<PAGE>
________________________________________________________________________________
UNITED STATES
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, 2000
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
incorporation or organization) Identification No.)
1776 West March Lane, Suite 250 95207
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 October 31, 2000, the Company had an aggregate of 35,934,951 shares of
common stock issued and outstanding.
<PAGE>
________________________________________________________________________________
PAC-WEST TELECOMM, INC.
Table of Contents
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) - September 30, 2000
and December 31, 1999................................................................... 1
Condensed Consolidated Statements of Operations and Comprehensive
Income (Unaudited) - Three and nine month periods ended
September 30, 2000 and 1999............................................................. 2
Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine
month periods ended September 30, 2000 and 1999......................................... 3
Notes to Unaudited Condensed Consolidated Financial Statements............................ 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risks............................... 20
PART II OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders....................................... 21
Item 6. Exhibits and Reports on Form 8-K.......................................................... 22
SIGNATURES........................................................................................... 23
EXHIBIT INDEX........................................................................................ 24
</TABLE>
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS
PAC-WEST TELECOMM, INC.
Condensed Consolidated Balance Sheets (Unaudited)
ASSETS
<TABLE>
<CAPTION>
Sept. 30, December 31,
2000 1999
------------ -------------
<S> <C> <C>
Current Assets:
Cash & cash equivalents $ 44,232,000 $ 82,688,000
Restricted cash - 10,087,000
Short-term investments 60,683,000 70,138,000
Trade accounts receivable, net of allowances for doubtful
accounts of $1,612,000 at September 30, 2000 and
$675,000 at December 31, 1999, respectively. 17,217,000 8,339,000
Accounts receivable from related parties 22,000 63,000
Income taxes receivable 195,000 195,000
Inventories 3,355,000 952,000
Prepaid expenses and other current assets 2,915,000 2,786,000
Deferred financing costs, net 853,000 864,000
Deferred tax assets 628,000 580,000
------------ ------------
Total current assets 130,100,000 176,692,000
Equipment, Vehicles and Leasehold Improvements, net 165,017,000 105,189,000
Costs in Excess of Net Assets of Acquired Businesses, net 17,898,000 210,000
Other Assets 7,473,000 8,009,000
------------ ------------
Total assets $320,488,000 $290,100,000
============ ============
</TABLE>
See notes to these condensed consolidated financial statements.
1
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<S> <C> <C>
Current Liabilities:
Current portion of notes payable $ 36,000 $ 99,000
Accounts payable 28,852,000 13,158,000
Accrued payroll and related expenses 3,268,000 1,719,000
Accrued interest on Senior Notes 3,375,000 8,435,000
Income taxes currently payable 43,000 520,000
Other accrued liabilities 4,575,000 1,269,000
------------ -----------
Total current liabilities 40,149,000 25,200,000
Long-Term Debt 150,000,000 150,017,000
Deferred Income Taxes 10,896,000 8,633,000
------------ ------------
Total liabilities 201,045,000 183,850,000
------------ ------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, $0.001 par value; 100,000,000 shares
authorized; 35,897,870 and 35,393,326 shares issued and
outstanding at September 30, 2000 and December 31, 1999,
respectively 36,000 35,000
Additional paid-in capital 182,784,000 173,345,000
Notes receivable from stockholders (200,000) (233,000)
Retained earnings (deficit) (62,508,000) (66,897,000)
Unrealized gains on investments 41,000 -
Deferred stock compensation (710,000) -
------------- ------------
Total stockholders' equity 119,443,000 106,250,000
------------ ------------
Total liabilities and stockholders' equity $320,488,000 $290,100,000
============ ============
</TABLE>
See notes to these cndensed cnsolidated financial statements.
2
<PAGE>
PAC-WEST TELECOMM, INC.
Condensed Consolidated Statements of Operations
and Comprehensive Income (Unaudited)
<TABLE>
<CAPTION>
Three Month Period Ended Nine Month Period Ended
------------------------------ ------------------------------
Sept. 30, 2000 Sept. 30, 1999 Sept. 30, 2000 Sept. 30, 1999
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues (Note 3) $ 35,981,000 $37,016,000 $100,127,000 $67,280,000
------------ ----------- ------------ -----------
Costs and Expenses:
Cost of sales and operating 10,919,000 5,794,000 31,123,000 14,547,000
Selling, general and administrative 14,587,000 5,463,000 37,607,000 15,026,000
Depreciation and amortization 5,774,000 2,455,000 14,752,000 5,747,000
------------ ----------- ------------ -----------
Total costs and expenses 31,280,000 13,712,000 83,482,000 35,320,000
------------ ----------- ------------ -----------
Income from operations 4,701,000 23,304,000 16,645,000 31,960,000
Other Expense (Income):
Interest expense 4,818,000 4,732,000 14,354,000 13,234,000
Interest income (1,790,000) (640,000) (6,059,000) (1,825,000)
Other income - - (18,000) -
------------ ----------- ------------ -----------
Total other expense, net 3,028,000 4,092,000 8,277,000 11,409,000
------------ ----------- ------------ -----------
Income before provision for income taxes 1,673,000 19,212,000 8,368,000 20,551,000
Provision for Income Taxes 912,000 9,190,000 3,982,000 9,725,000
------------ ----------- ------------ -----------
Net income 761,000 10,022,000 4,386,000 10,826,000
Accrued Preferred Stock Dividends - (1,227,000) - (3,552,000)
------------ ----------- ------------ -----------
Net income applicable to common stockholders $ 761,000 $ 8,795,000 $ 4,386,000 $ 7,274,000
=========== =========== ============ ===========
Basic net income per share $ 0.02 $ 0.50 $ 0.12 $ 0.41
Diluted net income per share $ 0.02 $ 0.43 $ 0.12 $ 0.40
Basic weighted average shares outstanding 35,878,204 17,587,458 35,804,098 17,587,458
Diluted weighted average shares outstanding 37,595,140 23,577,623 37,656,095 18,241,468
Comprehensive Income:
Net income $ 761,000 $ 8,795,000 $ 4,386,000 $ 7,274,000
Other comprehensive income from net
unrealized investment gains 221,000 - 41,000 -
------------ ----------- ------------ -----------
Comprehensive income $ 982,000 $ 8,795,000 $ 4,427,000 $ 7,274,000
=========== =========== ============ ===========
</TABLE>
See notes to these condensed consolidated financial statements.
3
<PAGE>
PAC-WEST TELECOMM, INC.
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine Month Period Ended
-------------------------------
Sept. 30, 2000 Sept. 30, 1999
-------------- --------------
<S> <C> <C>
Operating Activities:
Net income $ 4,386,000 $ 10,826,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 14,752,000 5,747,000
Amortization of deferred financing costs 640,000 950,000
Amortization of deferred stock compensation 198,000 -
Unrealized gain on investments 41,000 -
Gain on disposal of vehicles (18,000) -
Interest earned on restricted cash (38,000) (519,000)
Provision for doubtful accounts 570,000 75,000
Deferred income tax provision 2,223,000 5,243,000
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable (6,967,000) (1,201,000)
Income taxes receivable - 1,971,000
Inventories (917,000) (149,000)
Prepaid expenses and other current assets (225,000) (138,000)
Other assets (244,000) (1,222,000)
Accounts payable and accrued liabilities 15,427,000 13,666,000
Accrued interest on Senior Notes (5,060,000) 3,372,000
Income taxes payable (494,000) 4,112,000
------------ -------------
Net cash provided by operating activities 24,274,000 42,733,000
------------ -------------
Investing Activities:
Purchases of equipment, vehicles and leasehold improvements (71,420,000) (33,279,000)
Proceeds from disposal of vehicles 29,000 -
Redemption (purchase) of investments, net 19,580,000 (9,458,000)
Costs of acquisitions, net of cash received (11,005,000) -
------------ -------------
Net cash used in investing activities (62,816,000) (42,737,000)
------------ -------------
Financing Activities:
Proceeds from issuance of Senior Notes - 150,000,000
Proceeds from stock option exercises 135,000 -
Proceeds from repayment of note receivable from stockholders 33,000 -
Payments for financing costs (2,000) (6,105,000)
Repayment of senior secured borrowings - (100,000,000)
Principal payments on notes payable (80,000) (104,000)
------------ -------------
Net cash provided by financing activities 86,000 43,791,000
------------ -------------
Net increase (decrease) in cash and cash equivalents (38,456,000) (43,787,000)
Cash and Cash Equivalents:
Beginning of period 82,688,000 15,236,000
------------ -------------
End of period $ 44,232,000 $ 59,023,000
============ =============
</TABLE>
See notes to these condened consolidated financial statements.
4
<PAGE>
PAC-WEST TELECOMM, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
1. Basis of Presentation:
These accompanying unaudited condensed consolidated 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 three and nine month periods ended September 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000. The balance sheet at December 31, 1999 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 consolidated
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, 1999.
These consolidated financial statements include the results of operations
of Napa Valley Telecom (Napa Telecom), Installnet, Inc., and two other related
companies (collectively referred to as Installnet) and BTC Corp. (Baron
Telecommunications) since their acquisitions in January, February and September
2000, respectively (see Note 2).
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.
In January 2000, the Company acquired the customer base and certain other
assets of Napa Telecom, a switch-based, long distance telecommunications company
which was headquartered in Napa Valley, California. In February 2000, the
Company acquired all of the outstanding stock of Installnet, which is
headquartered in Southern California. Installnet was primarily in the business
of selling, installing and maintaining telecommunications equipment. In
September 2000, the Company acquired the customer base and certain other assets
of Baron Telecommunications which was headquartered in Seattle, Washington.
Baron Telecommunications provided telecommunications equipment to small and
medium sized businesses in Seattle and surrounding areas (see Note 6).
Effective November 1, 2000, the Company acquired the business and assets of
Communications Specialists, Inc., (CSI) a telecommunications company located in
Salt Lake City, Utah for cash and stock (see Note 17). The acquisition of
CSI's business customer base, distribution channels, and experienced technical
staff is consistent with Pac-West's strategy of accelerating our entry into new
markets through strategic acquisitions.
3. Revenue Recognition:
Revenues from the sale of telecommunications products are recognized in the
month in which the service is provided, except for reciprocal compensation
generated by calls placed to ISPs connected through the Company's network. The
rights of Competitive Local Exchange Carriers (CLECs), such as the Company, to
receive this type of compensation is the subject of numerous regulatory and
legal challenges (see Note 15). Until this issue is ultimately resolved, the
Company will continue to recognize reciprocal compensation revenue when received
in cash or when collectibility is reasonably assured.
Two Incumbent Local Exchange Carriers (ILECs) with which the Company has
interconnection agreements (see Note 15) 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 ILECs. Under the
<PAGE>
terms of the settlement, the ILEC paid $20.0 million to the Company. This
reciprocal compensation settlement is included in revenues for the three and
nine month periods ended September 1999.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101) "Revenue Recognition in Financial
Statements". SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition in financial statements, and will
be effective for the Company during the fourth quarter of 2000. We are
currently evaluating the impact of SAB 101, including recently released
interpretations and guidance, on our revenue recognition policies. At this
time, we do not expect that the effects of SAB 101 will have a material impact
on the Company's financial results.
Revenues from the sale of telecommunications products are recognized upon
installation, or if no installation is required, upon shipment.
4. Short-Term Investments:
All investments with an original maturity of greater than three months from
the date of acquisition are accounted for under Financial Accounting Standards
Board (FASB) Statement No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The Company determines the appropriate classification at the
time of purchase. All investments as of September 30, 2000 were classified as
available-for-sale and appropriately carried at fair value. Realized gains and
losses are included in interest income in the accompanying statements of
operations. Differences between cost and fair value are recorded as unrealized
gains and losses as a separate component of stockholders' equity. At September
30, 2000, $41,000 was recorded as unrealized gains on investments.
5. Equipment, Vehicles and Leasehold Improvements:
Equipment, vehicles and leasehold improvements include network and other
communications equipment, office furniture, business software and computer
equipment, vehicles, leasehold improvements and projects-in-progress. 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 $1,871,000 and $1,893,000 was recorded during the nine
month periods ended September 30, 2000 and 1999, respectively. Repair and
maintenance costs are expensed as incurred.
Equipment, vehicles and leasehold improvements at September 30, 2000 and
December 31, 1999 consist of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------------- --------------
<S> <C> <C>
Network and other communications
equipment.................................... $106,041,000 $ 71,142,000
Office furniture................................. 1,698,000 934,000
Business software and computer equipment......... 17,547,000 2,706,000
Vehicles......................................... 1,983,000 1,199,000
Leasehold improvements........................... 25,142,000 11,661,000
Projects-in-progress (see Note 12)............... 40,184,000 32,405,000
------------ ------------
192,595,000 120,047,000
Less: Accumulated depreciation and
amortization..................................... 27,578,000 14,858,000
------------ ------------
Equipment, vehicles and leasehold
improvements, net................................ $165,017,000 $105,189,000
============ ============
</TABLE>
Included in "network and other communications equipment" as of
September 30, 2000 is approximately $8.2 million, net of networking equipment
purchased from one supplier over the past 18 months. This equipment is being
upgraded subsequent to September 30, 2000, and will be returned to the supplier.
Management expects a full refund of all amounts paid related to this equipment
(approximately $3.9 million is included in accounts payable as of September 30,
2000 related to this equipment returned but not yet paid for). See Notes 11 and
12 for discussion of purchase commitments and financing of the new equipment.
<PAGE>
6. Costs in Excess of Net Assets of Acquired Businesses:
Costs in excess of net assets of acquired businesses primarily related to
the acquisitions of Napa Telecom, Installnet and Baron Telecommunications as
described in Note 2. Costs of all acquisitions consist of the following at
September 30, 2000:
<TABLE>
<CAPTION>
September 30,
2000
-------------
<S> <C>
Napa Telecomm..................................................... $ 3,612,000
Installnet........................................................ 14,810,000
Baron Telecommunications.......................................... 1,295,000
Other*............................................................ 205,000
-----------
$19,922,000
Less: accumulated amortization ................................... 2,024,000
-----------
Costs in excess of net assets of acquired businesses, net......... $17,898,000
===========
* Acquired prior to January 2000.
</TABLE>
Costs in excess of net assets acquired are being amortized over a period of
60 months for Napa Telecom and 84 months for Installnet and Baron
Telecommunications. The amortization amounts are included within depreciation
and amortization in the accompanying Consolidated Statements of Operations.
7. Other Assets:
At September 30, 2000 and December 31, 1999, other assets consist of the
following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Deferred financing costs................ $5,021,000 $5,648,000
Acquisitions of lease rights............ 1,320,000 1,513,000
Long-term portion of prepaid
expenses and deposits............... 1,132,000 848,000
---------- ----------
$7,473,000 $8,009,000
========== ==========
</TABLE>
Deferred financing costs consist primarily of capitalized amounts for
underwriter fees, professional fees and other expenses related to the issuance
and subsequent registration of the $150,000,000 Senior Notes. These deferred
financing costs are being amortized on a straight-line basis (which approximates
the effective interest method) over the estimated 10-year term of the notes
beginning January 29, 1999. Amortization of deferred financing costs for the
nine month periods ended September 30, 2000 and 1999 were $640,000 and $950,000,
respectively, and were $213,000 and $175,000 for the three month periods ended
September 30, 2000 and 1999, respectively. These amortization amounts are
included within interest expense in the accompanying statements of operations.
Acquisition of lease rights pertain to the purchase of lease rights in 1999
for additional space in Los Angeles, which costs are being amortized over the
life of the lease.
<PAGE>
8. Income Taxes:
The Company's effective income tax rate for the three and nine month
periods ended September 30, 2000 was 55% and 48%, respectively. The effective
income tax rate for the three and nine month periods ended September 30, 1999
was 48% and 47%, respectively. These rates reflect the applicable federal and
state statutory income tax rates along with the tax impact of the non-
deductibility of certain acquisition related amortization and the previously
stated reciprocal compensation settlement in 1999.
9. Other Comprehensive Income:
In September 1997, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income". SFAS No. 130
establishes the disclosure requirements for comprehensive income and its
components within the financial statements. For the three and nine month periods
ended September 30, 2000, there was $221,000 and $41,000, respectively, of other
comprehensive income pertaining to net unrealized investment gains. There were
no items of other comprehensive income for the three and nine month periods
ended September 30, 1999; therefore, comprehensive income was the same as net
income for those periods.
10. Other Recent Pronouncements:
In June 1998, the FASB issued 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 to have
a significant impact on the Company's financial statements in future periods.
In March 2000, the FASB issued Financial Accounting Standards Board
Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving
Stock Compensation - an Interpretation of APB No. 25". FIN 44 is effective July
1, 2000. FIN 44 clarifies the application of Accounting Principles Board Opinion
No. 25 for certain issues, specifically, (a) the definition of an employee, (b)
the criteria for determining whether a plan qualifies as a compensatory plan,
(c) the accounting consequence of various modifications to the terms of a
previous fixed stock option or award, and (d) the accounting for an exchange of
stock compensation awards in a business combination. The Company is in
compliance with FIN 44.
11. Long-Term Debt:
Long-term debt at September 30, 2000 and December 31, 1999 consist of the
following:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Senior Notes............................ $150,000,000 $150,000,000
Notes payable, less current portion..... - 17,000
------------------ -----------------
Total long-term debt.................... $150,000,000 $150,017,000
================== =================
</TABLE>
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 costs in connection with 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 senior credit facility bear
interest, at the Company's option, at (1) the Base Rate (as defined in our
senior credit facility) or (2) the LIBOR Rate (as defined in our senior credit
facility) plus between 2.25% and 3.5%. As of September 30, 2000, there were no
amounts outstanding under this facility and the borrowing rate would have been
8.87%.
In October 2000, the Company secured a lease facility of up to $20 million
to be used exclusively for networking products and services. Approximately $10
million of orders will be initially financed through this facility (see Note
12). The equipment financed under this facility will be leased for a term of 36
months at which time the Company may purchase the equipment at fair market
value. Purchases under this facility will be accounted for as a capital lease.
<PAGE>
12. Purchase Commitments:
At September 30, 2000, the Company had approximately $20 million of
purchase orders outstanding for network products and services due for delivery
in 2000. Approximately $10 million of these purchases will be financed through a
lease facility (see Note 11) and the balance is expected to be financed from
existing cash and short-term investments, from internally generated cash flows,
or from borrowings under the senior credit facility.
The Company is in the process of implementing new billing and operations
support systems. Total estimated costs for these systems aggregate approximately
$15.0 million, of which approximately $12.4 million of the total cost has been
incurred through September 30, 2000 and $1.1 million and $1.5 million of the
total cost is expected to be incurred during the balance of 2000 and 2001,
respectively. The $12.4 million incurred to date is recorded in Business
software and computers at September 30, 2000 (see Note 5).
The Company is also in the process of implementing a new Oracle business
enterprise and financial software system. Estimated costs for this system are
$5.0 million, of which $2.6 million has been incurred and is also recorded in
Business software and computers at September 30, 2000 (see Note 5).
On June 30, 2000, the Company entered into an Indefeasible Right of Use
("IRU") agreement with Qwest Communications to acquire dedicated fiber optics
circuits of OC-48 capacity connecting major metropolitan areas in California.
The IRU agreement is for a term of 20 years and includes one dollar purchase
options at the end of the term. The total cost of the IRU is approximately $23.0
million of which $5.7 million was paid on July 28, 2000 and the balance is
payable on June 30, 2001. The purchase price of approximately $23.0 million is
included in projects-in-progress and $17.2 million is in accounts payable at
September 30, 2000.
13. Stockholders' Equity:
Common and Preferred Stock
During the third quarter of 2000 the Board of Directors approved to amend
and restate the Articles of Incorporation of the Company so that the number of
authorized shares of common stock be increased from 50,000,000 to 100,000,000.
The Board of Directors also authorized to issue 10,000,000 shares of preferred
stock as they determine.
Stock Options
As of September 30, 2000 an aggregate of 5,375,500 shares of common stock
have been reserved for option grants under the Company's 1999 Stock Incentive
Plan, the 1998 Griffin and Bryson Non-Qualified Stock Incentive Plans and the
Company's 2000 Napa Valley Non-Qualified Stock Incentive Plan. This amount
includes an additional 2,225,500 of shares authorized during the third quarter
of 2000. During the nine month period ended September 30, 2000, options to
purchase 1,053,600 shares of common stock were granted, options to purchase
172,525 shares of common stock were canceled and options to purchase 62,441
shares of common stock were exercised.
<PAGE>
The following table summarizes information about the Company's stock options
outstanding as of September 30, 2000:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------------- ------------------------------------
<S> <C> <C> <C> <C>
Weighted
Number Outstanding Average Number
at September 30, Contractual Weighted Exercisable at Weighted
2000 Life Remaining Average September 30, Average
(Years) Exercise Price 2000 Exercise Price
-------------------- ------------------ ------------------ ------------------- -----------------
2,595,934 8.7 $ 6.44 1,045,251 $3.10
447,350 9.4 $28.52 -- --
--------------------
3,043,284 8.8 $ 9.69 1,045,251 $3.10
==================== ===================
</TABLE>
Employee Stock Purchase Plan
In the third quarter of 2000 the Company established the 2000 Employee Stock
Purchase Plan (the Purchase Plan) under which 1,000,000 shares of common stock
have been reserved for issuance. Employees who are eligible may designate up to
10% of their cash compensation, not to exceed $25,000 worth of common stock in
any one calendar year, which is deducted each pay period for the purchase of
common stock under the Purchase Plan. On the last business day of each six
month period, shares of common stock are purchased with the employees' payroll
deductions at 85% of the lesser of the market price on the first or last day of
the six month period. The Purchase Plan will terminate no later than May 2,
2020.
14. Income Per Share:
Net income per share for the three month periods ended September 30, 2000 and
1999 has been determined as follows:
<TABLE>
<CAPTION>
For the Three Month Period Ended
September 30, 2000
-----------------------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------ -------------------- ---------------
<S> <C> <C> <C>
Basic net income per share:
Net income applicable to common stockholders $761,000 35,878,204 $0.02
=====
Effect of Dilutive Securities:
Stock options 0 1,716,936
--------- -----------
Diluted net income per share:
Income available to common
stockholders $761,000 37,595,140 $0.02
======== ========== =====
</TABLE>
<PAGE>
<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 $10,022,000 23,577,623 $0.43
=========== ========== =====
</TABLE>
Net income per share for the nine month periods ended September 30, 2000 and
1999 has been determined as follows
<TABLE>
<CAPTION>
For the Nine Month Period Ended
September 30, 2000
-------------------------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------ -------------------- -----------------
<S> <C> <C> <C>
Basic net income per share:
Net income applicable
to common stockholders $4,386,000 35,804,098 $0.12
=====
Effect of Dilutive Securities:
Stock options 0 1,851,997
---------- ----------
Diluted net income per share:
Income available to common
stockholders $4,386,000 37,656,095 $0.12
========== ========== =====
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
For the Nine 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 $7,274,000 17,587,458 $0.41
=========
Effect of Dilutive Securities:
Convertible redeemable preferred stock (1) N/A N/A
Stock options 0 654,010
---------- -----------
Diluted net income per share:
Income available to common
stockholders $7,274,000 18,241,468 $0.40
========== =========== =========
</TABLE>
(1) The impact of including assumed conversion of convertible redeemable
preferred stock for the nine month period ended September 30, 1999 is
antidilutive.
15. Legal Proceedings:
The Company has established interconnection agreements with certain ILECs.
The Telecommunications Act of 1996 requires ILECs to enter into interconnection
agreements with CLECs, such as the Company and other competitors, and requires
state Public Utilities Commissions (PUCs) to arbitrate such agreements.
The interconnection agreements outline, among other items, compensation
arrangements for calls originating or terminating in the other party's switching
equipment, payment terms, and level of services.
Various ILECs have alleged, and are continuing to allege, that internet
traffic calls made to an ISP are not local calls, and as such are not covered by
the interconnection agreements.
The Company is a party to various legal proceedings, including the Pacific
Bell and California Public Utilities Commission (CPUC) and the Nevada Bell and
Public Utilities Commission of Nevada proceedings, relating to reciprocal
compensation payment and other interconnection agreement issues.
In February 1999 the Federal Communications Commission (FCC) issued a
Declaratory Ruling on the issue of reciprocal compensation for calls bound to
ISPs. The FCC ruled that the calls are jurisdictionally mixed, but largely
interstate calls. The FCC, however, determined that this issue did not resolve
the question of whether reciprocal compensation is owed. The FCC noted a number
of factors that would allow the state PUCs to leave their decisions requiring
the payment of compensation undisturbed. On March 17, 2000, the U.S. Courts of
Appeals for the District of Columbia vacated the FCC's declaratory ruling and
remanded the matter to the FCC. The court determined that the FCC has not
provided a reasonable basis for treating calls to ISP's differently from other
local calls, and therefore reciprocal compensation should apply.
Further, in February 2000 the CPUC commenced a separate generic proceeding
to develop its policy regarding reciprocal compensation. Similarly, in September
2000 the Colorado Commission commenced a similar investigation into intercarrier
compensation issues.
We cannot predict the impact of the FCC's ruling on existing state
decisions or the outcome of pending appeals or on additional cases in this
matter. Given the uncertainty concerning the final outcome of the PUCs
proceedings, the possibility of future extended appeals or additional
litigation, and future decisions by the FCC, we continue to recognize the
revenue associated with reciprocal compensation billings to ILECs when received
in cash or when collectibility is reasonably assured.
<PAGE>
16. Segment Reporting:
The following tables present consolidated revenues by service type:
<TABLE>
<CAPTION>
Three Month Periods Ended
-------------------------
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Local services...................................................... $26,628,000 $32,606,000
Long distance service............................................... 4,105,000 2,065,000
Dedicated transport services........................................ 1,860,000 1,346,000
Product and services................................................ 2,855,000 675,000
Other .............................................................. 533,000 324,000
----------- -----------
$35,981,000 $37,016,000
=========== ===========
Nine Month Periods Ended
------------------------
September 30, September 30,
2000 1999
------------- -----------
Local services...................................................... $73,207,000 $55,418,000
Long distance service............................................... 12,239,000 5,845,000
Dedicated transport services........................................ 5,524,000 3,599,000
Product and services................................................ 7,313,000 1,283,000
Other............................................................... 1,844,000 1,135,000
----------- -----------
$100,127,000 $67,280,000
============ ===========
</TABLE>
17. Subsequent Event:
Effective November 1, 2000 the Company acquired the business and assets of
Communications Specialists, Inc., a telecommunications company located in Salt
Lake City, Utah. The total purchase price, which was paid in cash and stock was
approximately $0.8 million. The acquisition will be accounted for using the
purchase method.
<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, the successful execution of
our expansion activities into new geographic markets on a timely and cost-
effective basis; the pace at which new competitors enter our existing and
planned markets; competitive responses of the Incumbent Local Exchange Carriers
(ILECs); execution of interconnection agreements with ILEC's on terms
satisfactory to us; maintenance of our supply agreements for transmission
facilities; continued acceptance of our services by new and existing customers;
the outcome of legal and regulatory proceedings regarding reciprocal
compensation for Internet-related calls and certain of our product offerings;
the ability to attract and retain talented employees; and our ability to
successfully access markets, install switching electronics, and obtain the use
of leased fiber transport facilities and any required governmental
authorizations, franchises and permits, all in a timely manner, at reasonable
costs and on satisfactory term and conditions, as well as regulatory,
legislative and judicial developments that could cause actual results to differ
materially from the future results indicated, expressed, or implied, in such
forward-looking statements. These and other factors are discussed in our
Prospectus dated November 3, 1999, and in our annual report as of December 31,
1999, on Form 10-K as filed with the Securities and Exchange Commission (SEC).
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. As discussed in Note 2 in
the accompanying Unaudited Condensed Consolidated Financial Statements, the
Company acquired the customer base and certain assets of Napa Telecom in January
2000, acquired all of the outstanding stock of Installnet in February 2000 and
acquired the customer base and certain assets of Baron Telecommunications in
September 2000. Each of these acquisitions have been included in our results
of operations from the date of acquisition.
For the three and nine month periods ended September 30, 2000, recognizing
compensation from other communications companies for completing their customers'
calls only to the extent such compensation was actually received in cash or when
collectibility was reasonably assured, we had net revenues of $36.0 million and
$100.1 million, respectively, and EBITDA of $10.5 million and $31.4 million,
respectively.
As of September 30, 2000, we had 169,050 lines in service, a 92% increase
from September 30, 1999. For the three and nine month periods ended September
30, 2000 our minutes of use were 6.1 billion and 17.1 billion, respectively, an
increase of 52% and 61%, respectively, over the same periods in 1999.
Factors Affecting Operations:
Revenues. We derive our revenues from monthly recurring charges, usage
charges, initial non-recurring charges and sales and service of telephone
equipment. 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 for completion of their
customers' calls through Pac-West, and access charges paid by carriers for long
distance traffic terminated by Pac-West. Initial non-recurring charges are paid
by end users, if applicable, for the installation of our service.
<PAGE>
We derive a substantial portion of our revenues from reciprocal
compensation paid by ILECs with which we have interconnection agreements.
Reciprocal compensation revenue increased in recent fiscal quarters as a result
of increasing inbound call volume from our ISP and other customers, and, as
described below, the effect of certain ILEC's discontinuing the withholding of
certain reciprocal compensation payments. Such increases in revenues, however,
were partially offset by lower contractual rates for reciprocal compensation. As
recently as fiscal year 1999, two ILECs with which we have interconnection
agreements refused to pay that portion of reciprocal compensation due under
their interconnection agreements that they estimated was the result of inbound
calls terminating to ISPs. These ILECs contended, and continue to contend, that
such ISP calls are not local calls within the meaning of their respective
interconnection agreements and that no reciprocal compensation is therefore
payable. In September 1999, a settlement agreement was entered into for
previously withheld reciprocal compensation, whereby $20.0 million was paid to
us and is included in revenue for the three month period ended September 30,
1999 (see Note 3 to accompanying Unaudited Condensed Consolidated Financial
Statements). For both the three and nine month periods ended September 30, 2000,
recorded reciprocal compensation accounted for 45% of revenues. For the three
and nine month periods ended September 30, 1999, recorded reciprocal
compensation accounted for 37% and 40%, respectively, of revenues excluding the
$20.0 million reciprocal compensation revenue settlement, and 71% and 58%,
respectively, of revenues including the settlement.
While these ILECs have been paying us the full amount of our reciprocal
compensation billings since the latter half of 1999, some of these payments may
be subject to a reservation of rights to appeal, contest or seek subsequent
reimbursement of amounts previously paid by them for 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 1999 renewal agreement is significantly lower than
it was under our previous agreement. Based on current market conditions, we
expect the per minute reciprocal compensation rate will continue to decline from
historic rates under interconnection agreements in the future.
Operating Costs. Operating costs are comprised primarily of leased
transport charges, usage charges for long distance and intrastate calls and, to
a lesser extent, reciprocal compensation related to calls that originate with a
Pac-West customer and terminate on the network of an 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 (S,G&A) expenses include network operation, 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 and premise leases. We
expect that these costs will grow significantly as we expand our operations and
that sales, marketing and administrative overhead will be a large portion of
these expenses during the start-up phase in each of our new markets.
<PAGE>
Quarterly Operating and Statistical Data:
The following tables summarize the results of operations as a percentage of
revenues for the three and nine month periods ended September 30, 2000 and 1999.
The following data should be read in conjunction with the Unaudited Condensed
Consolidated Financial Statements and notes thereto included elsewhere in this
report:
<TABLE>
<CAPTION>
Three Month Periods Ended
September 30,
--------------------------------------
2000 1999 1999
--------------------------------------
Consolidated Statements of Operations Data: (including (excluding
settlement) settlement)
<S> <C> <C>
Revenue......................................... 100.0% 100.0% 100.0%
Costs of sales and operating costs.............. 30.3% 15.7% 34.1%
Selling, general and administrative expenses.... 40.6% 14.8% 32.1%
Depreciation and amortization expenses.......... 16.0% 6.6% 14.4%
Income from operations.......................... 13.1% 62.9% 19.4%
Net income (loss)............................... 2.1% 27.1% (2.8)%
</TABLE>
<TABLE>
<CAPTION>
Nine Month Periods Ended
September 30,
---------------------------------------
2000 1999 1999
---------------------------------------
Consolidated Statements of Operations Data: (including (excluding
settlement) settlement)
<S> <C> <C> <C>
Revenue.......................................... 100.0% 100.0% 100.0%
Costs of sales and operating costs............... 31.1% 21.6% 30.8%
Selling, general and administrative expenses..... 37.6% 22.3% 31.8%
Depreciation and amortization expenses........... 14.7% 8.6% 12.1%
Income from operations........................... 16.6% 47.5% 25.3%
Net income....................................... 4.4% 16.1% 0.7%
</TABLE>
The following table sets forth unaudited statistical data for each of the
specified quarters of 1999 and 2000. The statistical data for any quarter is not
necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
1999 2000
-------------------------------------------------------------------------------
Mar. 31 Jun. 30 Sept. 30 Dec. 31 Mar. 31 Jun. 30 Sept. 30
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Ports equipped.................... 251,520 309,120 309,120 460,800 460,800 518,400 576,000
Lines sold to date................ 74,026 80,984 97,117 116,391 135,143 164,800 181,045
Lines in service to date.......... 67,691 76,263 88,009 105,147 124,340 151,957 169,050
Estimated data lines (% of
installed lines) ............... 85% 82% 76% 73% 72% 77% 75%
Lines on switch % ................ 96% 96% 96% 96% 94% 96% 96%
Internet service provider and
enhanced communications
service provider customer
lines collocated %.............. 83% 81% 83% 83% 84% 88% 76%
Quarterly minutes of use switched
(in millions)................... 3,116 3,523 4,020 4,552 5,378 5,626 6,110
Metropolitan statistical areas
served.......................... 25 25 25 25 26 26 27
Capital expenditures (in
thousands)...................... $ 3,633 $ 18,275 $ 11,371 $ 23,091 $ 11,610 $ 43,518 $ 16,292
Employees (consolidated).......... 168 187 216 271 482 551 630
</TABLE>
<PAGE>
Three Month Period Ended September 30, 2000 Compared to the Three Month Period
Ended September 30, 1999:
Consolidated revenues for the three month period ended September 30, 2000
were $36.0 million compared to $37.0 million for the corresponding period in
1999, a decrease of 3%. The decrease in revenues is due to revenue that was
received in connection with the reciprocal compensation settlement and recorded
as revenue in the third quarter of 1999. Excluding the reciprocal compensation
settlement, third quarter revenues increased 111% from revenues of $17.0 million
in the third quarter of 1999. Local interconnection revenues increased $9.8
million (excluding the reciprocal compensation settlement), revenues from
recurring charges and installation charges billed directly to ISPs increased
$2.0 million and local and long distance usage revenues increased $1.9 million
in the third quarter of 2000 compared to the same period ended 1999. In
addition, during the third quarter of 2000, we recorded $2.7 million in product
and service revenues from Installnet, which we acquired in February 2000.
During the first nine months of 1999, we activated a new higher capacity
switch in Oakland, continued to expand our switching capacity in Los Angeles and
finished construction of a switching facility in Las Vegas. During the fourth
quarter of 1999, we installed a second switching system at our Los Angeles
facility and constructed a switching facility in Seattle. During the second
quarter of 2000, we increased the capacity of our switching facilities in
Oakland and Stockton. As a result of additional switch capacities, the increased
utilization of our expanded switch capacities and the acquisitions completed
during 2000, our revenues for the three month period ended September 30, 2000
increased 111% from the three month period ended September 30, 1999, excluding
the reciprocal compensation settlement received in the third quarter of 1999.
Additionally, the Company increased access lines to small and medium businesses
to 41,842 as of September 30, 2000, a 127% increase from the same period ended
in 1999. The Company attributes this growth to its increased sales force and
continued strong demand for bundled communications services.
The total number of access lines in service increased 92% to 169,050 as of
September 30, 2000 from 88,009 lines as of September 30, 1999. Billable minutes
of use were 6.1 billion during the three months ended September 30, 2000, up 52%
from the 4.0 billion billed during the same period in 1999.
The number of inbound local calls and the minutes subject to reciprocal
compensation revenues in accordance with interconnection agreements increased
30% and 52% during the third quarter of 2000 over the third quarter of 1999,
respectively. The effect of these significant increases in inbound local calls
and minutes combined with Pacific Bell and GTE no longer withholding reciprocal
compensation payments on a portion of our billings resulted in a $9.9 million,
or 159%, increase in paid interconnection revenues for the three month period
ended September 30, 2000 over the corresponding period in 1999, excluding the
$20 million reciprocal compensation settlement received in the third quarter of
1999.
Direct billings to ISPs increased in the third quarter of 2000 by $2.0
million, or 44%, from the corresponding three month period in 1999. Lines in
service to ISPs increased from 64,795 lines at September 30, 1999 to 117,595
lines at September 30, 2000, an increase of 81%.
The $1.9 million increase in outbound local and long distance revenues,
including 800, 888, and 877 numbers and travel card calls, represented a 91%
increase for the three months ended September 30, 2000 over the corresponding
period in 1999. This increase is directly related to internal growth and the
acquisition of Napa Telecom customers, acquired in January 2000. These increases
are the result of Pac-West's focus on providing services to high-volume,
telecommunications intensive users and small and medium businesses.
Our consolidated cost of sales and operating costs for the three month
period ended September 30, 2000 increased $5.1 million, to $10.9 million from
$5.8 million for the corresponding period in 1999. This increase in costs was
primarily due to an increase in network operations associated with a higher
level of telecommunications activity. In addition, we continue to make
significant investments in our telephone infrastructure to accommodate future
growth of our communications services. Excluding the reciprocal compensation
settlement in the third quarter of 1999 , cost of sales and operating costs
represented 30% of revenues in the third quarter of 2000 compared to 34% for the
corresponding 1999 three month period.
Our consolidated S,G&A expenses for the three month period ended September
30, 2000 increased $9.1 million to $14.6 million from $5.5 million for the
corresponding period in 1999. The increase in S,G&A
<PAGE>
expenses was primarily a result of additional employees hired to accommodate the
growth in our business, including 127 additional employees in Pac-West's sales
and marketing departments; 42 additional network employees; 88 additional
service technicians; 54 additional customer service representatives; and 103
additional employees in other administration and information technology
functions. These new hires increased the total number of Pac-West employees from
216 at September 30, 1999 to 630 at September 30, 2000, which includes employees
from the acquired companies. S,G&A expenses were 41% of revenues for the three
month period ended September 30, 2000 as compared to 32% for the corresponding
period in 1999, excluding the $20 million revenue reciprocal compensation
settlement in the third quarter of 1999. As expected, these costs are increasing
and represent a larger percentage of revenue as we expand our operations.
Our consolidated depreciation and amortization expense for the three month
period ended September 30, 2000 increased $3.3 million to $5.8 million from $2.5
million for the corresponding period in 1999. The increase in depreciation and
amortization expense was primarily due to additional depreciation expense
incurred on purchases of equipment between periods. During the twelve months
between September 30, 1999 and September 30, 2000, the Company purchased an
additional $71.5 million of equipment, excluding $23 million of dedicated fiber
optics circuits purchased in June 2000, which we have not started depreciating
(see Note 12 in the accompanying financial statements).
Our consolidated interest expense for the three month period ended
September 30, 2000 slightly increased to $4.8 million from $4.7 million in the
corresponding period in 1999. Interest expense is net of amounts capitalized of
$0.6 million and $0.5 million for the three month periods ended September 30,
2000 and 1999, respectively.
The Company's effective income tax rate for the three month periods ended
September 30, 2000 and 1999 was 55% and 48%, respectively. These rates reflect
the applicable federal and state statutory income tax rates along with the tax
impact of the non-deductibility of certain acquisition-related amortization
expense and the tax impact of the reciprocal compensation settlement in the
third quarter of 1999.
Nine Month Period Ended September 30, 2000 Compared to the Nine Month Period
Ended September 30, 1999:
Consolidated revenues for the nine month period ended September 30, 2000
increased $32.8 million to $100.1 million from $67.3 million for the
corresponding period in 1999. The increase in revenues is attributed to an
increase in paid local interconnection revenues of $6.2 million, or a $26.2
million increase excluding the $20 million reciprocal compensation settlement in
the third quarter of 1999, an increase of $5.2 million in recurring charges and
installation charges billed directly to ISPs, an increase of $6.0 million in
local and long distance usage revenues, and $6.8 million in product and service
revenues from Installnet, which we acquired in February 2000.
As a result of additional switch capacities and increased utilization of
our expanded switch capacities, described above, our consolidated revenues for
the nine month period ended September 30, 2000 increased 49%, or 112% excluding
the $20 million reciprocal compensation settlement in the third quarter of 1999
from the nine month period ended September 30, 1999. This increase in revenues
was also the result of an increase in access lines to small and medium
businesses which total 41,842 lines as of September 30, 2000, a 127% increase
from the same period ended in 1999. The Company attributes this growth to its
increased sales force and continued strong demand for bundled communications
services.
The total number of access lines in service increased 92% to 169,050 as of
September 30, 2000 from 88,009 lines as of September 30, 1999. Billable minutes
of use were 17.1 billion during the nine months ended September 30, 2000, up 61%
from the 10.7 billion billed during the same period in 1999.
The number of inbound local calls and the minutes subject to reciprocal
compensation revenues in accordance with interconnection agreements increased
36% and 60% during the first nine months of 2000 over the first nine months of
1999, respectively. The effect of these significant increases in inbound local
calls and minutes combined with Pacific Bell and GTE no longer withholding
reciprocal compensation payments on a portion of our billings, partially offset
by lower contractual reciprocal compensation rates, resulted in a $6.2 million,
or 15.9%, increase ($26.2, or 138% increase excluding the $20 million reciprocal
compensation
<PAGE>
received in 1999) in paid interconnection revenues for the nine month period
ended September 30, 2000 over the corresponding period in 1999.
Direct billings to ISPs also increased in the first nine months of 2000 by
$5.2 million, or 40%, from the nine month period ended 1999. Lines in service to
ISPs increased from 64,715 lines at September 30, 1999 to 117,595 lines at
September 30, 2000, an increase of 81%.
The $6.0 million increase in outbound local and long distance revenues,
including 800, 888, and 877 numbers and travel card calls, represented a 102%
increase for the nine months ended September 30, 2000 over the corresponding
period in 1999. This increase is directly related to internal growth and the
acquisition of Napa Telecom customers, acquired in January 2000. These increases
are the result of our focus on providing services to high-volume,
telecommunications intensive users and small and medium businesses.
Our consolidated cost of sales and operating costs for the nine month
period ended September 30, 2000 increased $16.6 million to $31.1 million from
$14.5 million for the corresponding period in 1999. This increase in costs is
primarily due to an increase in network operations associated with a higher
level of telecommunications activity. In addition, we continue to make
significant investments in our telephone infrastructure to accommodate future
growth of our communications services. Excluding the reciprocal compensation
settlement in the third quarter of 1999, costs of sales and operating costs
represented 31% of revenues for the nine month periods ended September 1999 and
2000.
Our consolidated S,G&A expenses for the nine month period ended September
30, 2000 increased $22.6 million to $37.6 million from $15.0 million for the
corresponding period in 1999. This increase is primarily due to an increase in
headcount as we hired employees to accommodate the growth of our business.
Specifically, we increased our employees from 216 at September 30, 1999 to 630
at September 30, 2000, including employees from the acquired companies. The
acquisition of Installnet in February 2000 represented $5.7 million of the
increase in S,G&A expenses. Our S,G&A expenses were 38% of revenues for the nine
months ended September 30, 2000 as compared to 32% for the corresponding period
in 1999, excluding the $20 million reciprocal compensation settlement in the
third quarter of 1999. As expected, these costs are increasing and represent a
larger percentage of revenue as we expand our operations.
Our consolidated depreciation and amortization expense for the nine month
period ended September 30, 2000 increased $9.1 million to $14.8 million from
$5.7 million for the corresponding period in 1999. The increase in depreciation
and amortization expense was primarily due to additional depreciation expense
incurred on purchases of equipment between periods. During the twelve months
between September 30, 1999 and September 30, 2000, the Company purchased an
additional $71.5 million of equipment, excluding $23 million of dedicated fiber
optics circuits purchased in June 2000, which we have not started depreciating
(see Note 12 in the accompanying Unaudited Condensed Consolidated Financial
Statements).
Our consolidated interest expense for the nine month period ended September
30, 2000 increased to $14.4 million from $13.2 million in the corresponding
period in 1999. The increase in interest expense was primarily due to nine
months of interest expense in the nine month period ended September 30, 2000 on
the $150 million Senior Notes issued on January 29, 1999 compared to eight
months of interest expense during the corresponding period in 1999. Interest
expense is net of amounts capitalized of $1.9 million in each of the nine month
periods ended September 30, 2000 and 1999, respectively.
The Company's effective income tax rate for the nine month period ended
September 30, 2000 and 1999 was 48% and 47%, respectively. These rates reflect
the applicable federal and state statutory income tax rates along with the tax
impact of the non-deductibility of certain acquisition-related amortization
expense and the tax impact of the reciprocal compensation settlement in the
third quarter of 1999.
<PAGE>
Liquidity and Capital Resources:
Net cash provided by operating activities was $24.3 million for the nine
month period ended September 30, 2000 compared to $42.7 million for the
corresponding period in 1999. This decrease is primarily attributable to a $10.1
million semi-annual interest payment on the Senior Notes in the third quarter of
2000, increases in accounts receivable of $7.0 million, and the timing of cash
payments for income taxes between periods. On June 30, 2000 the Company entered
into an Indefeasible Right of Use ("IRU") agreement to acquire dedicated fiber
optics circuits at a price of approximately $23 million. Of this amount, $5.7
million was paid on July 28, 2000 and the balance is in accounts payable which
is payable on June 30, 2001. (See Note 12 in the accompanying Unaudited
Condensed Consolidated Financial Statements.)
Net cash used in investing activities was $62.8 million for the nine month
period ended September 30, 2000 compared to $42.7 million for the corresponding
period in 1999. During the nine month period ended September 30, 2000, the
Company invested approximately $71.4 million in new switching and related
equipment and network facilities, compared to $33.3 million during the
corresponding period in 1999. (See Note 12 in the accompanying financial
statements.) In 1999, $19.7 million of the proceeds from the senior note
offering were used to purchase short-term investments to fund an interest
reserve trust account for the first two scheduled interest payments on the
Senior Notes, less redemption of $10.2 million to pay the first scheduled
interest payment. In February 2000, the remaining balance of the interest
reserve trust account was redeemed to pay the second scheduled interest payment
of $10.1 million. Also, in 2000, $11.0 million was paid to acquire Napa Telecom,
Installnet and Baron Telecommunications.
Net cash provided by financing activities was $0.1 million for the nine
month period ended September 30, 2000 compared to $43.8 million for the
corresponding period in 1999. 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, which were partially offset by the payoff of
$100 million of senior secured borrowings.
The local telecommunications service 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 were $71.4 million for the first nine months of
2000, and $56.4 million for the year ended December 31, 1999. Of the capital
expenditures during 1999 and the first nine months of 2000, $40.2 million was
included in projects-in-progress at September 30, 2000 and therefore is not
being depreciated until placed in service in 2000. We have budgeted to make
additional capital expenditures of approximately $40.0 million during the
balance of 2000, excluding acquisitions. 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 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.
Our senior credit 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 our senior credit facility; or
(2) the LIBOR rate, as defined in our senior credit facility plus between 2.25%
and 3.5%. As of September 30, 2000, there were no amounts outstanding under this
facility and the borrowing rate would have been approximately 8.87%. Any
borrowings under our senior credit facility will be secured by substantially all
of our assets. Our senior credit facility has a three year term expiring June
2002.
In October 2000 the Company secured a lease facility of up to $20 million
to be used exclusively for the acquisition of Cisco networking equipment and
related services. The Company has ordered approximately $10 million of
networking equipment and related services to be financed under this lease
facility and anticipates utilizing the remainder of the facility by the third
quarter of 2001. These purchases will be recorded as capital leases.
Our principal sources of funds for the balance of 2000 are anticipated to
be current cash and short-term investment balances, cash flows from operating
activities, and if necessary, borrowings under the senior credit facility. We
believe that these funds will provide us with sufficient liquidity and capital
resources for us to fund our business plan for at least the next twelve months.
No assurance can be given, however, that this will be the case. The foregoing
statements do not take into account additional acquisitions which, if made, are
expected to be funded through a combination of cash and equity. Depending upon
our rate of growth and
<PAGE>
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.
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, 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:
During 1999, management completed the process of preparing for the Year
2000 date changes. This process involved identifying and remediating date
recognition problems in computer systems, software and other operating
equipment, working with third parties to address their Year 2000 issues, and
developing contingency plans to address potential risks in the event of Year
2000 failures. To date, we have successfully managed the transition. Although
considered unlikely, unanticipated problems in our core business processes,
including problems associated with non-compliant third parties and disruptions
to the economy in general could still occur despite efforts to date to remediate
affected systems and develop contingency plans. Management will continue to
monitor all business processes, including interaction with our customers,
vendors and other third parties, throughout 2000 to address any issues and
ensure all processes continue to function properly.
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 September 30, 2000 we had
$150 million of fixed rate notes outstanding, and consequently we currently have
no risk exposure associated with increasing interest rates on our debt. In
addition, we have a line of credit which may, at our option, have a variable
interest rate tied to LIBOR; however there were no amounts outstanding at
September 30, 2000. We are, however, exposed to changes in interest rates on our
investments in cash equivalents and short-term investments. Substantially all of
our investments in cash equivalents and short-term investments are in money
market funds that hold short-term investment grade commercial paper, treasury
bills or other U.S. government obligations. Currently this reduces our exposure
to long-term interest rate changes. We do not use interest rate derivative
instruments to manage our exposure to interest rate changes. A hypothetical 100
basis point decline in short-term interest rates would reduce the annualized
earnings on our $104.9 million of cash equivalents and short-term investments at
September 30, 2000 by approximately $1.0 million.
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings
See Note 15 to the Unaudited Condensed Consolidated 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 the Company.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders was held on July 27,
2000. The following proposals were adopted by the margins indicated:
1. To elect three members of our Board of Directors to hold office until
their successors are elected and qualified.
Number of Shares
For Withheld
--- ---------
Wallace W. Griffin 32,362,948 108,827
Jerry L. Johnson 32,345,754 126,021
John K. La Rue 32,359,933 111,842
2. To approve the amendment and restatement of our amended and restated
articles of incorporation, which would (i) increase the number of authorized
shares of our common stock from 50,000,000 shares to 100,000,000 shares; (ii)
authorize the issuance of 10,000,000 shares of preferred stock; and (iii) remove
authority to issue shares of Class A Participating Preferred Stock.
For 25,307,250
Against 2,375,665
Abstain 41,949
3. To approve the amendment and restatement of our 1999 Stock Incentive
Plan to increase the number of shares of common stock authorized and
reserved for option grants under the Plan by 2,225,500 shares and make certain
technical amendments.
For 25,180,165
Against 2,493,916
Abstain 50,783
4. To approve the adoption of our 2000 Employee Stock Purchase Plan.
For 27,317,881
Against 360,237
Abstain 46,746
5. To ratify the appointment of Arthur Andersen LLP as our independent
public accountants for the fiscal year ending December 31, 2000.
For 32,398,802
Against 49,562
Abstain 23,411
<PAGE>
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following exhibits are filed in connection with Item 601 of Regulation
S-K:
Exhibit
Number Description
------- -----------
10.6(a) Pac-West Telecomm, Inc. 1999 Stock Incentive Plan as amended and
restated.
10.43 Lease agreement, dated August 29, 2000, by and between Boyd
Enterprises Utah, LLC and Pac-West Telecomm, Inc. for 2302
S. Presidents Drive, West Valley City, Utah.
10.44 1998 Griffin Non-Qualified Stock Incentive Plan.
10.45 1998 Bryson Non-Qualified Stock Incentive Plan.
10.46 2000 Napa Valley Non-Qualified Stock Incentive Plan.
10.47 2000 Employee Stock Purchase Plan.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
September 30, 2000.
Note: ITEMS 2, 3, and 5 are not applicable and have been omitted.
<PAGE>
SIGNATURES
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 on November 13, 2000.
PAC-WEST TELECOMM, INC.
/s/ Richard E. Bryson
-----------------------------
Richard E. Bryson
Chief Financial Officer
(Principal Financial Officer)
/s/ Dennis V. Meyer
-----------------------------
Dennis V. Meyer
Vice President-Finance
(Principal Accounting Officer)
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
10.6(a) Pac-West Telecomm, Inc. 1999 Stock Incentive Plan as amended and
restated.
10.43 Lease agreement, dated August 29, 2000, by and between Boyd
Enterprises Utah, LLC and Pac-West Telecomm, Inc. for 2302
S. Presidents Drive, West Valley City, Utah.
10.44 1998 Griffin Non-Qualified Stock Incentive Plan.
10.45 1998 Bryson Non-Qualified Stock Incentive Plan.
10.46 2000 Napa Valley Non-Qualified Stock Incentive Plan.
10.47 2000 Employee Stock Purchase Plan.
27.1 Financial Data Schedule.
