> 19
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>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
FINANCIAL STATEMENTS FOR CHOICETEL COMMUNICATIONS, INC AND SUBSIDIARIES AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
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<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 505
<SECURITIES> 0
<RECEIVABLES> 1,257
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<OTHER-SE> 5,924
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