| PAC-WEST TELECOMM INC Item 1A Risk Factors 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 in this report |
| These uncertainties and risks include, among other things, the uncertainties and risks identified below |
| You should be aware; however, that the uncertainties and risks described below are not the only uncertainties and risks we are facing or will face in the future |
| Additional uncertainties and risks not presently known to us or that we currently believe to be immaterial may also adversely affect our business |
| We have a substantial amount of indebtedness and are highly leveraged |
| As of December 31, 2005, our long-term debt totaled dlra43dtta5 million |
| We may also incur additional indebtedness in the future to expand and develop our current business and services, make strategic acquisitions and enter new markets |
| Our substantial indebtedness could, among other things: • increase our vulnerability to general adverse economic and industry conditions; • limit our ability to fund future working capital, capital expenditures, marketing costs and other general corporate requirements; • require us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, marketing efforts and other general corporate purposes; 14 _________________________________________________________________ [73]Table of Contents • limit our flexibility in planning for or reacting to changes in our business and the industry in which we operate; • place us at a competitive disadvantage compared to our less leveraged competitors; and • limit our ability to borrow additional funds |
| On March 11, 2005, we utilized the proceeds from the sale of our enterprise customers to TelePacific, as well as cash on hand, to repay our outstanding dlra40dtta0 million Senior Secured Note to Deutsche Bank AG — London (Deutsche Bank), as well as retire the related warrants to purchase up to 26cmam666cmam667 shares of our common stock |
| We may not be able to generate sufficient cash to service our indebtedness |
| Failure to generate cash in the future either from operations or from additional financing will adversely affect our ability to make payments on and to refinance our indebtedness and to fund capital expenditures and marketing efforts |
| Our ability to generate cash from operations will be particularly dependent on our ability to expand our business and manage our growth, provide competitive services, comply with applicable governmental regulations, negotiate favorable agreements and to maintain or lower our current expenditure rate |
| In addition, we may need to refinance all or a portion of our indebtedness on or before maturity |
| We may not be able to refinance this indebtedness on commercially reasonable terms or at all |
| Migration to broadband Internet access will affect dial-up Internet access |
| Traditional dial-up access to the Internet is a mature technology |
| Major segments of this market may experience migration to broadband access where available and competitively priced |
| With the evolution of new technologies many new IP applications are now available, such as VoIP, which may hasten the transition of end-users from dial-up to broadband access |
| While we remain focused on serving the needs of our customers who provide dial-up access to their end-users, if migration to broadband access occurs faster than we anticipate our revenue streams may be adversely affected |
| A substantial portion of our total revenue is from intercarrier compensation payments, which are subject to regulatory and legal uncertainty |
| Intercarrier compensation payments from ILECs accounted for approximately 40dtta3prca, 32dtta1prca and 35dtta0prca of our total revenues for the years ended December 31, 2005, 2004 and 2003, respectively |
| Intercarrier compensation payments are a function of the number of calls we terminate, the minutes of use associated with such calls and the rates at which we are compensated by the ILECs |
| We believe that under the Telecommunications Act of 1996, other ILECs should have to compensate us when their customers place calls to Internet service providers who are our customers |
| Our right, to receive this type of compensation is the subject of continual regulatory and legal challenges by the ILECs |
| Potential change in the regulation of network neutrality could affect our operations |
| Network neutrality is the concept that network operators provide free and non-discriminatory transport on their networks between the endpoints of the Internet |
| There were principles that were adopted by the FCC to ensure that broadband networks are widely deployed, open, affordable and accessible to all consumers |
| Congress and federal regulation agencies are reviewing “network neutrality,” which may be resolved in a manner that strengthens or weakens interconnection rights and obligations for carriers, or leaves the existing rules intact |
| Weaker interconnection rights may make the environment more difficult for CLECs, including Pac-West |
| We may not have sufficient funds available to complete our planned national expansion or otherwise expand our product offerings |
| We may need to make significant capital expenditures in order to complete our planned national expansion or otherwise expand our product offerings |
| We expect to fund these expenditures through existing 15 _________________________________________________________________ [74]Table of Contents resources, through internally generated funds, or through future equity and debt financings |
| If we are unable to raise sufficient funds, we may have to delay or abandon some of our expenditures or plans for future growth |
| This could result in underutilization of our established infrastructure, reduced profitability and may negatively affect our ability to compete for and satisfy the demands resulting from the growth and expansion of our customer base |
| Our failure to develop and timely deliver products and services may impair our ability to achieve sufficient market acceptance to become profitable |
| To be successful, we must develop and market products and services that are widely accepted by customers at profitable prices |
| Our success will depend upon the willingness of our target customers to accept us as a high-value independent provider of integrated communications solutions that are timely delivered to market |
| The loss of key executive officers could negatively impact our business prospects |
| We believe that a critical component of our success will be the retention of our key executive officers |
| Henry R Carabelli, our President and Chief Executive Officer has significant expertise in the telecommunications industry and has been instrumental in establishing and executing our business plan and strategy |
| Carabelli or our other executive officers, including the following officers could adversely affect our business prospects, financial condition and results of operations: • H Ravi Brar, our Chief Financial Officer and Vice President of Human Resources; • Todd M Putnam, our Chief Information Officer; • Michael B Hawn, our Vice President Customer Network Services; • Sarita Fernandes, our Vice President Marketing; • Eric E Jacobs, our Vice President, General Manager Service Provider Sales; • Michael L Sarina, our Vice President Finance; • John F Sumpter, our Vice President Regulatory; • Robert C Morrison, our Vice President and General Counsel; and • Reid M Cox, our Vice President of Business Development and Investor Relations |
| Future success will depend on the ability to attract and retain highly skilled and qualified employees |
| Due to the telecommunication being a high tech industry we are subject to high employee turnover |
| Our need to comply with extensive government regulation can increase our costs and slow our growth |
| Our networks and the provision of telecommunications services are subject to significant regulation at the Federal, state and local levels |
| Delays in receiving required regulatory approvals or the enactment of new adverse regulation or regulatory requirements might slow our growth and have a material adverse effect upon us |
| Regulators at both the Federal and state level require us to pay various fees and assessments, file periodic reports, and comply with various rules regarding the contents of our bills, protection of subscriber privacy, service quality and similar matters on an ongoing basis |
| We cannot provide assurance that the FCC or state commissions will grant required authority or refrain from taking action against us if we are found to have provided services without obtaining the necessary authorizations, or to have violated other requirements of their rules and orders |
| Regulators or others could challenge our compliance with applicable rules and orders |
| Such challenges could cause us to incur substantial legal and administrative expenses |
| 16 _________________________________________________________________ [75]Table of Contents The Sarbanes-Oxley Act of 2002 is expected to be significant in terms of time, resources and costs |
| On July 30, 2002, the Sarbanes-Oxley Act of 2002 was signed into law and became some of the most sweeping federal legislation addressing accounting, corporate governance and disclosure issues |
| The impact of the Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and imposes significant new requirements for public company governance and disclosure requirements |
| Some of the provisions of the Sarbanes-Oxley Act became effective immediately while others are still being implemented |
| In general, the Sarbanes-Oxley Act mandates important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results |
| It establishes new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process and creates a new regulatory body to oversee auditors of public companies |
| It backs these requirements with new SEC enforcement tools, increases criminal penalties for federal mail, wire and securities fraud, and creates new criminal penalties for document and record destruction in connection with federal investigations |
| It also increases the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection |
| The economic and operational effects of this new legislation on public companies, including us, will be significant in terms of the time, resources and costs associated with complying with the new law |
| Because the Sarbanes-Oxley Act, for the most part, applies equally to larger and smaller public companies, we will be presented with additional challenges as a smaller, telecommunications company seeking to compete with larger telecommunications companies in our industry |
| In September 2005, the SEC decided to postpone the compliance date for filing internal control reports by companies not designated as accelerated filers |
| As discussions are continuing regarding the final implementation deadline of Sarbanes-Oxley Act, the ultimate timing, resources and costs to be incurred by the Company are unknown |
| We are dependent on many vendors and suppliers and their financial difficulties may adversely affect our business |
| We depend on many vendors and suppliers to conduct our business |
| For example, we purchase our network assets from equipment manufacturers and other suppliers and we lease fiber and other circuits from other carriers as well as from companies, which construct these network elements for resale |
| Many of these third parties have experienced substantial financial difficulties, in some cases leading to bankruptcies and liquidations |
| The financial difficulties of these companies could have a material adverse affect on our business and prospects |
| Our network expenses could increase if the TelePacific enterprise customer base migration occurs sooner than contemplated in the Transition Service Agreement |
| We have certain commitments and agreements with certain vendors associated with our circuits in which our network expenses could increase if the enterprise customers sold to TelePacific move off of our network sooner than what is contemplated in our Transition Service Agreement |
| If we do not interconnect with and maintain efficient working relationships with our primary competitors, the ILECs, our business will be adversely affected |
| Many carriers, including us, have experienced difficulties in working with the ILECs with respect to initiating, interconnecting, and implementing the systems used by these carriers to order and receive unbundled network elements and wholesale services and locating the new carriers’ equipment in the offices of the ILECs |
| We must coordinate with ILECs so that we can provide local service to customers on a timely and competitive basis |
| The Telecommunications Act of 1996 created incentives for regional Bell operating companies to cooperate with new carriers and permit access to their facilities by denying such companies the 17 _________________________________________________________________ [76]Table of Contents ability to provide in-region long distance services until they have satisfied statutory conditions designed to open their local markets to competition |
| The regional Bell operating companies have been fined numerous times by both Federal and state authorities for their failure to comply with applicable telecommunications laws and regulations |
| We do not believe these fines have had any meaningful impact on the anticompetitive practices of many of these companies and in fact believe that these practices are increasing in most of our markets |
| We attempt to enforce our rights against these incumbent monopolies but often times the remedies are inadequate to change their anticompetitive practices and in any event provide us with little or no recovery of the damages we have suffered as a result of these practices |
| Moreover, efforts by us to enforce our rights against these companies may further diminish the level of cooperation we receive from them |
| If we cannot obtain the cooperation of a regional Bell operating company in a region, or a regional Bell operating company otherwise fails to meet our requirements, for example, because of labor shortages, work stoppages or disruption caused by mergers or other organizational changes or terrorist attacks, our ability to offer services in such region on a timely and cost-effective basis will be adversely affected |
| Our principal competitors, the ILECs, and potential additional competitors, have advantages that may adversely affect our ability to compete with them |
| The telecommunications industry is both highly competitive and dominated by the ILECs who enjoy the benefit of significant market share earned over a time when there was little to no competition in the marketplace |
| Many of our current and potential competitors in the local market have financial, technical, marketing, personnel and other resources, including brand name recognition, substantially greater than ours, as well as other competitive advantages over us |
| In each of the markets targeted by us, we compete with the ILEC serving that area |
| ILECs are established providers of local telephone services to all or virtually all telephone subscribers within their respective service areas |
| ILECs also have long-standing relationships with Federal and state regulatory authorities |
| FCC and state administrative decisions and initiatives provide the ILECs with pricing flexibility for their products and services |
| We also face, and expect to continue to face, competition from other current and potential market entrants, including CLECS, cable television companies, electric utilities, microwave carriers, wireless telephone system operators and private networks built by large end users |
| In addition, a renewed trend toward consolidation as a result of mergers, acquisitions and strategic alliances in the telecommunications industry could also affect the level of competition we face |
| Furthermore, the development of new technologies could give rise to significant new competitors in the local market |
| These competitive forces could adversely affect our business |
| Some of our competitors have lower cost structures through restructuring activities |
| Due to the readily available sources of capital during the 1990s, many CLECs and other incumbent carriers included building their own networks, including fiber transport capacity, as a key component of their operating plans |
| This resulted in an excess of network capacity in many areas throughout the US with insufficient traffic volumes to cover the corresponding cost of capital and debt loads that were necessary to build the network infrastructures |
| Accordingly, some of the companies have not survived or have been forced to restructure, often through bankruptcy |
| When these companies restructure they generally have new, lower cost structures, which often allow them to aggressively price their products and services, effectively driving down the market rates in a way that could adversely affect our business |
| A system failure could delay or interrupt our services |
| Our operations are dependant upon our ability to support our network infrastructure |
| Many of our customers are particularly dependent on an uninterrupted supply of services |
| Any damage or failure that causes interruptions in our operations could result in the loss of these customers and could have a material adverse effect on our business and our financial condition |
| Because of the nature of the services we supply and the nature of our network, it is not feasible to maintain complete backup systems, and the occurrence of a 18 _________________________________________________________________ [77]Table of Contents natural disaster, act of terrorism or other operational disruption or unanticipated problem could cause interruptions in the services we provide |
| Additionally, the failure of a major supplier to provide the communications capacity we require, or of a major customer to continue buying our goods and services, as a result of a natural disaster, act of terrorism or other operational disruption or any other reason, could cause interruptions in the service we provide and adversely affect our business prospects, financial condition and results of operations |
| Telecommunication industry trends could slow or eliminate future growth |
| Competition in the communication services market has resulted in the consolidation of companies in our industry, a trend we expect to continue |
| In order to grow our business and better serve our customers, we continue to consider new business strategies, including potential acquisitions or new business lines |
| We believe that the statewide footprint of our network, which encompasses all of the major metropolitan areas of California, provides us with a significant competitive advantage that will enable us to successfully compete in the future, but we cannot guarantee that we will be able to sustain continued growth |
| The developing practice by the ILECs of bundling services including long distance over their comprehensive networks could make it difficult for us to retain customers or attract new ones |
| In addition, technology continues to evolve with the corresponding development of new products and services |
| There is no guarantee we will retain our customers with our existing product and service offerings or with any new products or services we may develop in the future |
| Our failure to achieve or sustain market acceptance at desired pricing levels could impair our ability to achieve profitability or positive cash flow |
| Market prices for our services face competitive pressures, a trend which may continue |
| Accordingly, we cannot predict to what extent we may need to further reduce our prices to remain competitive or whether we will be able to sustain future pricing levels as our competitors introduce competing services or similar services at lower prices |
| Our ability to meet price competition may depend on our ability to operate at costs equal to or lower than our competitors or potential competitors |
| There is a risk that competitors, perceiving us to lack capital resources, may undercut our rates, increase their services or take other actions that could be detrimental to us |
| If we are unable to effectively deliver our services to a substantial number of customers, we may experience revenue losses |
| We cannot guarantee that our network will be able to connect and manage a substantial number of customers at high transmission speeds |
| If we cannot achieve and maintain digital transmission speeds that are otherwise available in a particular market, we may lose customers to competitors with higher transmission speeds and we may not be able to attract new customers |
| Actual transmission speeds on our network will depend on a variety of factors many of which are beyond our control, including the distance an end user is located from a central office, the quality of the telephone lines, the presence of interfering transmissions on nearby lines and other factors |
| Our ability to provide certain services to potential customers depends on the quality, physical condition, availability and maintenance of telephone lines within the control of the ILECs |
| In addition, the ILECs may not maintain the telephone lines in a condition that will allow us to implement certain services effectively or may claim they are not of sufficient quality to allow us to fully implement or operate certain services |
| We may incur liabilities as a result of our Internet service offerings |
| United States law relating to the liability of on-line service providers and Internet service providers for information carried on, disseminated through, or hosted on their systems is currently unsettled |
| If liability is imposed on Internet service providers, we would likely implement measures to minimize our liability exposure |
| 19 _________________________________________________________________ [78]Table of Contents These measures could require us to expend substantial resources or discontinue some of our product or service offerings |
| In addition, increased attention to liability issues, as a result of litigation, legislation or legislative proposals could adversely affect the growth and use of Internet services |
| We are subject to audits with various tax authorities and may incur liabilities as a result |
| From time to time, we are subject to audits with various tax authorities that arise during the normal course of business which could result in a liability exposure |
| During the third quarter of 2005, the Company received two tax assessments arising from audits |
| Subsequent to the third quarter of 2005, the Company filed appeals against both assessments |
| Our stock has been extremely volatile |
| Our stock has experienced significant price and volume fluctuations, often times due to factors beyond our control |
| Given that our stock is thinly traded, sales by even a single large stockholder can materially decrease our market price |
| The market price for our common stock may continue to be subject to wide fluctuations in response to a variety of other factors, including but not limited to the following, some of which are beyond our control: revenues and operating results of our company or other emerging communications companies failing to meet the expectations of securities analysts or investors in any period; failure to successfully implement our business strategy; announcements of operating results and business conditions by our customers and competitors; technological innovations by competitors or in competing technologies; announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; announcements by third parties of significant claims or proceedings against us; investor perception of our industry or our prospects; economic developments in the telecommunications industry or general market conditions; or major geopolitical events such as war, terrorism or political change around the world |
| On September 15, 2005, we received a letter from The Nasdaq Stock Market (“Nasdaq”) notifying us that the bid price of our common stock had closed below the minimum bid price required for continued inclusion on the Nasdaq Capital Market |
| The letter further notified us that we will be provided 180 calendar days to regain compliance with the minimum bid price requirement |
| Compliance may be achieved if the bid price per share of our common stock closes at dlra1dtta00 per share or greater for a minimum of 10 consecutive business days |
| However, Nasdaq has the discretion to require a period in excess of 10 business days before determining that the ability to maintain long-term compliance has been demonstrated |
| The letter from Nasdaq further stated that, if compliance with the minimum bid price requirement cannot be demonstrated, but we otherwise meet the applicable initial listing requirements, we may qualify for an additional 180 day compliance period |
| On March 15, 2006, we received a letter from Nasdaq notifying us that we had been granted an additional 180-day compliance period |
| If we do not regain compliance with Nasdaq’s minimum bid price requirement, our common stock could be delisted from the Nasdaq Capital Market, which could reduce the liquidity of the market for our common stock and increase the volatility of the market price of our common stock |
| As of March 15, 2006, we had not regained compliance with the Nasdaq’s minimum bid price requirement |
| Consolidation in the telecommunications industry could lead to the creation of stronger competitors |
| There has been consolidation in the telecommunications industry with several mergers and acquisitions and this trend may continue |
| In addition, some telecommunication companies have filed for bankruptcy protection and enjoy court protection from creditors and lower their cost structures |
| These events could lead to the creation of substantially larger competitors, which may have greater resources and lower cost structures than us |