10KSB 1 a2045100z10ksb.txt FORM 10KSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-230 17 CHOICETEL COMMUNICATIONS, INC. (Name of small business issuer in its charter) MINNESOTA 41-1649949 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 9724 10TH AVENUE NORTH, PLYMOUTH, MN 55441 (Address of principal executive offices) Issuer's telephone number: (763) 278-6889 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Title of each class: Name of each exchange on which registered: COMMON STOCK, $.01 PAR VALUE THE NASDAQ SMALLCAP MARKET REDEEMABLE WARRANT THE NASDAQ SMALLCAP MARKET Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] The revenues for ChoiceTel Communications, Inc. for the fiscal year ended December 31, 2000 were $4,408,537 The aggregate market value of the voting and non-voting common equity held by non-affiliates as of March 15, 2001, based on the closing sale price of the Common Stock on such date as reported on the NASDAQ SmallCap Market, was $2,367,424. 1 On March 15, 2001, the Company had outstanding 3,334,581 shares of Common Stock, par value $.01 per share. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Form SB-2, Registration Number 333-29969, are incorporated by reference into Part II of this Form 10-KSB. Transitional Small Business Disclosure Format (Check one): Yes ; No X --------- --------- 2 TABLE OF CONTENTS
PART I PAGE ---- ITEM 1. DESCRIPTION OF BUSINESS...............................................4 ITEM 2. DESCRIPTION OF PROPERTY...............................................9 ITEM 3. LEGAL PROCEEDINGS.....................................................9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................9 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.............10 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION............10 ITEM 7. FINANCIAL STATEMENTS.................................................14 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..................................15 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT............16 ITEM 10. EXECUTIVE COMPENSATION................................................17 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................................................18 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................19 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K......................................21 SIGNATURES............................................................22 FINANCIAL STATEMENTS..................................................F1 INDEX TO EXHIBITS.....................................................
3 PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL ChoiceTel Communications, Inc. (the "Company") was formed as a Minnesota corporation in 1989. The Company installed its first payphones in early 1990 and as of December 31, 2000, had an installed phone base of approximately 1,500 payphones in Puerto Rico. During 2000 the Company sold approximately 900 phones located primarily Philadelphia. In 1999 the Choicetel Board of directors concluded that the pay telephone industry was no longer a growth industry and in order to successfully compete in the business, a provider must be significantly larger than the Company was in order to take advantage of economies of scale. The Board determined that the Company lacked the resources to achieve the size necessary to improve its economies of scale and authorized management to sell its payphone assets. Accordingly, by December 31, 2000 the Company completed sales of approximately 4,000 payphones leaving 1,500 phones located in Puerto Rico, which the Company intends to divest during 2001, although there can be no assurances that an acceptable transaction will be completed in 2001. Accordingly, the Company's payphone business is reflected as "discontinued operations" throughout this annual report. During 2000 the Company invested $3,331,000 in a majority owned subsidiary, Advants, Inc. Advants is seeking to develop a profitable model for employing internet access terminals. Additionally, during November and December the Company loaned approximately $175,000 to Advants. In February 2001, the Company decided to make no additional investments or loans to Advants as it does not believe Advants can successfully access the necessary capital to effectively implement its business model. Accordingly, the Company has decided to write-off its loans and investments in Advants. INDUSTRY OVERVIEW In 1996, calls made from pay telephones were estimated at $7 billion in annual revenues to the United States telecommunications industry. Pay telephones may be "public," meaning they are owned by local exchange carriers ("LECs"), or "independent," meaning they are owned and operated by companies independent of the LECs, such as the Company. Of the approximately 2 million pay telephones operating in the United States in 1996, it is estimated that approximately 350,000 were independent. Today's telecommunications marketplace was principally shaped by the 1985 AT&T divestiture of the 22 regional Bell operating companies ("RBOCs"), which provided local telephone services within their areas of operation. The AT&T divestiture and the many regulatory changes adopted by the FCC and state regulatory authorities in response to the AT&T divestiture resulted in the creation of new business segments in the telecommunications industry. As part of the AT&T divestiture, the United States was divided into geographic areas known as local access transport areas or "LATAs." Telephone service that both originates and terminates within the same LATA ("intraLATA") is priced based on tariffs filed with and approved by state regulatory authorities. LECs provide intraLATA telephone service to, among others, independent pay telephone companies. LECs are generally prohibited from offering or deriving revenues or income from services between LATAs ("interLATA"). In addition, most state regulatory authorities require LECs to provide local access line service to independent pay telephone companies. See "Business - Government Regulation." 4 Long-distance carriers provide interLATA service and, in some circumstances, may also provide long-distance service within LATAs. An interLATA long-distance pay telephone call begins with an originating LEC transmitting the call from the pay telephone that originates the call to a point of connection with a long-distance carrier. The long-distance carrier, through its owned or leased switching and transmission facilities, transmits the call across its long-distance network to the LEC serving the local area in which the recipient of the call is located. This terminating LEC then delivers the call to the recipient. Independent PSPs contract with one or more long-distance carriers to provide long-distance service to their pay telephones. BUSINESS STRATEGY The Company has focused on identifying payphone sites that have the potential to achieve a high return on investment ("ROI") after depreciating the equipment over the life of the phone lease. Although others in the industry have used shorter leases, the Company's analysis indicated that a long-term lease was necessary in order to achieve the Company's ROI objective and to offer a competitive commission to location owners ("Site Providers"). Therefore, most of the Company's pay telephones are placed with Site Providers under leases having terms of ten years or more. During 1998, the Company researched the Puerto Rican payphone market and determined that if and when the full benefits of the Telecommunications Act of 1996 are reflected in the Puerto Rican payphone market, Puerto Rico would be an attractive market for ChoiceTel to operate payphones. Whereas revenues have fallen at most of the Company's payphone located outside of Puerto Rico, payphones located within Puerto Rico have continued to generate above average revenues. Although the Company intends to divest its payphones in Puerto Rico during 2001, in order to maximize the value of the route it continues to contract for and install additional phones at acceptable locations. OPERATIONS During 2000 the Company operated, serviced and maintained a system of approximately 1,500 pay telephones, located in Puerto Rico. In addition, in March 2000, the Company sold approximately 900 pay telephones located principally in Pennsylvania. All of the Company's pay telephones accept coins as payment for local or long-distance calls and can also be used to place local or long-distance cashless calls. COIN CALLS The Company's pay telephones generate coin revenue primarily from local calls. Until October 1997, the public utilities commissions of the states in which the Company operated regulated the cost of local coin calls, at that time, rates were deregulated. Management believes it can maximize payphone coin revenues by matching the cost of a local call to the market conditions at the phone. In 2000 the amount charged for a local call ranged from $0.25 in Puerto Rico to $0.35 in Pennsylvania. Long-distance coin calls are carried by long-distance carriers that have agreed to provide long-distance service to the Company's telephones. The majority of the Company's phones sell coin long-distance for a rate of $0.25 per minute, with a two-minute minimum. Management believes that its $0.25 per minute long-distance rate results in considerable goodwill and is a point of differentiation between its phones and its local exchange carrier ("LEC") competitors. NON-COIN CALLS 5 The Company also receives revenue from non-coin, or cashless, calls made from its pay telephones, including credit card calls, calling card calls, collect calls and third party billed calls. These calls are processed by the Company's designated operator service provider ("OSP"). DIAL-AROUND CALLS A Dial-Around call originates from a payphone when the user dials a non-billable access number such as, for example, 1-800-Collect, 1-800-CallATT or 10-10-333, and thereby dials around the Company's long-distance carrier in order to reach another long-distance carrier or a toll free number. The user deposits no money for the call and, prior to 1992, the long-distance provider carrying the call paid no commission to the payphone owner. Since 1992, payphone owners have been compensated by long-distance carriers for Dial-Around calls. See "Government Regulation - Dial-Around Compensation." COMPUTER NETWORK AND EQUIPMENT. The Company focused its early efforts on building a computer processing network that automated many of the operations of managing a pay telephone enterprise. Specialized software was designed and written when it was not available from industry suppliers. The Company's smart phones are part of a centralized network that links all of the Company's phones in the field with central processors. The system allows the Company to monitor phone call volume, identify malfunctioning equipment, dispatch repair service, schedule efficient coin collections, calculate commissions, print checks to Site Providers, and generate necessary reports that analyze and monitor profitability of the phones. The Company installs pay telephones which it believes incorporate the latest technology. The equipment makes use of microprocessors to provide voice synthesized calling instructions in English or Spanish, detect and count coins deposited during each call, inform the caller at certain intervals of the time remaining on each call, and identify the need for and the amount of an additional deposit. The pay telephones can be programmed and reprogrammed from the Company's central computer facilities to update rate information or to direct different kinds of calls to particular carriers. The Company's pay telephones can distinguish coins by size and weight, report to a remote location the total coinage in the coin box, perform self-diagnosis and automatically report problems to a pre-programmed service number, and immediately report attempts of vandalism. Some of the telephones also operate on power available from the telephone lines, thereby avoiding the need for and reliance upon an additional power source at the installation location. The telephones are designed to have a user-friendly appearance and manner of operation similar to LEC-owned pay telephones. PLACEMENT OF PAY TELEPHONES. As of December 31, 2000, the Company's pay telephone system consisted of approximately 1,500 telephones located in Puerto Rico. The following table sets forth certain information as of the dates indicated concerning the number and location of pay telephones operated by the Company: NUMBER OF PAY TELEPHONES
STATE DECEMBER 31, DECEMBER 31, ----- ------------ ----------- 2000 1999 ---- ---- Puerto Rico............................. 1,500 995 Pennsylvania............................ 920 Additional phones ..................... 35 ----- ----- Total 1,500 1,950
6 The Company's ROI focus has enabled it to profile locations based on the likely profitability of a location. While this methodology is proprietary, as are the specific locations under contract, the Company's locations include a wide variety of establishments, such as restaurants, shopping malls, convenience stores, grocery stores, and gas stations. The Company's pay telephone lease mix includes indoor phones, walk-up outdoor phones and drive-up payphones. While the Company had a single Site Provider which accounted for more than 5% of its pay telephones and revenue in the years ended December 31, 1995 and 1996, no single Site Provider accounted for more than 5% of its pay telephones and revenues in either of the years ended December 31, 1997, 1998, 1999 and 2000. Agreements with Site Providers to install the Company's pay telephones (the "Site Agreements") provide for revenue sharing with Site Providers, typically a commission based on a negotiated percentage of revenue from the pay telephone. The Site Agreements give the Company the exclusive right to install pay telephones at that location and are generally of a ten-year term with automatic renewal provisions. The Company's Site Agreements normally give the Company the right to remove poor performing phones. Further, the Company can typically terminate a Site Agreement on 30 days notice to the Site Provider. Site Providers do not generally have the right to terminate a Site Agreement. PHONE LINE RATES. The Company pays local line charges for each of its installed payphones. These line charges cover basic service to the telephone as well as the transport of local calls. Line charges are regulated by state public utilities commissions ("PUCs"). MARKETING. The Company engages independent contractors to locate new sites for payphone installations in Puerto Rico. Management believes a successful contracting program requires identifying good locations, selling Site Providers on the benefits of the Company's payphones, and negotiating favorable Site Agreement terms. Identifying good locations for payphones is the most important aspect of the Company's marketing program, which includes an evaluation of population density, calling patterns and neighborhood socio-economic factors. The Company concentrates its efforts towards high traffic locations, lower income neighborhoods, and venues where people expect to find payphones. The Company promotes its payphone program to Site Providers by emphasizing service and maintenance. Site Providers generally view the payphone as a customer service rather than a profit center. Providing prompt repair and collection services and providing live call placement assistance sometimes is more important in securing the Site Agreement than the amount of commission paid to the Site Provider. SERVICE AND MAINTENANCE. The Company believes it offers many of its Site Providers a higher level of service than is provided by the LEC competitors, who typically offer low or no commissions and do not monitor payphone performance. The Company monitors its payphones electronically. The Company uses full- and part-time field service technicians who collect money, clean phones and respond to trouble calls made by either a consumer or by the telephone itself as part of its internal diagnostic procedures. Some technicians are also responsible for the installation of new telephones. Due to the ability of the field service technicians to perform multiple service and maintenance functions, the Company is able to limit the frequency of trips to each pay telephone as well as the number of employees needed to service the pay telephones. COMPETITION The Company competes for pay telephone locations with LECs and other independent pay telephone operators. Most LECs against which the Company competes and some independent pay telephone companies have substantially greater financial, marketing and other resources than the Company. In addition, many LECs, faced with competition from the Company and other independent pay telephone companies, have increased 7 their compensation arrangements with Site Providers to offer more favorable commission schedules. The Company believes the principal competitive factors in the pay telephone business are (i) responsiveness to customer service needs, (ii) the amount of commission payments to a Site Provider, and (iii) the quality of service and the availability of specialized services provided to a Site Provider and telephone users. Commencing in the 1998 fourth quarter, the Company began to experience a negative impact on its revenues, which management believes results from increased usage of wireless devices, which appear to be reducing consumers' reliance on payphones. This trend continued throughout 1999. This negative impact on revenue is the primary determinant of the Company's decision to divest its payphone assets. GOVERNMENT REGULATION In January 1996, Congress passed the Telecom Act, a comprehensive telecommunications bill that, in part, dealt with several concerns of the independent pay telephone industry. Congress stated that its intent was to create a "pro-competitive, de-regulatory national policy framework designed to accelerate rapidly private sector deployment of advanced telecommunications and information technologies and services to all Americans by opening all telecommunications markets to competition." The Telecom Act, among other things, requires local telephone companies to eliminate subsidies of their pay telephone services and to treat their own and independent payphones in a nondiscriminatory manner. Of particular importance to the Company, the Telecom Act addressed the inherently unfair disadvantage independent pay telephone companies have in competing with regulated monopolies, the compensation of independent pay telephone companies for calls made from their equipment that previously offered no compensation, and the issue of price regulation of local calls by the various state PUCs. COMPETITION WITH RBOCS. Under the Telecom Act, the RBOCs must operate their payphone divisions with separate profit and loss statements. The Company believes that this will likely result in the Company's RBOC competitors being less aggressive in bidding for locations. It also may result in the RBOCs removing many low volume pay telephones that collectively compete with the Company's pay telephones. DIAL-AROUND COMPENSATION. Pay telephones are required by the FCC to provide equal Dial-Around access to all long-distance carriers, either by access code (such as "10-10-333") or by 800 service. Prior to November 1996, the Company received $6 per payphone per month from long-distance carriers for providing this Dial-Around service. The Telecom Act recognized that it is a burden to payphone companies to provide such access and that the compensation paid to payphone companies for this access should be greater. Because the infrastructure to track and compensate for these calls did not exist at that time, the FCC's 1996 order raised the flat rate of compensation for the Dial-Around service to approximately $45 per payphone per month, based on $0.35 per call times the national average of 131 monthly Dial-Around calls placed per payphone. The FCC's 1996 order implementing the increased Dial-Around compensation was appealed, with the intent of decreasing the amount of Dial-Around compensation mandated by the order. In July 1997, the Court remanded the matter to the FCC for reconsideration of the rate of Dial-Around compensation. The Court found that the per call charge of $0.35 was inappropriate because the FCC did not consider evidence of the differences in the cost of coin calls and Dial-Around calls. The long-distance carriers then petitioned the Court to clarify the effect of the Court's July decision and to vacate the portion of the FCC's 1996 order setting the rate of Dial-Around compensation pending the FCC's re-examination of the Dial-Around rate. Further, in a letter to the FCC dated August 15, 1997, AT&T challenged the FCC's authority to order the long-distance carriers to make any payments during the pendency of the rate determination. The Court agreed with the long-distance carriers. In a decision dated September 16, 1997, the Court vacated the portion of the FCC's 8 1996 order setting the rate of Dial-Around compensation pending a new FCC order on remand. Accordingly, the long-distance carriers were not required to make Dial-Around payments to payphone service providers until the FCC issued a new order setting the Dial- Around rate. On October 9, 1997, the FCC issued an order establishing the Dial-Around rate as of October 7, 1997 at $0.284 per call ($0.35 minus an offset of $0.066 for expenses unique to coin calls) for the two years beginning October 7, 1997. On May 15, 1998 the Court again remanded the dial-around rate back to the FCC for further justification of the $0.35 starting point. On February 4, 1999 the FCC issued an order reducing the dial around rate to $0.24 retroactive to October 7, 1997 and going forward until at least January 31, 2002. Further, the FCC indicated that it planned to address Dial-Around compensation for the period from November 7, 1996 through October 6, 1997 in a subsequent order and tentatively concluded that the $0.24 per call rate adopted on a going forward basis should also govern compensation during the period from November 7, 1996 through October 6, 1997, though it has not yet issued an order as such. There can be no assurance that Dial-Around compensation will not be based on a rate that is less than what was previously collected by the Company. Such a rate could have an adverse effect on the results of operations and financial condition of the Company, which could be material. OPERATIONS OF ADVANTS, INC. Advants is in the business of providing public internet access through internet terminals located in perceived high traffic areas such as gas stations and supermarkets. At year end, Advants had 240 terminals in operation. In February 2001, the Company decided to make no additional investments or loans to Advants and since that time, Advants' operations have substantially decreased. Advants lacks sufficient working capital to continue operations and is looking for additional sources of funding. EMPLOYEES As of December 31, 2000, the Company had 22 full-time employees. No employees are covered by a collective bargaining agreement. The Company believes that its relationships with employees are good. ITEM 2. DESCRIPTION OF PROPERTY The Company's corporate offices are located in approximately 500 square feet of leased space in Wayzata, Minnesota. The lease for this property expires in April 2002. The Company also leases approximately 2,000 square feet of office space in San Juan Puerto Rico. The lease for this property expires in April 2001 and the Company holds two successive options to extend the lease for additional one-year periods. The Company believes that its current facilities are sufficient for its needs for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS MINNESOTA SALES TAX. During 2000 the Company reached a settlement with the Minnesota Department of Revenue covering all sales tax liability for the period the Company operated payphones in the State of Minnesota. Since 1996 the Company has carried, on its books, a reserve for potential liability and as a result of the settlement, the Company recognized a $500,000 gain on the reserve. DEBTS OF ADVANTS, INC. In November of 2000, a suit was commenced in Hennepin County, Minnesota District Court by TKI Consulting against Advants, Inc. and Choicetel Communications, Inc. TKI was a software provider to Advants and is suing, for breach of contract, for approximately $750,000. While Choicetel Communications is not a party to the contract, the plaintiff is seeking to hold the Company liable for the alleged debt of Advants. Choicetel has answered the complaint and denied the claim. An additional suit was filed on April 3, 2001 in Ramsey County, Minnesota District Court by Tomato Land Displays seeking damages in excess of $50,000 for Advants for alleged services provided. While Choicetel Communications is not a party to the transaction, the plaintiff is seeking to hold the Company liable for the alleged debt of Advants. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the 4th quarter of the fiscal year ended December 31, 2000. 9 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock and Redeemable Warrants have been quoted on the NASDAQ SmallCap Market under the symbol "PHON" and "PHONW", respectively, since November 10, 1997 . The following table sets forth, for the periods indicated, the range of high and low prices for the Company's Common Stock and Redeemable Warrants as reported on the NASDAQ SmallCap Market.
COMMON STOCK REDEEMABLE ------------ WARRANTS ----------- High Low High Low 1999: First Quarter................................. $3.25 $2.50 $0.13 $0.06 Second Quarter................................ $3.63 $1.50 $0.56 $0.13 Third Quarter................................. $3.00 $1.88 $0.31 $0.19 Fourth Quarter................................ $2.94 $1.75 $0.44 $0.13 2000: First Quarter................................. $8.00 $2.25 $2.00 $0.06 Second Quarter................................ $5.94 $2.50 $1.00 $0.25 Third Quarter................................. $3.75 $2.13 $0.38 $0.19 Fourth Quarter................................ $3.38 $1.25 $0.25 $0.06
As of March 15, 2001 there were approximately 665 shareholders of the Company's Common Stock. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS EXCEPT FOR HISTORICAL INFORMATION CONTAINED IN THIS REPORT, INFORMATION CONTAINED IN THIS FORM 10-KSB CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY", "WILL", "EXPECT", "PLAN", "ESTIMATE", OR "CONTINUE" OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. THERE ARE CERTAIN IMPORTANT FACTORS THAT COULD CAUSE RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED BY SOME OF THESE FORWARD-LOOKING STATEMENTS, INCLUDING WITHOUT LIMITATION, THE EFFECTS OF CHANGES IN ECONOMIC CONDITIONS AND CERTAIN OF THE "RISK FACTORS" ENTITLED "COMPETITION," "OTHER REGULATORY FACTORS," "TECHNOLOGICAL CHANGE AND NEW SERVICES," "DEPENDENCE UPON THIRD-PARTY PROVIDERS," "SERVICE INTERRUPTIONS; EQUIPMENT FAILURES," "RELIANCE ON SINGLE BRAND OF PAYPHONES," AND "RELIANCE ON KEY PERSONNEL" CONTAINED IN THE COMPANY'S PROSPECTUS DATED NOVEMBER 10, 1997 INCLUDED IN THE REGISTRATION STATEMENT ON FORM SB-2 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION (REGISTRATION NO. 333-29969). SUCH "RISK FACTORS" ARE INCORPORATED HEREIN BY REFERENCE. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS INVOLVE RISK AND UNCERTAINTY. GENERAL The Company derives revenue from three principal sources: coin calls, non-coin calls and dial-around calls. Coin calls represent calls paid for with coins deposited in the telephone. The Company recognizes coin revenue in the amount deposited. Non-coin calls are calls charged to a customer credit card or billed to the called party (collect calls). These calls are routed to and processed by an operator service provider ("OSP"). 10 Compensation for Dial-Around calls is paid by long-distance carriers when consumers access a long-distance carrier directly by dialing an access number, or by dialing an 800 number, or by using a non-billable calling card. The principal costs related to ongoing operation of the Company's payphones include telephone line charges, consisting of payments made by the Company to telephone companies and long-distance carriers for access charges and use of their networks; commission payments to Site Providers; and service, repair and maintenance costs. RESULTS OF DISCONTINUED OPERATIONS The following table presents certain items related to the discontinued operations as a percentage of revenue for the years ended December 31, 1999 and 2000.
STATEMENT OF OPERATIONS DATA: 2000 1999 ---- ---- REVENUE: Coin revenue............................. 52.1% 70.2% Non-coin revenue......................... 21.7 13.5 Dial-around revenue...................... 26.2 16.3 Total Revenue............................ 100% 100% SERVICE COSTS AND EXPENSES: Telephone line charges................... 23.3% 30.3% Commissions.............................. 8.6 16.3 Total cost of service.................... 31.9% 46.6% Gross margin............................. 68.1% 53.4% Selling, general and admin. ............. 42.7 33.2 Interest................................. 4.6 Depreciation and amortization............ 6.6 13.7 Net income (loss) before income tax provision................................ 5.9% 1.9% Average phones in service................ 1,430 4,500
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31 1999. CONTINUING OPERATIONS The after tax loss on continuing operations, for the year ended December 31, 2000 was $3,174,000 compared to a loss of $178,000 in the year ended December 31, 1999. Continuing operations includes the effect of consolidating Advants Inc.'s operations with the Company's other investing activities. All payphone related activity is reported as discontinued operations. As long as the Company owns a controlling percentage ownership of Advants, Inc. stock it will consolidate and report operations as continuing. Choicetel has decided to make no additional investments or loans to Advants as it does not believe Advants can successfully access the necessary capital to effectively implement its business model. Advants is currently looking for addition funding as it is without sufficient working capital to continue operations. Advants' revenues for the year ended December 31, 2000 were $121,000 compared to $5,000 in the year ended December 31, 1999. During the year, Advants increased the number of terminals in service from 25 to 210. The cost of service in 2000 was $364,000 compared to $10,000 in 1999. Advants' SG&A spending in 2000 was $2,089,000 in 2000 compared to $292,000 in 1999. Spending was incurred to develop, deploy and support a national network of public access internet terminals. In 2000, Advants recognized an impairment loss of $2,744,000 principally on kiosks, computer hardware and software developed to be run internet access terminals, and Choicetel amortized and wrote-off $1,062,000 in goodwill, recognized on Choicetel's investments in Advants, Inc. stock. During 2000, other income and expense includes $203,000 earned by Choicetel on its investment in Whitebox Arbitrage Trading LLP and $113,000 interest earned by Choicetel from investing excess cash balances in money market accounts. DISCONTINUED OPERATIONS The after tax income from discontinued operations for the year ended December 31, 2000 was $153,000 compared to income of $161,000 in 1999. Total Revenue for 2000 was $4,288,000 compared to $10,216,000 in 1999. The Company operated an average of 1,430 payphones during 2000, primarily in Puerto Rico. This compares to 4,500 phones in 1999, located primarily in Minnesota, Pennsylvania, Oregon and Puerto Rico. 11 During the year ended December 31, 2000 the Company operated an average of 1,275 phones in Puerto Rico compared to 935 for the year ended December 31, 1999. Revenue from the Puerto Rico route in 2000 was $3,932,000 or 91.7% of 2000 revenue, compared to $2,430,000 or 23.7% of total revenue in 1999. Puerto Rico coin revenue in 2000 was $2,050,000 compared to $1,574,000 which was an increase of $476,000 or 30.2% this increase was due to the greater number of phones in service although, the newer phones did not match, on a per phone basis, the coin revenue of phones already in service at the beginning of the year. Noncoin commission revenue from operator service providers was $903,000 in 2000 compared to $596,000 in 1999 which was an increase of $307,000 or 51.5%. Dial around compensation in 2000 was $979,000 compared to 260,000 in 1999, which was an increase of $719,000 or 277%. Dial-around revenue in 2000 includes the collection of $232,000 which was earned but not recognized in 1999. Cost of service for the Company was $1,366,000 in 2000 compared to $4,763,000 in 1999. Cost of service for routes disposed of by December 31, 2000 was $147,000 or 10.8%, compared to $3,504,000 or 73.6% in 1999. Cost of service for the Puerto Rico route was $1,219,000 in 2000, compared to $1,259,078 in 1999 a decrease of $40,000 or 3.2%. Cost of service in 2000 includes telephone line charges of $904,000 or 74.1% in 2000 compared to $960,000 or 76.2% in 1999. During 2000 the company recognized the benefit of a reduced tariff for line charges in Puerto Rico, which included an expense reversal of approximately $25,000 related to the periods prior to 2000. Cost of service also includes commission to location site providers of $315,000 or 25.9% compared to $299,000 or 23.8% in 1999. Sales, General, and Admin (SG&A) was $1,787,000 in 2000 compared to $3,707,000 in 1999. SG&A in 2000 includes $773,000 (43.3%) related to the Puerto Rico route, $633,000 (35.4%) related to Corporate Overhead, and $381,000 (21.3%) related to the disposed routes. Puerto Rico SG&A in 2000 was $773,000 compared to $798,000 in 1999, a decrease of $25,000 or 3.19%. During 2000, the Company improved its procedures to identify SG&A expenses incurred when installing phones. These expenses are capitalized into property. SG&A spending before capitalization of installation expenses in Puerto Rico increased $20,000 or 2.3 % in 2000 compared to 1999. Corporate SG&A includes the cost of Corporate officers, the Corporate offices, and other recurring expenses related to maintaining the corporate entity, such as directors' compensation, shareholder services, and audit and reporting expenses. Corporate SG&A in 2000 was $633,000 compared to $837,000 in 1999, a decrease of $204,000, primarily due to having fewer corporate officers in 2000 compared to 1999. EBITDA was $1,134,000 in 2000 compared to $1,746,000 in 1999. EBITDA from the Puerto Rico route was $1,939,000 in 2000 compared to $372,000 in 1999. Depreciation and amortization totaled $287,000 in 2000 compared to $1,401,000 in 1999. Depreciation and amortization for 2000 includes $240,000 related to the Puerto Rico route and $47,000 related to disposed routes. During 2000 the Company recognized a $509,000 gain related to settling its sales tax dispute with the Minnesota Department of Revenue, took a $1,033,000 charge related to the sale of payphone assets, and recognized a $66,000 deferred loss on the sale of payphone assets. YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31 1998. The loss on continuing operations (Advants Inc., - subsidiary) for the year ended December 31, 1999 was $178,000 compared to a loss of $1,000 in the year ended 1998. The loss resulted from SG&A spending to develop, fund and begin implementing the Company's strategy for public internet access terminals. The after tax income from discontinued operations for the year ended December 31, 1999 was $161,000 compared to an after tax loss of $116,000 in 1998. The Company operated 4,500 payphones in 1999 compared to 3,800 in 1997. SUBSIDIARY ACTIVITIES IN PUBLIC INTERNET ACCESS TERMINALS - ADVANTS, INC. 12 During 1998, the Company began test marketing public internet access terminals, which allow a customer to access the internet while away from their home or office computer. Customers have the option of paying the charges, currently $1.00 for 5 minutes, using cash or a credit card. In 1999, the Company engaged consultants to devise a strategy to develop the market more quickly by bringing into the business joint venture partners who might benefit in owning part of a network of public internet terminals. Subsequently, these activities were transferred to a newly formed subsidiary, Advants, Inc., and several consultants were engaged as full-time management employees and senior executives of Advants. In November 1999 Advants completed a private placement of common stock raising approximately $500,000 to implement the strategy. Subsequent to the private placement, and the issuance of shares to the initial management team at Advants, Inc., Choicetel's equity position in Advants, Inc. stood at 60%. The Company provided additional equity funding in 2000 of approximately $3.3 million and thereby increased its equity position to approximately 80%. Additionally the Company loaned approximately $175,000 to Advants. During 2001, the Company determined to make no additional investments or loans to Advants as it no longer believes Advants can successfully access the necessary capital to effectively implement its business model. Accordingly, the Company has written-off its loans and investments in Advants. Although the results of Advants, Inc. are consolidated in conformance with Generally Accepted Accounting Principals (GAAP), management believes that as a shareholder in Advants, Inc., Choicetel Communications' financial exposure is likely limited to the amount invested in the common stock plus the amounts loaned to Advants. Inc. The following is the condensed balance sheet of Advants:
12/31/00 -------- Property and equipment $ 239,500 Other Assets, mostly cash 4,200 -------- Total Assets $ 243,700 Account payable and accrued expenses $ 1,812,000 Due to Choicetel Communications, Inc 172,000 Shareholders' Equity (1,740,300) ---------- Total liability and Shareholder equity $ 243,700 ==========
SALES TAX CONTINGENCY The Company, based on its analysis of the published regulations of the Minnesota Department of Revenue at the time of its inception, did not remitted any sales tax payments to the State of Minnesota. In 1996, the Company learned that the opinion of the Department was that calls from payphones were subject to state sales tax. Management was of the view that the payphone service it provided was not subject to sales tax and challenged the imposition of the tax. Nonetheless, on December 31, 1996, the Company established a reserve of $865,000 for the years prior thereto and reserved an additional $243,000, $254,000 and $213,500 for the year ended December 31, 1997, 1998 and 1999 respectively. During 2000 the Company reached a settlement with the Minnesota Department of Revenue covering all sales tax liability for the period the Company operated payphones in the State of Minnesota. As a result of the settlement, the Company recognized a $500,000 gain. ENTRY INTO PUERTO RICO PAYPHONE MARKET During 1998, the Company began researching the Puerto Rico payphone market. It was determined that although the Puerto Rico Regulatory Board (PRRB) had not required the Puerto Rico Telephone Company (PRTC) to provide "competition neutral" service to independent payphone providers at a "cost-based rate", the Company was confident that the Telecom Act would eventually correct this situation. In March 1998, the Company began contracting with local businesses to provide payphone service. In April 1998 the Company received its first payphone lines from the PRTC and installed its first payphones. As of December 31, 2000 the Company had installed 1,500 payphones. In March 1998, the Company received verbal assurances from the Puerto Rican Telephone Company (PRTC) that pay phone lines would be made available and the charge would be a flat rate of $50.00 per month per line. However, when phone bills were received in the Company's offices, they included additional charges ranging from $0.13 to $0.26 per call. At that time, the PRTC and the Company agreed that until a final decision was reached on a rate case before the Puerto Rican Regulatory Board (PRRB), the Company would not pay the per call charges. On May 27, 1998 the PRRB ruled on that rate case and instructed the PRTC to reduce the per call charges to between $.01 and $.03 per call, depending upon the routing of the call. The PRTC appealed the ruling to the Court of Appeals, which upheld the ruling. The PRTC then appealed the ruling to the Puerto Rico Supreme Court, which upon agreeing to hear the case, issued a stay of execution until the court rendered its decision on the appeal. In June 2000 the Puerto Rico supreme court upheld the court of appeals ruling and ordered the PRTC to obey the PRRB rate regulation orders. From April through September 1998, the Company accrued unpaid line charges at the rate of $0.15 per call. In October 1998, the 13 Company reduced the rate it was accruing line charges to $0.06 per call based upon progress of this case. At December 31, 1999 the Company had accrued unpaid line charges of $356,000. In 2000 the Company reversed all accruals for unpaid line charges related to this matter. During the period of March 1998 to May 2000 when line rates were in dispute, the Company was unable to reconcile outstanding invoice balances with PRTC. Both Companies are currently attempting to reconcile outstanding balances but remain in disagreement. The PRTC, in its most recent written communication, claims the Company owes $250,000. The Company's own analysis shows that the PRTC owes the Company a $120,000 refund. At December 31, 2000 the Company has accrued a $250,000 liability which it believes will be adequate to settle this dispute. LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 2000, the Company's operating activities provided $292,000 the proceeds from sales of phones and rental agreements were $2,071,000, and the proceeds from issuing stock generated an additional $2,331,000. Purchases of equipment used $3,836,000, payments of long-term debt and notes used $435,000. In addition $251,000 was used to repurchase common stock and $2,000,000 was used to purchase short-term investments resulting in a $1,828,000 decrease in cash balances. In March 2000 the Company completed the sale of approximately 930 phones located in the Pennsylvania, New Jersey and Delaware, and received $2.0 million. Proceeds were placed in money market and investment accounts. Cash and cash on hand and investments were $2.7 million at year end. On July 26, 2000 the Board of Directors authorized the Company to repurchase up to 5% of the outstanding common stock of the Company at market rates. From October 2000 to December 2000, the Company purchased 122,218 shares for $250,407. On January 26, 2001 the Board of Directors authorized the Company to repurchase an additional 10% of the outstanding common stock. From January through March 2001, the company purchased 108,300 shares for $145,828. ITEM 7. FINANCIAL STATEMENTS The following financial information of the Company is included as follows:
PAGE ---- Report of Independent Auditors......................................................... F-1 Consolidated Financial Statements: Consolidated Balance Sheets for Years Ended December 31, 2000 and 1999.......... F-2 Consolidated Statements of Operations for Years Ended December 31, 2000 and 1999.................. ..................................................... F-3 Consolidated Statements of Shareholders' Equity for Years Ended December 31, 2000 and 1999.................. ................................................ F-4 Consolidated Statements of Cash Flows for Years Ended December 31, 2000 And 1999........................................................................ F-5 Notes to Consolidated Financial Statements...................................... F-7
14 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 15 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT DIRECTORS The following discussion sets forth certain information concerning the directors of the Company. GARY S. KOHLER is a founder of the Company and since its inception in 1989 has served as Chairman of the Board of Directors. Mr. Kohler is a partner and portfolio manager for Pyramid Trading, L.P., which he joined in October 1999. Prior to that he served as a managing director of Second Avenue Capital Management, a money management company, from December 1998 through September 1999. Prior to that he served as President of Kohler Capital Management from October 1997 through November 1998. From July to October 1997, Mr. Kohler was a partner in Tarmachan Holdings, Inc. From 1984 through June 1997, Mr. Kohler was Vice President and Portfolio Manager at Okabena Company. Mr. Kohler serves on the Board of Printware, Inc., a publicly traded printing equipment manufacturer, and a number of private companies, including Northwest Mortgage Services' and Health EZ, Inc. Mr. Kohler has an M.B.A. degree from Cornell University and a B.A. degree from the University of Minnesota. Mr. Kohler is the brother of Jack S. Kohler. JEFFREY R. PALETZ is a founder of the Company, has been a director since its inception and has been President since 1991. Prior to founding the Company in 1989, Mr. Paletz was employed for 13 years at Sportsman's Guide, a mail order retailer, where he oversaw the computer data operations. Mr. Paletz has a B.S. degree in Business from the University of Minnesota. ROBERT A. HEGSTROM became a director of the Company in June 1997. In January 1997, Mr. Hegstrom joined Northwest Mortgage Services, Inc. and served as Chairman, President and Chief Executive Officer until its sale in March 2000. Prior to that, he was a private investor for two years and, from October 1979 to January 1995, he was Executive Vice President of Green Tree Financial Corporation. Mr. Hegstrom is also a director of Excelsior Financial and Dermatrends Corp. MICHAEL WIGLEY became a director of the Company in January 1998. Since 1989 Mr. Wigley has been President and Chief Executive Officer of Great Plains Companies, Inc., a diversified holding company. Mr. Wigley has an M.B.A. from Harvard Business School, a M.S. from Stanford University and a B.S. degree from the University of Minnesota. Mr. Wigley serves on the Board of Intelefilm, Inc. and is a regent of Luther College. BOARD COMMITTEES AND ACTIONS During calendar year 2000, the Board of Directors met 4 times and each director attended all meetings. The Board of Directors has two standing committees, a Compensation Committee and an Audit Committee. During 2000, the Compensation Committee met once and the Audit Committee met twice. The Compensation Committee reviews and make recommendations to the Board of Directors regarding salaries, compensation and benefits of executive officers of the Company and administers the Company's 1997 Long-Term Incentive and Stock Option Plan. The Committee members are Robert A. Hegstrom, Gary S. Kohler and Jeffrey R. Paletz. The Audit Committee is responsible for recommending the appointment of a firm of independent public accountants to audit the books and records of the Company and its subsidiaries, reviews the internal and external financial reporting of the Company and the scope of the independent audit. The Committee members are Michael Wigley, Robert A. Hegstrom and Gary S. Kohler. 16 The Board of Directors acts as the nominating committee. See "Information Concerning directors and Nominees - Nomination of Directors" DIRECTOR COMPENSATION No cash compensation is paid to the Company's directors. Independent, non-employee directors (Mr. Hegstrom and Mr. Wigley) upon reelection receive an option to purchase $75,000 of Common Stock, valued as of the annual shareholders meeting. The options are pursuant to the Company's 1997 Long-Term Incentive and Stock Option Plan, are exercisable upon grant and have five-year term and an exercise price equal to the fair market value of the Common Stock as of the date of grant. No options will be issued to employee directors for their service as directors. NOMINATION OF DIRECTORS The Board of Directors acts as the nominating committee for selecting the Board's nominees for election as directors. The Board does not intend to consider nominees recommended by shareholders. Directors of the Company are elected annually to serve until the next annual meeting of shareholders or until their successors are duly elected. The Company knows of no arrangements or understandings between a director or nominee and any other person pursuant to which he has been selected as a director or nominee. The only family relationship between any of the nominees, directors or executive officers of the Company is between Gary S. Kohler and Jack S. Kohler, who are brothers. EXECUTIVE OFFICERS The following discussion sets forth information about the executive officers of the Company who are not directors. JACK S. KOHLER has been Vice President and Chief Financial Officer of the Company since 1993. Prior to joining the Company, Mr. Kohler was employed for 13 years in various management and accounting positions at Cargill, Inc. Mr. Kohler has a B.S. degree in Accounting from the University of Minnesota. Mr. Kohler is the brother of Gary S. Kohler. ITEM 10. EXECUTIVE COMPENSATION The following table and accompanying footnotes set forth certain summary information, relating to the three years ended December 31, 1998, 1999 and 2000, with respect to the Company's Chief Executive Officer. 17
LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS ------------------------------------ ------------ SECURITIES NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING POSITION YEAR SALARY($) BONUS($) COMPENSATION($) OPTIONS/SARS(#) ALL OTHER --------------------------- ------------------------------------------- --------------- --------- COMPENSATIONS ------------- Jeffrey R. Paletz, 2000 $108,000 $ 32,000 ------ ------- -------- President 1999 108,375 ------ ------- -------- 1998 86,398 ------ ------- --------
AGREEMENTS WITH EXECUTIVES -------------------------- The Company has no employment agreements. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information as of December 31, 2000, regarding the beneficial ownership of shares of Common Stock of the Company by each director and executive officer of the Company, by all directors and executive officers of the Company as a group, and by each shareholder known by the Company to own beneficially more than five percent (5%) of the outstanding shares of the Company's Common Stock. Unless otherwise noted, each person or group identified possesses sole voting and investment power with respect to such shares.
------------------------------------------------------------------------------------------- NUMBER OF SHARES PERCENT OF NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED OUTSTANDING SHARES ------------------------------------ (1) (2) ------------------ ------------------- Perkins Capital Management, Inc. (3) 466,782 13.0% 730 East Lake Street Wayzata, MN 55391-1769 Andrew Redleaf (4) 379,654 11.1% 3033 Excelsior Blvd. Minneapolis, Minn. 55416 DIRECTORS, NOMINEES AND EXECUTIVE OFFICERS: Gary S. Kohler (5)(6)(9)............................ 918,460 28.8% Jeffrey R. Paletz.................................. 347,358 10.5% Jack S. Kohler (6)(7)............................... 334,500 9.4% Robert A. Hegstrom (8).............................. 101,873 3.0% Michael Wigley (8)(9)............................... 297,522 8.7% All directors, nominees and executive officers as a group (5 persons) 1,704,388 47.8%
18 (1) Each person has sole voting power and sole dispositive power with respect to all outstanding shares, except as otherwise noted or disclosed by the beneficial owners in the Schedule 13G filing described at footnote 3 below. (2) Based on 3,305,381 shares outstanding at March 31, 2001. Such amount does not include 1,099,203 shares of common stock issuable upon exercise of stock options. Each figure showing the percentage of outstanding shares owned beneficially has been calculated by treating as outstanding and owned the shares which could be purchased by the indicated person(s) within 60 days upon the exercise of existing stock options or warrants. (3) Reflects information included on Schedule 13G dated January 22, 2001 filed with the Securities and Exchange Commission. (4) Reflects information included on Schedule 13G dated March 30, 2001 filed with the Securities and Exchange Commission. (5) Includes 40,000 shares held by Gary S. Kohler as custodian for the benefit of his children. Mr. Kohler disclaims beneficial ownership of such shares. (6) Includes 200,000 shares currently owned by Gary S. Kohler, who has granted Jack S. Kohler an option to purchase such shares. (7) Includes options to acquire 70,000 shares from the Company. (8) Includes options to acquire 96,873 shares from the Company. (9) Includes 95,325 shares currently owned by Gary S. Kohler, who has granted Michael Wigley an option to purchase such shares SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's officers, directors, and persons who own more than ten percent of a registered class of the Company's equity securities to file certain reports regarding ownership of, and transactions in, the Company's securities with the Securities and Exchange Commission (the "SEC"). These officers, and directors and stockholders are also required by SEC rules to furnish the Company with copies of all Section 16(a) reports that are filed with the SEC. Based solely on a review of copies of such forms received by the Company, the Company believes that for the year ended December 31, 2000, all Section 16(a) reports required to be filed by the Company's executive officers, directors and 10% stockholders were filed on a timely basis, except for Andrew Redleaf, a beneficial owner of more than ten percent of the Company's common stock, who filed a late Form 5 to report his initial acquisition of more than ten percent of the Company's common stock and to report certain subsequent purchases of common stock and warrants. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 19 The information concerning certain relationships and related transaction is set forth in the Proxy Statement under the heading "Certain Transactions", which information is incorporated herein by reference. The Company has an arrangement with Gary S. Kohler, the Company's Chairman of the Board, pursuant to which Mr. Kohler advises the Company's management on an as-needed basis. The consulting fees paid to Mr. Kohler for rendering this service for the year ended December 31, 2000 totaled $28,800. During 2000, the Company invested $2,000,000 in Whitebox Arbitrage Fund, LLC. Andrew Redleaf, a holder of more than 10% of the Company's stock, is President of Whitebox Advisors, Inc., which is the general partner of Whitebox Arbitrage Fund, LLC. 20 PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS. SEE "EXHIBIT INDEX" ON PAGE FOLLOWING SIGNATURES. (b) REPORTS ON FORM 8-K 21 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHOICETEL COMMUNICATIONS, INC. Date: April 17, 2001 By /s/ GARY S. KOHLER -------------- Gary S. Kohler Chairman of the Board of Directors In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Power of Attorney Each person whose signature appears below constitutes and appoints JEFFREY R. PALETZ and JACK S. KOHLER as his true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-KSB and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof.
SIGNATURE TITLE DATE /s/ GARY S. KOHLER Director April 17, 2001 ------------------------------------------------ Gary S. Kohler /s/ JEFFREY R. PALETZ President and Director April 17, 2001 ------------------------------------------------ Jeffrey R. Paletz /s/ JACK S. KOHLER Vice President and Chief April 17, 2001 ------------------------------------------------ Financial Officer Jack S. Kohler /s/ ROBERT A. HEGSTROM Director April 17, 2001 ------------------------------------------------ Robert A. Hegstrom /s/ MICHAEL WIGLEY Director April 17, 2001 ------------------------------------------------ Michael Wigley
22 INDEPENDENT AUDITORS' REPORT Board of Directors ChoiceTel Communications, Inc. Minneapolis, Minnesota We have audited the accompanying consolidated balance sheets of ChoiceTel Communications, Inc. and Subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ChoiceTel Communications, Inc. and Subsidiaries as of December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles. /s/ Schechter Dokken Kanter Andrews & Selcer Ltd. Minneapolis, Minnesota April 13, 2001 F-1 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31
2000 1999 ------------ ------------- ASSETS: Current assets: Cash and cash equivalents $ 495,312 $ 2,323,344 Investments 2,203,306 Receivables 521,072 1,241,952 Prepaid and other assets 88,167 319,492 Deferred taxes 1,873,000 302,000 ------------ ------------- Total current assets 5,180,857 4,186,788 Property and equipment, net 239,500 113,302 Net assets of discontinued operations 1,943,228 4,849,926 ------------ ------------- $ 7,363,585 $ 9,150,016 ============ ============= LIABILITIES AND SHAREHOLDERS' EQUITY: Current liabilities: Notes payable $ 350,000 Current portion of long-term debt 383,190 Accounts payable $ 1,788,235 157,808 Accrued expenses 207,841 1,835,251 Income tax payable 221,000 ------------ ------------- Total current liabilities 1,996,076 2,947,249 Long-term debt, net of current portion 4,285 Minority interest 23,611 Shareholders' equity 5,367,509 6,174,871 ------------ ------------- $ 7,363,585 $ 9,150,016 ============ =============
See notes to consolidated financial statements. F-2 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31
2000 1999 ---------------- --------------- Service revenue $ 120,967 $ 5,031 Cost of service 363,646 9,940 ---------------- --------------- Gross margin (242,679) (4,909) ---------------- --------------- Selling, general and administrative expenses 2,089,389 292,235 Loss from impairment 2,744,184 Amortization and write-off of goodwill 1,061,735 ---------------- --------------- Total operating expenses 5,895,308 292,235 ---------------- --------------- Operating loss (6,137,987) (297,144) ---------------- --------------- Other income (expense): Investment income 203,306 Interest income, net 113,051 ---------------- 316,357 Loss from continuing operations before income tax benefit (5,821,630) (297,144) Provision for income tax benefit 1,856,000 66,000 ---------------- --------------- Loss from continuing operations before minority interest (3,965,630) (231,144) Minority interest 791,654 53,338 ---------------- --------------- Loss from continuing operations (3,173,976) (177,806) Income from discontinued operations (net of income tax expense of $105,000 and $42,000 for 2000 and 1999, respectively) 152,648 160,890 ---------------- --------------- Net loss $ (3,021,328) $ (16,916) ================ =============== Earnings (loss) per share: Continuing operations, basic and diluted $ (0.98) $ (0.06) ================ =============== Discontinued operations, basic and diluted $ 0.05 $ 0.05 ================ =============== Net loss, basic and diluted $ (0.93) $ (0.01) ================ =============== Weighted average number of shares outstanding: Basic 3,245,016 2,915,528 ================ =============== Diluted 3,245,016 2,925,776 ================ ===============
See notes to consolidated financial statements. F-3 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2000 AND 1999
15,000,000 shares AUTHORIZED, $.01 PAR ------------------------ Additional paid-in Accumulated Subscriptions Shares Amount Capital Deficit Receivable Total ----------- --------- -------------- ------------- ------------- ----------- Balance, January 1, 1999 2,915,006 $ 29,150 $ 5,986,072 $ (19,103) $(10,000) $ 5,986,119 Issuance of minority shares of subsidiary 73,050 73,050 Issuance of stock options for services 99,562 99,562 Issuance of common stock 11,900 119 22,937 23,056 Collection of subscription receivable 10,000 10,000 Net loss (16,916) (16,916) ----------- --------- -------------- ------------- ------------- ----------- Balance, December 31, 1999 2,926,906 29,269 6,181,621 (36,019) 0 6,174,871 Issuance of minority shares of subsidiary 135,000 135,000 Issuance of stock options for services 38,000 38,000 Issuance of common stock 618,793 6,188 2,285,741 2,291,929 Repurchase of common stock (137,618) (1,376) (249,587) (250,963) Net loss (3,021,328) (3,021,328) --------- -------- ----------- ------------- -------- ----------- Balance, December 31, 2000 3,408,081 $ 34,081 $ 8,390,775 $ (3,057,347) $ 0 $ 5,367,509 ========= ======== =========== ============= ======== ===========
See notes to consolidated financial statements. F-4 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31
2000 1999 ---------------- --------------- Cash flows from operating activities: Net loss $ (3,021,328) $ (16,916) Adjustments to reconcile net loss to net cash provided by operating activities: Deferred taxes (1,571,000) (245,000) Depreciation 392,055 873,911 Amortization and goodwill write-off, net 770,542 510,214 Stock based compensation issued 38,000 122,618 Minority interest loss (791,654) (53,338) Loss on disposal 1,449,336 (14,621) Impairment loss 2,744,184 Increase in value of investments (203,306) Changes in operating assets and liabilities: Coin in phone 12,841 108,877 Income tax receivable (180,000) Receivables 942,634 162,898 Prepaid expenses (33,745) 241,107 Checks outstanding in excess of bank balance (74,604) Accounts payable 1,723,548 (81,136) Accrued expenses (1,758,870) 7,953 Income tax payable (221,000) 221,000 ---------------- --------------- Net cash provided by operating activities 292,237 1,762,963 ---------------- --------------- Cash flows from investing activities: Purchase of: Equipment (3,836,481) (1,063,710) Short-term investments (2,000,000) Proceeds from sale of equipment and rental contracts 2,071,200 6,035,000 ---------------- --------------- Net cash provided by (used in) investing activities (3,765,281) 4,971,290 ---------------- --------------- Cash flows from financing activities: Proceeds from issuance of: Common stock in subsidiary 225,000 150,000 Common stock 2,106,308 Collection of subscription receivable 10,000 Repurchase of common stock (250,963) Principal payments on long-term debt (387,475) (4,726,816) Payment in notes payable (47,858) ---------------- --------------- Net cash provided by (used in) financing activities 1,645,012 (4,566,816) ---------------- ---------------
See notes to consolidated financial statements. F-5 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31
2000 1999 ---------------- --------------- Net increase (decrease) in cash and cash equivalents $ (1,828,032) $ 2,167,437 Cash and cash equivalents, beginning 2,323,344 155,907 ---------------- --------------- Cash and cash equivalents, ending $ 495,312 $ 2,323,344 ================ =============== Supplemental disclosure of cash flow information: Cash paid for interest $ 4,584 $ 509,060 ================ =============== Supplemental cash flow information: Non cash investing and financing activities: Receivable from sale of assets $ 365,810 =============== Note payable settled partially by prepaid expenses $ 302,142 ================ Common stock issued and capital contributed in non-cash transactions $ 185,621 ================
See notes to consolidated financial statements. F-6 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 1. NATURE OF BUSINESS AND DISCONTINUED OPERATIONS: Nature of business: ChoiceTel Communications, Inc., and Subsidiaries (the Company) includes an 80% owned subsidiary, Advants, Inc. (formerly Public Internet Access Holdings Corporation). ChoiceTel Communications, Inc. increased its ownership interest in Advants, Inc. (Advants) from 60% in 1999 to 80% during 2000 mainly by providing a significant investment in Advants common stock. Advants is in the business of providing public Internet access through kiosks located in perceived high traffic areas such as gas stations and supermarkets. Advants has had minimal revenue since inception and has incurred large expenses for hardware and software development. Advants' total liabilities exceed total assets by approximately $1.7 million as of December 31, 2000. Advants' operations after year end have substantially decreased and in April 2001, Advants disposed of certain assets to help pay certain creditors. ChoiceTel Communications, Inc. announced that it does not intend to further fund Advants' operations and although the results of Advants are consolidated in conformance with generally accepted accounting principles, management believes that ChoiceTel Communications, Inc.'s financial exposure regarding its subsidiary is generally limited to the amount of its investment in the subsidiary's stock (see Note 8 regarding contingencies). The condensed balance sheet of Advants as of December 31, 2000 is as follows: Property and equipment $ 239,500 Other assets, mostly cash 4,200 ---------------- Total assets $ 243,700 ================ Accounts payable and accrued expenses $ 1,812,000 Due to ChoiceTel Communications, Inc. 172,000 Equity (1,740,300) ---------------- Total liabilities and shareholders equity $ 243,700 ================ Advants is continuing to look for new financing or strategic partners, although there is no assurance that it will be able to find further financing. Discontinued operations: The Company decided to discontinue its pay phone operations in December 1999 (measurement date). The Company has estimated it will realize an overall gain on the disposal of discontinued operations. In 1999, the Company sold all of its phones in two territories (the Northwest and Midwest) in separate transactions totaling approximately $6.4 million. The Northwest sale occurred prior to the measurement date and a gain of approximately $32,000 is included in income from discontinued operations in 1999. Additionally, the Company entered into an agreement with the Midwest purchaser to sell 100% of the outstanding stock of ChoiceTel, Inc., the Company's local exchange carrier subsidiary, for $100,000. This transaction was closed during 2000. In March 2000, the Company sold its operations in the Eastern United States for approximately $2,000,000. F-7 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 1. NATURE OF BUSINESS AND DISCONTINUED OPERATIONS (CONTINUED): Discontinued operations (continued): The results of discontinued operations are as follows:
2000 1999 --------------- ---------------- Service revenue $ 4,287,575 $ 10,376,055 Cost of service 1,519,455 4,885,419 --------------- ---------------- Gross margin 2,768,120 5,490,636 Selling, general and administrative 1,915,225 4,811,306 Loss on sale of assets 1,032,599 Adjustment of accrued sales tax liability (508,876) Deferred loss 66,280 Interest expense 5,244 476,440 --------------- ---------------- Income before taxes 257,648 202,890 Income taxes 105,000 42,000 --------------- ---------------- Income from discontinued operations $ 152,648 $ 160,890 =============== ================
The net assets of the discontinued operations consist of the following as of December 31:
2000 1999 --------------- ---------------- Cash $ 85,614 $ 98,455 Accounts receivable 41,753 Prepaid expenses 139,887 176,960 Property and equipment, net 2,068,183 2,828,458 Rental contracts, net 30,591 2,150,527 Deferred loss 66,280 Accrued expenses (381,047) (512,507) --------------- ---------------- $ 1,943,228 $ 4,849,926 =============== ================
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Principles of consolidation: The consolidated financial statements for 2000 and 1999 include the accounts of ChoiceTel Communications, Inc., and its 80% owned subsidiary, Advants. All material intercompany balances have been eliminated. The consolidated financial statements for 1999 include the accounts of ChoiceTel Communications, Inc. and its wholly owned subsidiary, ChoiceTel, Inc. and its 60% owned subsidiary, Advants. All material intercompany balances have been eliminated. Concentration of credit risk: The Company maintains its cash in bank deposit accounts at financial institutions where balances, at times, may exceed federally insured limits. It is management's opinion that the risk of loss is minimal. The Company also has an investment of $2,203,306, including accrued earnings, with Whitebox Statistical Arbitrage Fund, LP, a fund with a stated objective of providing superior short-term risk adjusted returns through the use of a statistical arbitrage trading strategy. This investment is neither guaranteed nor insured. Consequently, the entire investment is subject to market risk. Property and equipment and depreciation methods: Property and equipment is recorded at cost. Depreciation is being provided by the straight-line method over the estimated useful lives generally between 5 and 10 years. F-8 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Impairment of assets: The Company has determined that substantially all of the assets of Advants and related goodwill have become impaired, as defined by Statement of Financial Accounting Standards No. 121 (SFAS No. 121) ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG LIVED ASSETS TO BE DISPOSED OF. The impaired assets include its public access Internet kiosks, related equipment and capitalized software development costs. Pursuant to the requirements of SFAS 121, the Company has recorded an impairment loss on these assets. Capitalization of computer software development costs: The Company capitalizes certain costs incurred in the development of software, including external direct material and service costs, once technical feasibility is reached. Deferred financing: Deferred financing costs were being amortized over the life of the related notes on a straight-line basis. The related note was paid off during 1999 and the remaining deferral was written-off. Income taxes: Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes. Deferred taxes are recognized from differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. The deferred tax assets and liabilities represent the future tax expense of those differences. For 2000, the Company will file a consolidated tax return that includes Advants for the period August 1, 2000 through December 31, 2000. Prior to that, Advants filed a separate tax return. For 1999, the Company filed a consolidated tax return that included only ChoiceTel Communications, Inc. and ChoiceTel, Inc. Stock-based compensation: The Company accounts for its stock options in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB No. 25), ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. The Company has also adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which permits entities to recognize the expense over the vesting period of the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB No. 25 and provide pro forma net income disclosures for employee stock option grants as if the fair-value based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. F-9 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Earnings per share: The Company adopted SFAS No. 128, EARNINGS PER SHARE. Basic earnings per common share are based on the weighted average number of common shares outstanding in each year. Diluted earnings per common share assume that outstanding common shares were increased by shares issuable upon exercise of stock options and warrants for which market price exceeds exercise price, less shares which could have been purchased by the Company with related proceeds. This calculation added 0 and 10,248 shares to the diluted weighted average shares outstanding for 2000 and 1999, respectively. Stock options and warrants of 1,085,282 and 1,226,000, for December 31, 2000 and 1999, respectively, were not used in the calculation of diluted earnings per share because they were antidilutive. Cash equivalents: The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, the actual amounts could differ from those estimates. Any adjustments applied to estimated amounts are recognized in the year in which such adjustments are determined. Estimates that are susceptible to significant change are contingencies, asset impairment, and deferred taxes. 3. RELATED PARTY TRANSACTIONS: The Company has invested $2,000,000 in Whitebox Arbitrage Fund, LLC. A holder of more than 10% of the Company's common stock is President of Whitebox Advisors, Inc., which is the general partner of Whitebox Arbitrage Fund, LLC. The value of the investment at December 31, 2000 is $2,203,306. 4. WRITE-OFF OF GOODWILL AND ASSET IMPAIRMENTS: During the fourth quarter of 2000, management determined that the Company's efforts to penetrate the public access Internet kiosk business were not going to generate a cash flow sufficient to support the cost of the related assets. Consequently, the Company wrote-off goodwill generated in 2000 of approximately $1,062,000. Additionally, in the fourth quarter of 2000, the Company recorded asset impairments of $2,744,184. These asset impairments were required to reduce the carrying value of the Company's Internet kiosks, related equipment and related capitalized software development costs. The reported values of the profitable assets were determined from an analysis of projected undiscounted cash flows, which were no longer deemed adequate to support the value of the goodwill or of the assets. Reported values of most of the assets were based upon salvage values net of costs required for disposal. These write-downs relate to substantially all of the assets of Advants and related goodwill generated by common stock purchases of Advants by ChoiceTel Communications, Inc. F-10 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 5. Property and equipment: 2000 1999 -------------- --------------- Office equipment $ 35,000 $ 20,658 Kiosks 154,500 54,682 Accumulated depreciation (10,738) -------------- --------------- 189,500 64,602 In process software 50,000 48,700 -------------- --------------- $ 239,500 $ 113,302 ============== =============== 6. NOTE PAYABLE: 1999 Note payable, Computer Assisted Technology, Inc., interest only at 8.5% through February 7, 1998. Convertible to shares of common stock at $6.75 plus adjustment based on IPO price of stock. See Note 8. $ 350,000 ============ 7. LONG-TERM DEBT:
1999 Note payable, Telco, due in monthly installments of $21,342 including interest at 10% through July 2001, secured by equipment, subordinated to notes payable, bank, paid off in January 2000. $ 378,061 Notes payable, vehicles, due in monthly installments of $480 including interest at 8.95% through December 2001, paid off during 2000. 9,414 ------------ 387,475 Less current portion 383,190 ------------ $ 4,285 ============
8. COMMITMENTS AND CONTINGENCIES: Phone locations: The Company rents phone locations from merchants and property owners under varying lease terms, usually ten years, generally cancelable by the Company upon 30 days notice. Consulting agreement: The Company paid a director/shareholder $28,800 for certain consulting services in each year 2000 and 1999. Leases: The Company leases its offices in Puerto Rico under an operating lease expiring in May 2001. The lease has renewal options and requires the Company to pay certain common area costs and real estate taxes. The Company leases it corporate offices under a month-to-month lease. Advants leases its office space under an operating lease expiring in 2003. Rent expense was $121,878 and $121,246 for the years ended December 31, 2000 and 1999, respectively. Future minimum lease payments are as follows: 2001 $ 62,583 2002 64,471 2003 10,798 Contingencies: Sales tax: During 2000, the Company reached a settlement with the Minnesota Department of Revenue covering all sales tax liabilities during the period the Company operated pay phones in the State of Minnesota. As a result of the settlement the Company recognized a $509,000 gain. At December 31, 1999 the Company had recorded a sales tax liability of $1,549,685. F-11 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 8. COMMITMENTS AND CONTINGENCIES (CONTINUED): Contingencies (continued): Lawsuits: ChoiceTel, Inc. and Advants have been named in several lawsuits for unpaid bills of Advants, as well as for claims of promissory estoppel and other matters. The Company intends to defend these lawsuits. The unpaid bills for these parties, as of December 31, 2000, that are recorded in accounts payable in the financial statements are approximately $1,140,000, which does not include interest, legal fees, court costs if assessed, or any other additional claims. The Company has no amounts recorded above amounts billed. Additional liability, if any, is not determinable. Puerto Rico line charges: In March 1998, the Company received verbal assurances from the Puerto Rican Telephone Company (PRTC) that pay phone lines would be made available and the charge would be a flat rate of $50.00 per month per line. However, when phone bills were received in the Company's offices, they included additional charges ranging from $0.13 to $0.26 per call. At that time the PRTC and the Company agreed that until a final decision was reached on a rate case before the Puerto Rican Regulatory Board (PRRB), the Company would not pay the per call charges. On May 27, 1998 the PRRB ruled on that rate case and instructed the PRTC to reduce the per call charges to between $.01 and $.03 per call, depending upon the routing of the call. The PRTC appealed the ruling to the Court of Appeals, which upheld the ruling. PRTC has since appealed the ruling to the Puerto Rico Supreme Court, which has agreed to hear the case and has issued a stay of execution until the court renders a decision on the appeal. In June 2000, the Puerto Rico Supreme Court upheld the court of appeals ruling and ordered the PRTC to obey the PRRB rate regulation orders. From April through September 1998, the Company accrued unpaid line charges at the rate of $0.15 per call. In October 1998, the Company reduced the rate it was accruing line charges to $0.06 per call based upon progress of this case. At December 31, 1999 the Company had accrued unpaid line charges of $356,000. As a result of the affirmation of this court ruling in 2000, the Company reversed all accruals for unpaid line charges related to this matter. During the period of March 1998 to May 2000 when line rates were in dispute the Company was unable to reconcile outstanding invoice balances with PRTC. Both parties are currently attempting to reconcile outstanding balances but remain in disagreement. The PRTC, in its most recent written communication, claims the Company owes $250,000. The Company's own analysis shows that PRTC owes the Company a $120,000 refund. At December 31, 2000 the Company has accrued a $250,000 liability which is believed to be adequate to cover any losses resulting from resolution of this matter. It is reasonably possible that a change in this estimate will occur in the near term as the Company continues negotiating with the PRTC. Dial around compensation: The Company receives compensation for dial around activity related to its pay phones. The rates are set by the Federal Communication Commission and are subject to change both prospectively and retroactively. The 1999 financial statements include a provision for $80,000 as an estimated liability for amounts that may require repayment. During 2000, the Company revised its estimate to $0. F-12 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 8. COMMITMENTS AND CONTINGENCIES (CONTINUED): Contingencies (continued): Computer Assisted Technologies (CAT): The Company's 1999 financial statements included the following amounts related to a 1997 purchase from CAT of a route of pay telephones: Prepaid expenses $ 302,142 Accrued expenses (93,121) Note payable (See Note 5) (350,000) --------------- Net liability $ (140,979) =============== In 2000, the Company entered into an agreement to settle these amounts by issuing 46,560 shares of common stock and a $175,000 payment. 9. STOCK OPTIONS AND WARRANTS: On April 11, 1997, the Company's Board of Directors adopted the 1997 Long-Term Incentive and Stock Option Plan (the Plan). The Plan provides for the issuance of incentive stock options and non-qualified stock options to key employees and directors of the Company. The total number of shares of common stock authorized and reserved for issuance under the Plan is 350,000 shares. The exercise price for each incentive stock option granted under the Plan may not be less than the fair market value of the common stock on the date of the grant, unless, in the case of incentive stock options, the optionee owns greater than 10% of the total combined voting power of all classes of capital stock of the Company, in which case the exercise price may not be less than 110% of the fair market value of the common stock on the date of the grant. The exercise price for each non-qualified option may not be less than 85% of the fair market value of the common stock on the date of grant. Unless otherwise determined by the Board, incentive options granted under the Plan have a maximum duration of 10 years, non-qualified options and awards have a maximum duration of 15 years. Vesting is based on such terms and conditions as the Board shall determine. 9. Stock options and warrants (continued): The proforma effects of options issued to employees are as follows: AS REPORTED PROFORMA 2000: Net loss $ (3,021,328) $ (3,025,968) ================ =============== Loss per share $ (.93) $ (.93) ================ =============== 1999: Net loss $ (16,916) $ (93,728) ================ =============== Loss per share $ (0.01) $ (0.03) ================ =============== Assumptions used to estimate the fair value of options issued to employees using the Black Scholes model are as follows: 2000 1999 ------------ ----------- Estimated: Risk free interest rate 5.13% 5.85% Life 4 YEARS 2 years Volatility 0.00% 140.00% Dividends 0.00% 0.00% F-13 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 9. STOCK OPTIONS AND WARRANTS (CONTINUED): Information with respect to options outstanding as of December 31 is summarized as follows:
2000 1999 ---------------------------------- ------------------------------------ Weighted Average Weighted average Shares Exercise Price Shares Exercise Price ----------- ---------------- ----------- ------------------ Outstanding at beginning of year 252,666 $ 3.21 130,000 $ 4.34 Granted 123,158 3.18 136,666 2.25 Exercised Forfeited 30,000 5.75 14,000 3.62 ----------- ---------------- ----------- ------------------ Outstanding at end of year 345,824 $ 3.02 252,666 $ 3.21 ============ === ============ ============ ================== Range of exercise prices of options outstanding at December 31 $2.25-$5.00 $2.25-$6.75 Options exercisable at year end 342,491 245,999 Weighted average remaining life 2.4 years 2.9 years
At December 31, the Company has the following outstanding warrants:
Weighted average 2000 1999 exercise price ------------ ------------- ------------------ Issued as part of units in public offering 800,000 800,000 $ 9.50 Granted to underwriter in public offering 160,000 160,000 8.95 Granted to underwriter in private offering 629,457 4.95 Granted to investment relations company 100,000 150,000 6.50 ------------ ------------- Outstanding at year end 1,689,457 1,110,000 $ 7.58 ============ ============= ========== Warrants exercisable at year end 1,689,457 1,110,000 Weighted average remaining life 2.9 YEARS 2.8 years
F-14 CHOICETEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000 AND 1999 10. INCOME TAXES:
2000 1999 ------------- -------------- Provisions calculated at statutory rates: Deferred Benefit: Federal $ 2,014,000 $ 101,000 State 355,000 18,000 ------------- -------------- 2,369,000 119,000 Valuation allowance 513,000 53,000 ------------- -------------- $ 1,856,000 $ 66,000 ============= ==============
The deferred tax asset and deferred tax liability consist of the following at December 31:
2000 1999 ------------- -------------- Deferred tax asset (liability): PRTC settlement $ 100,000 Sales tax contingency $ 620,000 Accrued expenses 25,000 27,000 Accrued dial-around compensation 32,000 Depreciation (230,000) (395,000) Amortization 425,000 45,000 Net operating loss carryforward 981,000 53,000 Deferred loss on disposal (27,000) Impairment loss 1,138,000 ------------- -------------- 2,439,000 355,000 Valuation allowance 566,000 53,000 ------------- -------------- $ 1,873,000 $ 302,000 ============= ==============
On a consolidated basis, the Company has available loss carryforwards of $1,518,000 expiring in 2020. Additionally, Advants has federal and state net operation loss carryforwards of $1,414,000 expiring in 2019 and 2020. These carryforwards are available only to offset future income of Advants. Utilization of the deferred tax asset of $1,873,000 disclosed above is dependent on future taxable profits in excess of profits arising from existing taxable temporary differences. Assets have been recognized based on management's estimate of future taxable income which includes a valuation allowance related to Advants, which has no operating history to determine future use of the net operating loss carryforward. 11. FINANCIAL INSTRUMENTS: The Company's financial instruments recorded on the balance sheet include cash, investments, accounts receivable, notes and accounts payable and debt. Because of their short maturity, the carrying amount of cash, investments, accounts receivable and notes and accounts payable approximates fair value. Fair value of long-term debt approximates recorded value based on rates available to the Company for similar terms and maturities. 12. SUBSEQUENT EVENTS: In January 2001, Advants borrowed $75,000 from a bank, secured by substantially all of Advants' assets and by personal guarantees of several employees of Advants. The loan was due in April of 2001. The Company has made approximately $18,000 in principal payments and is in default on the outstanding balance. F-15 SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. EXHIBIT INDEX TO FORM 10-KSB OF CHOICETEL COMMUNICATIONS, INC. For the Fiscal Year Ended December 31, 2000 Commission File Number: 0-230 17
EXHIBIT DESCRIPTION NO. ------------ --- 3.1 Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 3.2 Bylaws (incorporated by reference to Exhibit 3.2 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 4.2 Form of Redeemable Warrant Agreement with Norwest Bank Minnesota, National Association, including certificate representing the Redeemable Warrants (incorporated by reference to Exhibit 4.2 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 10.1* 1997 Long-Term Incentive and Stock Option Plan (incorporated by reference to Exhibit 10.1 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 10.3* Bonus Program (incorporated by reference to Exhibit 10.3 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 10.17* Employment Agreement with Jeffrey R. Paletz, dated as of April 15, 1997 (incorporated by reference to Exhibit 10.17 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 10.19* Employment Agreement with Jack S. Kohler, dated as of April 15, 1997 (incorporated by reference to Exhibit 10.19 of the Registrant's Registration Statement on Form SB-2; Registration No. 333-29969) 10.27** Agreement for Sale and Purchase of Business Assets with Alpha Telcom, Inc., dated March 2000. 24 Power of Attorney (included on the signature page of this Form 10-KSB) ______________________ * Management contract or compensatory plan or arrangement. ** Filed herewith.