<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-27743
PAC-WEST TELECOMM, INC.
(Exact name of registrant as specified in its
charter)
California 68-0383568
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4210 Coronado Avenue 95204
Stockton, California (Zip Code)
(Address of principal executive offices)
(209) 926-3300
(Registrant's telephone number, including area code)
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 November 12, 1999, the Company had an aggregate of 35,393,326 shares of
common stock issued and outstanding.
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<PAGE>
PAC-WEST TELECOMM, INC.
Table of Contents
<TABLE>
<CAPTION>
PAGE
----
PART I FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements
Condensed Balance Sheets (Unaudited) - September 30, 1999 and December 31, 1998.......................... 1
Condensed Statements of Operations (Unaudited) - Three month periods ended
September 30, 1999 and 1998 and nine month periods ended
September 30, 1999 and 1998........................................................................... 2
Condensed Statements of Cash Flows (Unaudited) - Nine month periods
ended September 30, 1999 and 1998.................................................................... 3
Notes to Unaudited Condensed Financial Statements....................................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................................. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risks............................................. 21
PART II OTHER INFORMATION
Item 1. Legal Proceedings....................................................................................... 22
Item 2. Changes in Securities and Use of Proceeds............................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders..................................................... 22
Item 6. Reports on Form 8-K..................................................................................... 23
SIGNATURES......................................................................................................... 24
</TABLE>
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
PAC-WEST TELECOMM, INC.
Condensed Balance Sheets (Unaudited)
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
Current Assets:
Cash & cash equivalents $ 59,023,000 $ 15,236,000
Restricted cash 9,977,000 --
Trade accounts receivable, net of allowances
for doubtful accounts of $475,000 at
September 30, 1999 and $400,000 at
December 31, 1998, respectively 5,727,000 4,623,000
Accounts receivable from related parties 86,000 64,000
Income taxes receivable -- 1,971,000
Inventories 596,000 447,000
Prepaid expenses and other current assets 999,000 861,000
Deferred financing costs, net 750,000 457,000
Deferred tax assets 714,000 151,000
------------ ------------
Total current assets 77,872,000 23,810,000
Equipment, Vehicles and Leasehold Improvements, net 84,976,000 57,294,000
Deferred Financing Costs, Net 6,057,000 1,195,000
Other Assets 1,266,000 194,000
------------ ------------
Total assets $170,171,000 $ 82,493,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Current portion of notes payable $ 106,000 $ 132,000
Accounts payable 18,127,000 5,147,000
Accrued payroll and related expenses 1,177,000 846,000
Accrued interest on Senior Notes 3,372,000 --
Income taxes currently payable 4,112,000 --
Other accrued liabilities 2,508,000 2,153,000
------------ ------------
Total current liabilities 29,402,000 8,278,000
Long-Term Debt and Other Long-Term Obligations 150,038,000 100,116,000
Deferred Income Taxes 7,694,000 1,888,000
------------ ------------
Total liabilities 187,134,000 110,282,000
------------ ------------
Commitments and Contingencies
Convertible Redeemable Preferred Stock, $0.001 par
value; 1,750,000 shares authorized; 1,750,000 issued
and outstanding (preference in liquidation of
$45,000,000, plus accrued cumulative dividends of
$4,876,000 at September 30, 1999 and $1,324,000 at
December 31, 1998) 49,876,000 46,324,000
------------ ------------
Stockholders' Equity (Deficit):
Common stock, $0.001 par value, 50,000,000 shares
authorized and 17,587,458 shares issued and
outstanding 18,000 18,000
Additional paid-in capital 5,353,000 8,905,000
Notes receivable from stockholders (233,000) (233,000)
Retained earnings (deficit) (71,977,000) (82,803,000)
------------ ------------
Total stockholders' equity (deficit) (66,839,000) (74,113,000)
------------ ------------
Total liabilities and stockholders' equity (deficit) $170,171,000 $ 82,493,000
============ ============
</TABLE>
See notes to these condensed financial statements.
1
<PAGE>
PAC-WEST TELECOMM, INC.
Condensed Statements of Operations (Unaudited)
<TABLE>
<CAPTION>
Three Month Period Ended Nine Month Period Ended
-------------------------------- --------------------------------
Sept. 30, 1999 Sept. 30, 1998 Sept. 30, 1999 Sept. 30, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues (Note 10) $37,016,000 $ 9,500,000 $67,280,000 $ 29,432,000
----------- ----------- ----------- ------------
Costs and Expenses:
Operating 5,794,000 3,867,000 14,547,000 11,658,000
Selling, general and administrative:
Selling, general and administrative 5,463,000 2,715,000 15,026,000 6,936,000
Transaction bonuses and
consultant's costs (a) -- 3,798,000 -- 3,798,000
Depreciation and amortization 2,455,000 1,063,000 5,747,000 2,764,000
----------- ----------- ----------- ------------
Total costs and expenses 13,712,000 11,443,000 35,320,000 25,156,000
----------- ----------- ----------- ------------
Income (loss) from operations 23,304,000 (1,943,000) 31,960,000 4,276,000
Other Expense (Income):
Interest expense 4,732,000 882,000 13,234,000 1,668,000
Interest income (640,000) (78,000) (1,825,000) (206,000)
Other income -- (3,000) -- (3,000)
Cost of merger with PWT Acquisition
Corp. and recapitalization (a) -- 2,857,000 -- 2,937,000
----------- ----------- ----------- ------------
Total other expense, net 4,092,000 3,658,000 11,409,000 4,396,000
----------- ----------- ----------- ------------
Income (loss) before provision
(benefit) for income taxes
and extraordinary item 19,212,000 (5,601,000) 20,551,000 (120,000)
Provision (Benefit) for Income Taxes 9,190,000 (1,205,000) 9,725,000 988,000
----------- ----------- ----------- ------------
Income (loss) before 10,022,000 (4,396,000) 10,826,000 (1,108,000)
extraordinary item
Extraordinary item - loss on early extinguishment
of debt, net of income tax benefit of $278,000(a) -- (417,000) -- (417,000)
----------- ----------- ----------- ------------
Net income (loss) $10,022,000 $(4,813,000) 10,826,000 $ (1,525,000)
=========== =========== =========== ============
Accrued Preferred Stock Dividends $(1,227,000) $ (185,000) (3,552,000) $ (185,000)
----------- ----------- ----------- ------------
Net income (loss) applicable to
common stockholders $ 8,795,000 $(4,998,000) 7,274,000 $ (1,710,000)
=========== =========== =========== ============
Basic income (loss) before extraordinary $ 0.50 $ (1.54) $ 0.41 $ (1.18)
item per share
Basic net income (loss) per share $ 0.50 $ (1.68) $ 0.41 $ (1.56)
Diluted income (loss) before extraordinary $ 0.43 $ (1.54) $ 0.40 $ (1.18)
item per share
Diluted net income (loss) per share $ 0.43 $ (1.68) $ 0.40 $ (1.56)
Basic weighted average shares outstanding 17,587,458 2,970,435 17,587,458 1,093,846
Diluted weighted average shares outstanding 23,577,623 2,970,435 18,241,468 1,093,846
</TABLE>
- --------------------
(a) Transaction bonuses and consultant's costs, costs of merger and
recapitalization and the extraordinary item in 1998 all relate to the
recapitalization described in Note 2 to these condensed financial
statements.
See notes to these condensed financial statements.
2
<PAGE>
PAC-WEST TELECOMM, INC.
Condensed Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine Month Period Ended
-------------------------------
Sept. 30, 1999 Sept. 30, 1998
-------------- --------------
<S> <C> <C>
Operating Activities:
Net income (loss) $ 10,826,000 $ (1,525,000)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Extraordinary item - loss on early extinguishment of debt, net of income tax benefit -- 417,000
Costs of merger with PWT Acquisition Corp. and recapitalization -- 2,937,000
Depreciation and amortization 5,747,000 2,764,000
Amortization of deferred financing costs 950,000 147,000
Interest earned on restricted cash (519,000) --
Provision for doubtful accounts 75,000 6,000
Deferred income tax provision 5,243,000 712,000
Changes in operating assets and liabilities:
Accounts receivable (1,201,000) 793,000
Income taxes receivable 1,971,000 (2,313,000)
Inventories (149,000) (102,000)
Prepaid expenses and other current assets (138,000) (165,000)
Other assets (1,222,000) (954,000)
Accounts payable and accrued liabilities 13,666,000 1,743,000
Accrued interest on Senior Notes 3,372,000 --
Income taxes payable 4,112,000 --
------------ ------------
Net cash provided by operating activities 42,733,000 4,460,000
------------ ------------
Investing Activities:
Purchase of equipment, vehicles and leasehold improvements (33,279,000) (20,606,000)
Purchase of investments, net of redemption of $10,238,000 (9,458,000) --
Proceeds from disposal of equipment -- 145,000
------------ ------------
Net cash used in investing activities (42,737,000) (20,461,000)
------------ ------------
Financing Activities:
Proceeds from issuance of Senior Notes 150,000,000 --
Payments for financing costs (6,105,000) --
Repayment of senior secured borrowings (100,000,000) --
Borrowings under notes payable -- 10,514,000
Principal payments on notes payable and capital leases (104,000) (3,448,000)
Merger with PWT Acquisition Corp. and recapitalization:
Proceeds from the issuance of Preferred Stock -- 31,844,000
Proceeds from the issuance of common stock -- 5,968,000
Proceeds from senior secured borrowings -- 75,413,000
Payments to existing shareholders -- (73,615,000)
Extinguishments of notes payable and capital leases -- (23,159,000)
Payments for deferred financing costs -- (1,759,000)
Costs of merger with PWT Acquisition Corp. and recapitalization -- (2,937,000)
------------ ------------
Net cash provided by financing activities 43,791,000 18,821,000
------------ ------------
Net increase in cash and cash equivalents 43,787,000 2,820,000
Cash and Cash Equivalents:
Beginning of period 15,236,000 3,603,000
------------ ------------
End of period $ 59,023,000 $ 6,423,000
============ ============
</TABLE>
See notes to these condensed financial statements.
3
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
September 30, 1999
1. Basis of Presentation:
These accompanying unaudited condensed financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and notes required by generally accepted accounting principles 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 nine month period ended September 30, 1999 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1999. The
balance sheet at December 31, 1998 has been derived from the audited balance
sheet at that date, but does not include all of the information and notes
required by generally accepted accounting principles for complete financial
statements. These unaudited interim condensed financial statements should be
read in conjunction with the audited financial statements and the notes thereto
of Pac-West Telecomm, Inc. (the Company) as of and for the year ended December
31, 1998.
Revenue and income before provision for income taxes for the three month
period ended September 30, 1999 include the recognition of a $20,000,000 cash
payment in settlement of claims for unpaid reciprocal compensation from prior
periods (see Note 10).
2. Organization:
Pac-West Telecomm, Inc. is a rapidly-growing provider of integrated
communications services in the western United States. Our customers include
Internet service providers (ISPs), small and medium businesses and enhanced
communications service providers, many of which are communications intensive
users.
On September 16, 1998, the Company completed a merger with PWT Acquisition
Corp. (PWT) and a recapitalization of the Company (the Transaction). PWT was
formed by a group of investors for the purpose of injecting additional equity
into the Company and effecting the recapitalization. In connection with the
Transaction, PWT was merged into the Company, with the Company being the
surviving corporation. Immediately following consummation of the Transaction,
the previous stockholders continued to hold approximately 28 percent of the
issued and outstanding common stock of the Company. As a result of the continued
significant ownership interests of the previous stockholders, no adjustments
were made to the historical carrying amounts of the Company's assets and
liabilities as a result of the Transaction.
3. Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and for Hedging Activities," effective for fiscal years beginning
after June 15, 1999. Management does not expect adoption of SFAS No. 133 in
future periods to have a significant impact on the Company's financial
statements.
4. Restricted Cash:
Restricted cash represents short-term investments deposited in an interest
reserve trust account to fund initial interest payments due through February 1,
2000 under the $150,000,000 of senior notes.
4
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(Continued)
5. Equipment, Vehicles and Leasehold Improvements:
Equipment, vehicles and leasehold improvements include network and other
communication equipment, office furniture and equipment, vehicles, leasehold
improvements, projects-in-progress and equipment deposits. These assets are
stated at cost, which includes direct costs and capitalized interest, and are
depreciated once placed in service using the straight-line method. Capitalized
interest of $1,893,000 and $0 was recorded during the nine month periods ended
September 30, 1999 and 1998, respectively. Repair and maintenance costs are
expensed as incurred.
Equipment, vehicles and leasehold improvements at September 30, 1999 and
December 31, 1998 consist of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Network and other communication equipment............ $ 61,720,000 $29,817,000
Office furniture and equipment....................... 2,824,000 1,965,000
Vehicles............................................. 1,062,000 717,000
Leasehold improvements............................... 9,877,000 5,581,000
Projects-in-progress................................. 21,473,000 25,597,000
------------ -----------
96,956,000 63,677,000
Less: Accumulated depreciation and amortization...... (11,980,000) (6,383,000)
------------ -----------
Equipment, vehicles and leasehold improvements, net.. $ 84,976,000 $57,294,000
============ ===========
</TABLE>
Included in projects-in-progress at December 31, 1998 is $20,828,000 for
deposits paid or payable on equipment not in service at year-end.
6. Deferred Financing Costs, net:
Deferred financing costs, net consist primarily of capitalized amounts for
underwriter fees, professional fees and other expenses related to the issuance
and subsequent registration of the $150,000,000 of senior notes. These deferred
financing costs are being amortized over the estimated 10-year term of the notes
beginning January 29, 1999. Other deferred financing costs are for the senior
notes exchange offering, costs relating to the senior credit facility, and costs
relating to the company's initial public offering (which was consummated
November 9, 1999). Amortization expense for the nine month period ended
September 30, 1999 was $950,000, which is included in interest expense in the
accompanying condensed statements of operations.
7. Income Taxes:
The Company's effective income tax rate for the nine month period ended
September 30, 1999 was 47%. Such rate reflects the applicable federal and state
statutory income tax rates along with the tax impact of the previously stated
reciprocal compensation settlement. The income tax provision (benefit) for the
period ended September 30, 1998 includes $1,025,000 for the tax effect of non-
deductible costs related to the merger and recapitalization.
5
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(Continued)
8. Long-Term Debt and Other Long-Term Obligations:
Long-term debt and other long-term obligations at September 30, 1999 and
December 31, 1998 consist of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Senior secured borrowings and other
long-term obligations.............. $ 0 $100,000,000
Senior notes......................... 150,000,000 0
Notes payable, less current portion.. 38,000 116,000
------------ ------------
Total long-term debt................. $150,038,000 $100,116,000
============ ============
</TABLE>
On January 29, 1999, the Company issued $150,000,000 of senior notes at
par. The senior notes bear interest at 13.5 percent payable in semiannual
installments, with principal due on February 1, 2009.
Proceeds of the senior notes were used to repay $100,000,000 of senior
secured borrowings (including $9,000,000 of other long-term obligations
subsequently financed through senior secured borrowings) and to establish an
interest reserve account to cover interest payments due under the senior notes
through February 1, 2000.
The senior notes carry provisions that allow the Company, at its option, to
(i) redeem up to 35 percent of the notes with proceeds of certain-public
offerings of equity prior to February 1, 2002, (ii) redeem all or part of the
notes at specified prices on or after February 1, 2004, or (iii) offer to
exchange the notes within 180 days from the issue date for a new issue of
identical debt securities registered under the Securities Act of 1933, as
amended (the Securities Act). In August 1999, the Company completed the
registration of these notes under the Securities Act and on September 22, 1999
all of the unregistered senior notes were exchanged for senior notes registered
under the Securities Act of 1933.
Basic covenants of these notes restrict the Company's future ability to pay
dividends, repurchase stock, pledge or sell assets as security for other
transactions, or engage in mergers and business combinations. The covenants
allow the Company to incur additional debt subject to various limitations.
The Company has a three-year senior credit facility expiring June 15, 2002
that provides for maximum borrowings of $40.0 million to finance working
capital, the cost of the Company's planned capital expansion and other corporate
transactions. The borrowings are secured by substantially all of the Company's
assets. Borrowings under this new senior credit facility will bear interest, at
the Company's option, at (1) the Base Rate (as defined) or (2) the LIBOR Rate
(as defined) plus between 2.25% and 3.5%. As of September 30, 1999, there were
no amounts outstanding under this facility and the borrowing rate would have
been 8.15%. The credit facility requires the Company to meet certain financial
tests, including, without limitation, maximum levels of debt as a ratio of
EBITDA (as defined), minimum interest coverage and maximum amount of capital
expenditures. The credit facility contains certain covenants which, among other
things, limit the incurrence of additional indebtedness, investments, dividends,
transactions with affiliates, asset sales, acquisitions, mergers and
consolidations, prepayments of other indebtedness (including the senior notes),
liens and encumbrances and other matters customarily restricted in such
agreements.
6
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(Continued)
9. Purchase Commitments:
At September 30, 1999, the Company has approximately $30,000,000 of
purchase orders outstanding for network equipment due for delivery during 1999
and 2000. These purchase orders are cancelable up to 60 days prior to delivery
without penalty and are expected to be financed from proceeds received from the
senior notes (see Note 8), from internally generated cash flows, from borrowings
under the senior credit facility or from proceeds from the Company's initial
public offering consummated November 9, 1999 (see Note 16).
In addition, the Company is in the process of implementing a new billing
and operations support system. Total estimated costs for this system aggregate
approximately $15,000,000 of which approximately $7,500,000 is estimated to be
incurred in 1999, $6,000,000 in 2000, and $1,500,000 in 2001. Of the $7,500,000
estimated to be incurred in 1999, $5,500,000 is recorded in projects-in-progress
at September 30, 1999.
10. Revenue Recognition:
Service revenue is recognized in the month in which the service is
provided, except for reciprocal compensation generated by calls placed to
Internet service providers connected through the Company's network. The rights
of competitive local exchange carriers, such as the Company, to receive this
type of compensation is the subject of numerous regulatory and legal challenges
(see Note 14). Until this issue is ultimately resolved, the Company will
recognize this revenue on a cash-received basis.
Two incumbent local exchange carriers (ILECs) with which the Company has
interconnection agreements had withheld payments from amounts billed by the
Company under their agreements since August 1997. In September 1999, a
settlement was entered into with one of these ILEC's. Under the terms of the
settlement, the ILEC has paid $20.0 million to the Company and $20.0 million to
certain shareholders of the Company as of the date of the recapitalization in
settlement of those claims. In addition, subsequent to September 30, 1999, the
other ILEC paid $6,308,000 of the reciprocal compensation it had withheld
subject to certain rights of recovery (see Note 14).
11. Stockholders' Equity:
Stock Splits
On March 19, 1999, the board of directors authorized a ten-for-one split of
the Company's authorized and outstanding common stock and preferred stock. On
October 7, 1999, the board of directors authorized a 1.4-for-1 split of the
Company's outstanding common and preferred stock. In addition, on October 7,
1999, the board of directors approved a resolution to increase the authorized
shares of common stock to 50,000,000 shares. All share and per share data have
been restated to reflect these stock splits.
Convertible Redeemable preferred stock
The preferred stock has preference over common stock in liquidation equal
to its liquidation value of $25.72 per share, plus accrued dividends computed at
a 10 percent rate, compounded quarterly (collectively, the Preference Amount).
After payment of the Preference Amount, the preferred stock and the common stock
share ratably in any distribution by the Company. At September 30, 1999,
$4,876,000 (or $2.786 per outstanding share of preferred stock) is accrued for
cumulative preferred dividends. See Note 16 for discussion of the conversion of
all outstanding preferred stock and cumulative dividends into common stock in
November 1999.
7
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(Continued)
11. Stockholders' Equity (continued):
Stock Options
In January 1999, the Company's board of directors approved the terms of the
1999 Stock Incentive Plan (the Plan) which authorizes the granting of stock
options, including restricted stock, stock appreciation rights, dividend
equivalent rights, performance units, performance shares or other similar rights
or benefits to employees, directors, consultants and advisors. Options granted
under the Plan have a term of ten years. In addition, options have been granted
to two senior officers outside of the 1999 Plan but governed by the rules of the
1999 plan.
An aggregate of 3,150,000 shares (after the 1.4-for-1 stock split) of
common stock have been reserved for option grants. Options to purchase 1,250,200
shares of common stock have been granted and options to purchase 28,700 shares
of common stock have been canceled during the nine month period ended September
30, 1999.
The following table summarizes information about the Company's stock
options outstanding as of September 30, 1999 (after 1.4-for-1 stock split):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------------------------------------
Number Outstanding Weighted Average
at September 30, Contractual Life Weighted Average Number Exercisable at Weighted Average
1999 Remaining (Years) Exercise Price September 30, 1999 Exercise Price
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
568,750 9.0 $0.48 350,000 $0.48
1,221,500 9.6 $2.14 -- --
--------- -------
1,790,250 9.4 $1.61 350,000 $0.48
========= =======
</TABLE>
12. Income (Loss) Per Share:
Diluted net income (loss) per share information for the three and nine
month periods ended September 30, 1998, is presented in the accompanying
statements of operations as being the same as basic net income (loss) per share
information since the impact of the potential issuance of common shares from the
exercise of common stock options is antidilutive. Basic and diluted (loss) per
share for extraordinary item for the three and nine month periods ended
September 30, 1998 was $(0.14) and $(0.38), respectively.
8
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(Continued)
12. Income (Loss) Per Share (continued):
Diluted net income per share for the three and nine month periods ended
September 30, 1999 has been determined as follows:
<TABLE>
<CAPTION>
For the Three Month Period Ended
September 30, 1999
----------------------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------------- --------------------- --------------
<S> <C> <C> <C>
Basic net income per share:
Net income applicable
to common stockholders $ 8,795,000 $17,587,458 $0.50
==============
Effect of Dilutive Securities
Convertible redeemable preferred stock 1,227,000 4,864,900
Stock options 0 1,125,265
----------------- ---------------------
Diluted net income per share:
Income available to common
stockholders and assumed
conversions $10,022,000 23,577,623 $0.43
================= ===================== ==============
For the Nine Month Period Ended
September 30, 1999
----------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------------- --------------------- --------------
Basic net income per share:
Net income applicable
to common stockholders $ 7,274,000 17,587,458 $0.41
==============
Effect of Dilutive Securities
Convertible redeemable preferred stock 0 0
Stock options 0 654,010
----------------- ---------------------
Diluted net income per share:
Income available to common
stockholders and assumed
conversions $ 7,274,000 18,241,468 $0.40
================= ===================== ==============
</TABLE>
Conversion of the convertible redeemable preferred stock for the nine month
period ended September 30, 1999 is antidilutive and has been excluded from the
calculation of diluted income per share. The Company consummated an initial
public offering of common stock and conversion of all outstanding convertible
redeemable preferred stock on November 9, 1999 (see Note 16).
9
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(C0NTINUED)
13. Comprehensive Income:
In September 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes reporting and disclosure requirements for
comprehensive income and its components within the financial statements. There
were no items of other comprehensive income for the nine-month periods ended
September 30, 1999 and 1998; therefore comprehensive income is the same as net
income (loss) for both periods.
14. Legal Proceedings:
The Company is a party to the Pacific Bell and California Public Utility
Commission proceedings related to reciprocal compensation payment and other
interconnection agreement issues. See Note 10 to these condensed financial
statements elsewhere in this report.
On June 24, 1999, the California PUC adopted a decision in the arbitration
proceeding between the Company and Pacific Bell which held that reciprocal
compensation would be payable for Internet service provider calls under the new
interconnection agreement with Pacific Bell which became effective on June 29,
1999. Pacific Bell has requested a rehearing of the decision, although Pacific
Bell has paid the full amount of billings for calls since the effective date of
the new agreement.
On September 9,1999, the Company entered into a settlement agreement with
Pacific Bell regarding its claims for unpaid reciprocal compensation under their
prior interconnection agreement. Under the terms of the settlement agreement,
Pacific Bell agreed to pay $20.0 million to the Company and $20.0 million to
certain stockholders of the Company as of the date of the recapitalization in
settlement of those claims. As a result of these payments, the terms of the
September 1998 recapitalization requiring additional distribution to certain
shareholders have been satisfied.
On August 25, 1999, the Company along with the commissioners of the
California Public Utilities Commission and others, were named as a defendant in
an action filed by GTE California (GTE). The action challenges the legality of
the California Public Utilities Commission's decisions regarding requiring
reciprocal compensation for traffic termination to Internet service providers.
GTE argues that such calls to Internet service providers are not local calls
within the meaning of its agreement with the Company even though they are dialed
and billed as local calls. The Company intends to seek dismissal of the action
or otherwise contest the claims of GTE.
Subsequent to September 30, 1999, GTE paid, and the Company recorded as
revenue, $6,308,000 of reciprocal compensation that GTE had previously withheld.
GTE has not waived its rights to appeal, contest and seek subsequent
reimbursements of amounts paid for reciprocal compensation.
15. Segment Reporting:
The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 131, "Disclosures about Segments of an Enterprise and Related Information".
As an integrated telecommunications provider, the Company has one reportable
operating segment. While the Company's chief decision-maker monitors the revenue
streams of various services, operations are managed and financial performance is
evaluated based upon the delivery of multiple services over common networks and
facilities. This allows the Company to leverage its costs in an effort to
maximize return. As a result, there are many shared expenses generated by the
various revenue streams; because management believes that any allocation of the
expenses to multiple revenue streams would be impractical and arbitrary,
management does not currently make such allocations internally. The chief
decision-maker does however, monitor revenue streams at a more detailed level
than those depicted in the Company's historical general-purpose financial
statements.
10
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(C0NTINUED)
15. Segment Reporting (continued):
Specifically, the following table presents revenues by service type:
<TABLE>
<CAPTION>
Nine Month Period Ended
-----------------------
<S> <C> <C>
September 30, September 30,
1999 1998
------------- -------------
Local services................ $55,418,000 $19,050,000
Long distance service......... 5,845,000 4,828,000
Dedicated transport services.. 3,599,000 3,061,000
Product and services.......... 1,283,000 1,127,000
Other......................... 1,135,000 1,365,000
----------- -----------
$67,280,000 $29,431,000
=========== ===========
</TABLE>
Local services revenues for the nine month period ended September 30, 1999
include the $20,000,000 reciprocal compensation settlement payment.
16. Subsequent Events:
The Company consummated an initial public offering of common stock on
November 9, 1999. The offering was for 11,400,000 shares of previously unissued
common stock plus additional 1,365,000 shares to cover the underwriters over-
allotments.
All outstanding preferred stock and related cumulative dividends were
converted into 5,040,868 shares of the Company's common stock as of November 9,
1999.
11
<PAGE>
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, and as
a result, our actual results may differ materially from those discussed here.
These uncertainties and risks include among others, our substantial debt
leverage, the demand for our services, our ability to successfully attract and
retain personnel, competition, uncertainties regarding our dealings with
Incumbent Local Exchange Carriers (ILECs), other telecommunications carriers
and facility providers, regulatory uncertainties, reliance on leased
transmission capacity and the cost of the capacity, the need to finance future
capital expenditures, the possibility of an adverse decision related to
reciprocal compensation owing to us by ILECs, as well as our future success in
our rapid business expansion into additional markets.
Overview
Pac-West Telecomm, Inc. is a rapidly-growing provider of integrated
communications services in the western United States. Our customers include
Internet service providers (ISPs), small and medium businesses and enhanced
communications service providers, many of which are communications intensive
users. Our predecessor (also known as Pac-West Telecomm, Inc.) began selling
office phone systems in 1980 and reselling long distance service to small and
medium businesses and residential customers in 1982. Beginning in 1986, our
predecessor began offering paging and telephone answering services to its
customers. Effective September 30, 1996, our predecessor transferred its
telephone and answering service divisions to us. Prior to September 30, 1996,
we did not conduct any operations and, since that time, we have disposed of the
answering service division and have focused our business strategy on operating
as a provider of integrated communications services. For the three month period
ended September 30, 1999 and the nine month period ended September 30, 1999,
recognizing compensation from other communications companies for completing
their customers' calls only to the extent such compensation was actually
received in cash, we had net revenues of approximately $37.0 million and $67.3
million and adjusted EBITDA of approximately $25.8 million and $37.7 million,
respectively (these results include $20.0 million in settlement of claims for
unpaid reciprocal compensation revenues).
Factors Affecting Operations:
Revenues. We derive our revenues from monthly recurring charges, usage
charges and initial non-recurring charges and telephone equipment sales and
service. Monthly recurring charges include the fees paid by customers for lines
in service and additional features on those lines, as well as equipment
collocation services. Usage charges consist of fees paid by end users for each
call made, fees paid by ILECs as reciprocal compensation (which results from
Pac-West terminating calls made by ILEC customers), and access charges paid by
carriers for long distance traffic originated or terminated by Pac-West. Initial
non-recurring charges are paid by end users, if applicable, for the initiation
of our service.
We derive a substantial portion of our revenues from reciprocal
compensation paid by ILECs with which we have interconnection agreements. Until
recently, two ILECs with which we have interconnection agreements, Pacific Bell
and GTE, refused to pay that portion of reciprocal compensation due under their
prior agreement that they estimated was the result of inbound calls terminating
to ISPs. These ILECs contend that such ISP calls are not local calls within the
meaning of their respective interconnection agreements and claim that no
reciprocal compensation is therefore payable. On June 24, 1999, the California
Public Utilities Commission adopted a decision in an arbitration proceeding
between us and Pacific Bell which held that reciprocal compensation would be
payable for ISP calls under our new interconnection agreement with Pacific Bell
which became effective on June 29, 1999. Pacific Bell has paid the full amount
of our billings for calls since the effective date of the new agreement. In
September 1999, a settlement agreement was entered into with Pacific Bell for
previously withheld reciprocal compensation, whereby $20.0 million was paid to
us and is
12
<PAGE>
included in revenue for the three month period ended September 30, 1999 (see
Note 14 to accompanying Unaudited Condensed Financial Statements). For the three
month and nine month periods ended September 30, 1999, recorded reciprocal
compensation accounted for 36.5 % and 39.9% of our revenue excluding the $20.0
million settlement revenue, and 70.8% and 57.8% of our revenues including the
settlement revenue. For the comparable 1998 periods, these percentages were
32.9% for the three month and 35.6% for the nine month periods.
On August 25, 1999, we, along with the commissioners of the California
Public Utility Commission and others, were named as a defendant in an action
filed by GTE. The action challenges the legality of the California Public
Utility Commission's decisions regarding reciprocal compensation as discussed
above. We intend to seek dismissal of the action or otherwise contest the claims
of GTE. In October 1999, GTE paid, and the Company recorded as revenue, $6.3
million of reciprocal compensation that GTE had previously withheld. GTE has not
waived its rights to appeal, contest or seek subsequent reimbursements of
amounts paid by it as reciprocal compensation.
We expect that reciprocal compensation will continue to represent a
significant portion of our revenues in the future. We are currently negotiating
and implementing new interconnection agreements and the terms of the related
reciprocal compensation. The per minute reciprocal compensation rate we receive
from Pacific Bell under our new agreement is significantly lower than it was
under our previous agreement. Based on current market conditions, we also expect
that the per minute reciprocal compensation rate will similarly decline from
historic rates under any other future interconnection agreements.
Operating Costs. Operating costs are comprised primarily of leased
transport charges, usage charges for long distance and intrastate calls and, to
a lesser extent, reciprocal compensation related to calls that originate with a
Pac-West customer and terminate on the network of an ILEC or other CLEC. Our
leased transport charges are the lease payments we incur for the transmission
facilities used to connect our customers to our switches and to connect to the
ILEC and other CLEC networks. Our strategy of leasing rather than building our
own transport facilities results in our operating costs being a significant
component of total costs and expenses.
Selling, General and Administrative Expenses. Our selling, general and
administrative expenses include network operations, development, administration
and maintenance costs, selling and marketing, customer service, information
technology, billing, corporate administration and personnel. We expect to incur
significant selling and marketing costs as we continue to expand our operations,
a significant amount of which will be incurred in a particular market before the
switch becomes operational and begins to generate revenue. Consequently, selling
and marketing expenses are expected to increase until implementation of our
expansion plan is substantially complete. We will incur other costs and
expenses, including the costs associated with the development and maintenance of
our networks, administrative overhead, premises leases and bad debts. We expect
that these costs will grow significantly as we expand our operations and that
sales and marketing and administrative overhead will be a large portion of these
expenses during the start-up phase in each of our new markets.
13
<PAGE>
Results of Operations
The following tables summarize the results of operations as a percentage of
revenues for the nine month periods ended September 30, 1999 and 1998 and for
the three month periods ended September 30, 1999 and 1998. For 1999, these
tables reflect percentages of revenue including and excluding the $20.0 million
reciprocal compensation settlement received in September 1999. The following
data should be read in conjunction with the condensed financial statements and
notes thereto included elsewhere in this report:
<TABLE>
<CAPTION>
Nine Month Period Ended
September 30,
-------------------------------------------------------
1999 1998
------------------------------------ ------------
(including (excluding
settlement) settlement)
<S> <C> <C> <C>
Statements of Operations Data:
Revenue 100.0% 100.0% 100.0%
Operating Costs 21.6% 30.8% 39.6%
Selling, general and administrative expenses 22.3% 31.8% 36.5%
Depreciation and amortization expense 8.6% 12.1% 9.4%
Income (loss) from operations 47.5% 25.3% 14.5%
Net income (loss) 16.1% 0.7% (5.2%)
Three Month Period Ended
September 30
-------------------------------------------------------
1999 1998
------------------------------------ ------------
(including (excluding
settlement) settlement)
Statements of Operations Data
Revenue 100.0% 100.0% 100.0%
Operating Costs 15.7% 34.1% 40.7%
Selling, general and administrative expenses 14.8% 32.1% 68.6%
Depreciation and amortization expense 6.6% 14.4% 11.2%
Income (loss) from operations 62.9% 19.4% (20.5%)
Net income (loss) 27.1% (2.8%) (50.7%)
</TABLE>
Nine Month Period Ended September 30, 1999 Compared to Nine Month Period Ended
September 30,1998
Revenues for the nine month period ended September 30, 1999 increased $37.9
million to $67.3 million (increase of $17.9 million to $47.3 million excluding
the $20.0 million reciprocal compensation settlement) from $29.4 million for the
corresponding period in 1998. The increase in revenues was primarily attributed
to an increase of $28.4 million in paid local interconnection revenues
(including the $20.0 million reciprocal compensation settlement) and an increase
of $6.4 million in recurring charges and installation charges billed directly to
ISPs.
In the third quarter of 1998, we installed new higher capacity switches at
our Stockton and Los Angeles switching sites (Super POPs). During the fourth
quarter of 1998, we expanded switch capacity to
14
<PAGE>
existing and new customers. In the second quarter of 1999, we activated a new
higher capacity switch in Oakland and continued to expand our switching capacity
in Los Angeles. Our revenues for the nine months of 1999 significantly increased
compared to the nine months of 1998 as a result of additional switch capacities,
and increased utilization of our expanded switch capacities, primarily
attributable to ISP customers. In addition, new service orders from small and
medium businesses have continued to accelerate in 1999 as we have built our
sales force.
The number of access lines in service increased 150% to 88,009 as of
September 30, 1999 from 35,141 as of September 30, 1998. Billable minutes of use
were 10.7 billion in the first nine months of 1999, up 106% from 5.2 billion for
the first nine months of 1998.
Inbound local calls and minutes subject to reciprocal compensation revenues
in accordance with interconnection agreements increased 62% and 104%,
respectively, for the first nine months of 1999 over the first nine months of
1998. These significant increases in inbound local calls and minutes resulted in
an $8.4 million (80%) increase in paid interconnection revenues.
The $6.4 million increase in the first nine months of 1999 over the first
nine months of 1998 in direct billings to Internet service providers represented
a 95% year to year increase. Lines used by our Internet service providers
significantly increased in the first nine months of 1999 over the same period in
1998, to 64,795 lines in service by Internet service providers at September 30,
1999, from 29,692 lines in service at September 30, 1998.
Our operating costs for the nine months ended September 30, 1999 increased
$2.8 million, to $14.5 million from $11.7 million for the corresponding period
in 1998. The increase in operating costs was primarily due to an increase in
network operations associated with a higher level of telecommunications
activity. We made significant investments in our telephone infrastructure during
the first nine months of 1998 and the first nine months of 1999 to accommodate
future growth of our communications services. As a result of increased
utilization of our newly installed switching equipment and the use of higher
capacity transmission facilities, our operating costs decreased as a percentage
of revenues.
Excluding in 1998 the $3.8 million of bonuses paid to certain key
executives in connection with their assistance with our recapitalization and
consulting payments made to our current president in connection with services
provided by him prior to his joining our company, our selling, general and
administrative expenses for the nine months ended September 30, 1999 increased
$8.1 million to $15.0 million from $6.9 million for the corresponding period in
1998. The increase in selling, general and administrative expenses was primarily
due to the addition of 41 employees in sales and marketing; an increase in
network operational, development and administration costs including 28
additional network employees; an increase of 23 service technicians; and 12
additional employees in other administration, customer service and information
technology functions. Total number of our employees increased from 112 at
September 30, 1998 to 216 at September 30, 1999.
Our depreciation and amortization expense for the nine months ended
September 30, 1999 increased $2.9 million to $5.7 million from $2.8 million for
the corresponding period in 1998. The increase in depreciation and amortization
expense was primarily due to the additional depreciation on the $42.5 million of
equipment acquired during 1998 and the $33.3 million of equipment acquired
during the nine months ended September 30, 1999.
Our interest expense for the nine months ended September 30, 1999 increased
$11.5 million to $13.2 million from $1.7 million in the corresponding period in
1998. The increase in interest expense was primarily due to the financing of a
significant portion of the $42.5 million of equipment acquired during 1998 and
interest on the $150 million senior notes issued on January 29, 1999, including
amortization over 10 years of the related deferred financing costs associated
with that offering. In addition, the interest rate on the senior notes since
January 29, 1999 is a higher interest rate than the rates paid on the equipment
financings outstanding during the nine months ended September 30, 1998.
The Company's effective income tax rate for the nine month period ended
September 30, 1999 was 47%. Such rate reflects the applicable federal and state
statutory income tax rates along with the tax impact of
15
<PAGE>
the previously stated reciprocal compensation settlement. The income tax
provision (benefit) for the period ended September 30, 1998 includes $1,025,000
for the tax effect of non-deductible costs related to the merger and
recapitalization.
Three Month Period Ended September 30, 1999 Compared to Three Month Period Ended
September 30,1998
Our revenues for the three month period ended September 30, 1999 increased
$27.5 million to $37.0 million (increase of $7.5 million to $17.0 million
excluding the $20.0 million reciprocal compensation settlement) from $9.5
million for the corresponding period in 1998. The increase in revenues was
primarily attributed to an increase of $23.1 million in paid local
interconnection revenues (including the $20.0 million reciprocal compensation
settlement) and an increase of $2.2 million in recurring charges and
installation charges billed directly to ISPs.
In the third quarter of 1998, we installed new higher capacity switches at
our Stockton and Los Angeles switching sites (Super POPs). During the fourth
quarter of 1998, we expanded switch capacity to existing and new customers. In
the second quarter of 1999, we activated a new higher capacity switch in Oakland
and continued to expand our switching capacity in Los Angeles. Our revenues for
the three month period ended September 30, 1999 significantly increased compared
to the three month period ended September 30, 1998 as a result of the increased
utilization of this newly installed switch capacity, primarily attributable to
ISP customers. In addition, new service orders from small and medium businesses
have continued to accelerate in the three month period ended September 30, 1999
as we have built our sales force.
The number of access lines in service increased 150% to 88,009 as of
September 30, 1999 from 35,141 as of September 30, 1998. Billable minutes of use
were 4.0 billion in the three month period ended September 30, 1999, up 100%
from 2.0 billion for the three month period ended September 30, 1998.
Inbound local calls and minutes subject to reciprocal compensation revenues
in accordance with interconnection agreements increased 57% and 101%,
respectively, for the three month period ended September 30 of 1999 over the
three month period ended September 30 of 1998. These significant increases in
inbound local calls and minutes resulted in a $3.1 million (99%) increase in
paid interconnection revenues.
The $2.2 million increase in the three month period ended September 30,
1999 over the three month period ended September 30, 1998 in direct billings to
Internet service providers represented a 95% year to year increase. Lines used
by our Internet service providers significantly increased in the first nine
months of 1999 over the same period in 1998, to 64,795 lines in service by
Internet service providers at September 30, 1999, from 29,692 lines in service
at September 30, 1998.
Our operating costs for the three month period ended September 30, 1999
increased $1.9 million, to $5.8 million from $3.9 million for the corresponding
period in 1998. The increase in operating costs was primarily due to an increase
in network operations associated with a higher level of telecommunications
activity. We made significant investments in our telephone infrastructure during
the nine months of 1998 and the first nine months of 1999 to accommodate future
growth of our communications services. As a result of increased utilization of
our newly installed switching equipment and the use of higher capacity
transmission facilities, our operating costs decreased as a percentage of
revenues.
Excluding in 1998 the $3.8 million of bonuses paid to certain key
executives in connection with their assistance with our recapitalization and
consulting payments made to our current president in connection with services
provided by him prior to his joining our company, our selling, general and
administrative expenses for the three month period ended September 30, 1999
increased $2.8 million to $5.5 million from $2.7 million for the corresponding
period in 1998. The increase in selling, general and administrative expenses was
primarily due to the addition of 41 employees in sales and marketing; an
increase in network operational, development and administration costs including
28 additional network employees; an increase of 23 service technicians; and 12
additional employees in other administration, customer service and information
technology functions. Total number of employees increased from 112 at September
30, 1998 to 216 at September 30, 1999.
16
<PAGE>
Our depreciation and amortization expense for the three month period ended
September 30, 1999 increased $1.4 million to $2.5 million from $1.1 million for
the corresponding period in 1998. The increase in depreciation and amortization
expense was primarily due to the additional depreciation on the $42.5 million of
equipment acquired during 1998, and the $33.3 million of equipment acquired
during the nine months ended September 30, 1999.
Our interest expense for the three month period ended September 30, 1999
increased $3.8 million to $4.7 million from $0.9 million in the corresponding
period in 1998. The increase in interest expense was primarily due to the
financing of a significant portion of the $42.5 million of equipment acquired
during 1998 and interest on the $150 million senior notes issued on January 29,
1999, including amortization over 10 years of the related deferred financing
costs associated with that offering. In addition the interest rate on the senior
notes since January 29, 1999 is a higher interest rate than the rates paid on
the equipment financings outstanding in the third quarter of 1998.
The Company's effective income tax rate for the three month period ended
September 30, 1999 was 48%. Such rate reflects the applicable federal and state
statutory income tax rates along with the tax impact of the previously stated
reciprocal compensation settlement. The income tax provision (benefit) for the
period ended September 30, 1998 includes $1,025,000 for the tax effect of non-
deductible costs related to the merger and recapitalization.
Liquidity and Capital Resources
Net cash provided by operating activities was $42.7 million for the nine
month period ended September 30, 1999 compared to $4.5 million for the nine
month period ended September 30, 1998. This increase primarily is attributable
to income from operations being $27.7 million more in 1999 than in 1998
(reflecting the impact of the $20.0 million reciprocal compensation settlement),
and accounts payable of approximately $12.0 million at September 30, 1999 for
new switching and related equipment.
Net cash used in investing activities was $42.7 million for the nine month
period ended September 30, 1999 compared to $20.5 million for the nine month
period ended September 30, 1998. During the nine month period ended September
30, 1999, the Company invested $33.3 million in new switching and related
equipment as compared to $20.6 million during the comparable 1998 period.
Further, $19.7 million of the proceeds from the senior note offering was used to
purchase short-term investments to fund the interest reserve trust account for
the first two scheduled interest payments on the notes, less redemption of $10.2
million to pay the first scheduled interest payment.
Net cash provided by financing activities was $43.8 million for the nine
month period ended September 30, 1999 compared to $18.8 million for the nine
month period ended September 30, 1998. The net cash provided in the nine month
period ended September 30, 1999 was primarily attributable to proceeds from the
issuance of $150 million of our senior notes reduced by the payoff of $100
million of senior secured borrowings.
The local telecommunications services business is capital intensive. Our
operations have required and will continue to require substantial capital
investment for the design, acquisition, construction and implementation of our
network. Capital expenditures (including amounts financed under capital leases
in 1998) were $33.3 million for the first nine months of 1999, and $42.5 million
for the year ended December 31, 1998. Of the $42.5 million of capital
expenditures during 1998, $25.6 million was included in projects-in-progress at
December 31, 1998 and therefore is not being depreciated until placed in service
in 1999. We expect to make additional capital expenditures between $7.0 and
$17.0 million during the balance of 1999. Actual and planned capital expenditure
projects during 1999 include: completion of an upgraded and expanded switch at
the existing Oakland, California facility; construction of switching facilities
in Las Vegas, Nevada and Seattle, Washington; addition of a second switch in Los
Angeles, California; and implementation of a new billing and operations support
system. The actual cost of our planned expansion will depend on a variety of
factors, including the cost of the development of our network in each of our new
markets, the extent of
17
<PAGE>
competition and pricing of the telecommunications services in such markets and
the acceptance of our services. Accordingly, our actual capital requirements may
exceed the amounts described above.
Effective June 15, 1999, we entered into a new senior credit facility
having a three year term. This facility provides for maximum borrowings of $40.0
million for working capital and other general corporate purposes, and bears
interest, at our option, at:
1) the base rate, as defined in the senior credit facility; or
2) the LIBOR rate, as defined in the senior credit facility, plus between
2.25% and 3.5 %.
As of September 30, 1999, there were no amounts outstanding under this facility
and the borrowing rate would have been 8.15%. Borrowings under this senior
credit facility are secured by substantially all of our assets. See Note 8 to
Unaudited Condensed Financial Statements included elsewhere in this report.
Our principal sources of funds for the balance of 1999 are anticipated to
be current unrestricted cash balances, cash flows from operating activities,
proceeds from our initial public offering consummated November 9, 1999, and
borrowings under the senior credit facility. In addition, we purchased and
pledged to the trustee for the benefit of the holders of the senior notes
approximately $19.7 million of U.S. government securities (classified as
restricted cash) to provide for the payment of the first two scheduled interest
payments due under the senior notes, of which $10.2 million was redeemed to pay
the initial payment due. We believe that these funds will provide us with
sufficient liquidity and capital resources for us to meet our financial
obligations for the balance of 1999, as well as to provide funds for our working
capital, capital expenditures and other needs. No assurance can be given,
however, that this will be the case. Depending upon our rate of growth and
profitability, especially if we pursue any significant acquisitions, we may
require additional equity or debt financing to meet our working capital
requirements or capital equipment needs. There can be no assurance that
additional financing will be available when required or, if available, will be
on terms satisfactory to us. Our future operating performance and ability to
service or refinance the senior notes and to repay, extend or refinance the new
senior credit facility will be subject to future economic conditions and to
financial, business and other factors, many of which are beyond our control.
Instruments governing our indebtedness, including the senior credit
facility and the senior notes indenture, contain financial and other covenants
that restrict, among other things, our ability to incur additional indebtedness,
incur liens, pay dividends or make certain other restricted payments, consummate
certain asset sales, enter into certain transactions with affiliates, merge or
consolidate with any other person or sell, assign, transfer, lease, convey or
otherwise dispose of substantially all of our assets. Such limitations, together
with our highly leveraged nature, could limit corporate and operating
activities, including our ability to respond to market conditions to provide for
unanticipated capital investments or to take advantage of business
opportunities.
Year 2000 Issues
Year 2000 Compliance Issues. The information in this section is a "Year
2000 Readiness Disclosure" as defined in the Year 2000 Information and Readiness
Disclosure Act of 1998 and contains forward-looking statements. These statements
include, but are not limited to, anticipated costs and the date by which we
expect to complete actions and are based on management's current estimates,
which are in turn based on assumptions about future events, including, but not
limited to, the availability of resources, representations received from third
parties and other factors. There can be no guarantee that these estimates will
be achieved, and actual results could differ materially from those anticipated.
Specific factors that might cause material differences include, but are not
limited to, our ability to identify and remediate all relevant systems, results
of Year 2000 testing, adequate resolution of Year 2000 issues by business and
other third parties that are service providers, suppliers and customers of ours,
unanticipated system costs, the adequacy of and ability to implement contingency
plans and similar uncertainties. The forward-looking statements made in this
Year 2000 discussion speak only as of the date on which these statements are
made.
18
<PAGE>
Impact of the Year 2000 computer problem. The Year 2000 computer problem
refers to the potential for system and processing failures of date-related data
as a result of computer-controlled systems using two digits rather than four to
define the applicable year. For example, computer programs that have time-
sensitive software may recognize a date represented as "00" as the year 1900
rather than the Year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices or engage in
similar normal business activities. To date, we have not experienced any Year
2000 issues with any of our internal systems or our products, and we do not
expect to experience any of them.
Assessment. The Year 2000 problem affects the computers, software and other
equipment that we use, operate or maintain for our operations. Accordingly, we
have organized a program team responsible for monitoring the assessment and
remediation status of our Year 2000 issues and reporting to our management. This
project team has completed assessing the potential effect and costs of
remediating Year 2000 issues for our internal systems. We have not obtained
independent verification or validation to assure the reliability of our risk and
cost estimates because we do not feel that the scope of our program warrants
this time and expense.
Internal infrastructure. We believe that we have identified all major
computers, software applications and related equipment used in connection with
our internal operations that will need to be evaluated to determine if they must
be modified, upgraded or replaced to minimize the possibility of a material
disruption to our business. We have completed assessing the potential impact of
Year 2000 issues on these computers, equipment and applications, and are
currently modifying, upgrading and replacing major systems that we believe have
Year 2000 issues. Our long distance billing system is not yet Year 2000
compliant. We are in process of replacing our long distance billing system to
accommodate future anticipated growth with a new Year 2000 compliant system.
Systems other than information technology systems. In addition to computers
and related systems, the operation of office and facilities equipment, such as
fax machines, security systems and other common devices may have Year 2000
issues. We are currently assessing the potential effect on and the costs of
remediating these issues, if any, for our office equipment and our facilities in
Stockton, Los Angeles, and Oakland, California and Las Vegas, Nevada.
Products. We have designed our products to be Year 2000 compliant and
believe that using our products as documented should not cause any Year 2000-
related issues. We have tested and intend to continue to test all of our
products for Year 2000 issues. While we believe our products are Year 2000
compliant, it is impractical for us to test our products in every
telecommunications systems environment or with all available combinations of our
products with components supplied by our customers or other third party
suppliers. As a result, there may be situations where the combination of our
products working with components supplied by other third parties could result in
Year 2000 issues.
Costs of remediation. We currently anticipate that our total cost of
addressing our Year 2000 issues will be $150,000, substantially all of which has
been incurred and expensed through September 30, 1999. We do not have a separate
information technology or similar budget. The cost of addressing Year 2000
issues have been reported as a general and administrative expense. We have not
deferred any material information technology projects due to our Year 2000
efforts. Since we have been working on a Year 2000 resolution for over one year,
all major decisions regarding replacements of equipment and software were done
with Year 2000 compliance as major purchase criteria. Costs of software upgrades
and additions, as well as hardware upgrades which were required for
compatibility, enhancement, capability/capacity, or efficiency were not
considered as a Year 2000 cost.
Suppliers. We have contacted third-party suppliers of components and our
key subcontractors used in the manufacture of our products to identify, and to
the extent possible, resolve issues relating to the Year 2000 issue. While we
expect that we will be able to resolve any significant Year 2000 issue
identified with these third parties, because we have no control over the actions
of these parties, these third parties may not remediate any or all of the Year
2000 issues identified. Any failure of any of these third parties to timely
resolve Year 2000 issues with either their products sold to us, or their systems
could have a material adverse effect on our
19
<PAGE>
business, operating results and financial condition. We believe that many
incumbent local exchange carriers and long distance carriers are also impacted
by the Year 2000 issue, which in turn could affect us.
Most reasonably likely worst case consequence of Year 2000 issues. We
expect to identify and resolve all Year 2000 issues that could materially
adversely affect our business operations. However, for the reasons discussed
above, we believe that it is not possible to determine with complete certainty
that all Year 2000 issues affecting us have been identified or corrected. As a
result, we believe that the following consequences are possible:
. operational inconveniences and inefficiencies for us, our contract
manufacturers and our customers that will divert our management's time
and attention and our financial and human resources from ordinary
business activities;
. business disputes and claims for pricing adjustments or penalties by our
customers due to Year 2000 issues, which we believe will be resolved in
the ordinary course of business; and
. business disputes alleging that we failed to comply with the terms and
conditions of contracts or industry standards of performance that result
in litigation on contract termination.
Contingency plan. We have completed our contingency plan. Depending on the
systems affected, the plan could include:
. accelerated replacement of affected equipment software;
. short to medium-term use of backup equipment and software;
. increased work hours for our personnel; and
. use of contract personnel to correct on an accelerated schedule any Year
2000 issues that arise or to provide manual workarounds for information
systems.
Our implementation of any of these contingency procedures could have a material
adverse effect on our business, operating results and financial conditions.
Inflation
We do not believe that inflation has had any material effect on our
business during the nine month periods ended September 30, 1999 and September
30, 1998.
20
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The SEC's rule related to market risk disclosure requires that we describe
and quantify our potential losses from market risk sensitive instruments
attributable to reasonably possible market changes. Market risk sensitive
instruments include all financial or commodity instruments and other financial
instruments that are sensitive to future changes in interest rates, currency
exchange rates, commodity prices or other market factors. We are not exposed to
market risks from changes in foreign currency exchange rates or commodity
prices. We do not hold derivative financial instruments nor do we hold
securities for trading or speculative purposes. At December 31, 1998, we had
$100 million of long-term debt and other long-term obligations subject to
variable interest rates. However, all of this $100 million was replaced by the
issuance of $150 million of fixed rate notes in January 1999, and consequently
we currently have no risk exposure associated with changing interest rates on
debt. We are exposed to changes in interest rates on our investments in cash
equivalents. All of our investments in cash equivalents are in money market
funds that hold short-term investment grade commercial paper, treasury bills or
other U.S. government obligations. Therefore this investment policy reduces our
exposure to long-term interest rate changes. Under our current policies, we do
not use interest rate derivative instruments to manage our exposure to interest
rate changes. A hypothetical 100 basis point decline in short-term interest
rates would reduce the annualized earnings on our $59.0 million of cash
equivalent investments at September 30, 1999 by approximately $590,000. We do,
however, have market risk exposure associated with the market price on the $150
million of notes outstanding. These notes are recorded at book value, which
could vary from current market prices in the future, especially if interest
rates decline. As of September 30, 1999, the market value of the notes
approximated their book value.
21
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings
See Note 14 to the Unaudited Condensed Financial Statements included
elsewhere in this Form 10-Q and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors Affecting Operations--
Revenues" for a description of certain legal proceedings involving Pac-West.
On October 12, 1998, we filed at the Public Utilities Commission of Nevada
a petition for arbitration of an interconnection agreement with Nevada Bell in
accordance with Section 252 (b) of the Telecommunications Act of 1996. The
issues in this arbitration are whether reciprocal compensation is payable for
calls placed to Internet service providers and whether reciprocal compensation
is payable for a local-rated call placed by a dialing party in one local calling
area that is routed to a second local calling area for completion. On April 8,
1999, the Public Utilities Commission of Nevada held that calls placed to
Internet service providers are subject to reciprocal compensation in the same
manner as other calls, but held that, under current Nevada regulatory policy,
calls routed from one local calling area to another area for completion should
not be deemed local calls. Due to the geographic centralization of Nevada
populations within large local calling areas, we do not believe that Public
Utilities Commission of Nevada's ruling on the classification of local calls
will have a material effect on our planned operations in Nevada. On September 2,
1999, Nevada Bell appealed the decision of the Public Utilities Commission of
Nevada to the U.S. District Court in Nevada. We intend to defend the validity of
the decision before the Court.
ITEM 2. Changes in Securities and Use of Proceeds
On September 22, 1999, all of our unregistered Series A senior notes due
2009 were exchanged for Series B senior notes due 2009 registered under the
Securities Act of 1933.
See Note 16 to the Unaudited Condensed Financial Statements for discussion
of the conversion of all outstanding preferred stock and cumulative dividends
into common stock in November 1999. Also see Item 4 below.
ITEM 4. Submission of Matters to a Vote of Security Holders
In April, 1999, in an action in lieu of a special meeting, all of our
common stock shareholders approved the First Amendment to the September 16, 1998
Shareholders Agreement. The amendment increased the authorized number of
directors on the Company Board of Directors from 7 to 9 and provided that two of
the directors were to be outside directors.
In October, 1999, in two separate actions in lieu of special meetings, all
of our common stock shareholders and all of our preferred stock shareholders
approved: (a) an increase in the total number of authorized shares to 50,000,000
common shares and 1,750,000 preferred shares; (b) the conversion of each
outstanding share of common and preferred stock to 1.4 shares of the same class
of stock; and (c) the amendment of the definition of "Original Cost" of
preferred stock in Section III.B.11 of our Articles of Incorporation to mean
$25.72 per share.
In October, 1999, in two separate actions in lieu of special meetings, all
of our common stock shareholders and all of our preferred stock shareholders
approved the amendment of our Bylaws so as to:
. eliminate the necessity of a special shareholders meeting to fill a
board vacancy;
22
<PAGE>
. eliminate cumulative voting for election of directors;
. eliminate voting by written consent of shareholders to fill a vacancy on
the board;
. within 10 days following the effective date of an initial public
offering, change the expiration of the directors' terms so that the term
of only three directors expires at every annual meeting;
. provide for the removal of the entire Board of Directors or an
individual director without cause by a majority vote of the outstanding
shares entitled to vote on such removal; and
. amendment of the section covering board resignations and vacancies.
ITEM 6. Exhibit and Reports on Form 8-K
(a) Exhibit
The following exhibit is filed in connection with Item 601 of Regulation
S-K:
Exhibit
Number Description
------ -----------
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company did not file any current reports on Form 8-K during the quarter
ended September 30, 1999.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on November 12, 1999.
PAC-WEST TELECOMM, INC.
By: /s/ Richard E. Bryson
-------------------------------
Richard E. Bryson
Chief Financial Officer
(Principal Financial Officer)
By: /s/ Dennis V. Meyer
-------------------------------
Dennis V. Meyer
Vice President-Finance
(Principal Accounting Officer)
24
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
27 Financial Data Schedule
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the September 30, 1999 unaudited financial statements and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 59,023,000
<SECURITIES> 9,977,000
<RECEIVABLES> 6,288,000
<ALLOWANCES> (475,000)
<INVENTORY> 596,000
<CURRENT-ASSETS> 77,872,000
<PP&E> 96,956,000
<DEPRECIATION> (11,980,000)
<TOTAL-ASSETS> 171,171,000
<CURRENT-LIABILITIES> 29,402,000
<BONDS> 150,038,000
0
48,876,000
<COMMON> 18,000
<OTHER-SE> (66,857,000)
<TOTAL-LIABILITY-AND-EQUITY> 170,171,000
<SALES> 0
<TOTAL-REVENUES> 67,280,000
<CGS> 0
<TOTAL-COSTS> 35,245,000
<OTHER-EXPENSES> (1,825,000)
<LOSS-PROVISION> 75,000
<INTEREST-EXPENSE> 13,234,000
<INCOME-PRETAX> 20,551,000
<INCOME-TAX> 9,725,000
<INCOME-CONTINUING> 10,826,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,826,000
<EPS-BASIC> 0.41
<EPS-DILUTED> 0.41
</TABLE>
