-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CQjv/YOco9uxzeQ/1tQgF/H5oHq+3QD68yLQfKNGKs+PNbpT61MTCrp4lMfMyZRm 7qxy+s3cnChC2qPfHd1d9A== 0000912057-97-028822.txt : 19970825 0000912057-97-028822.hdr.sgml : 19970825 ACCESSION NUMBER: 0000912057-97-028822 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 19970822 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHOICETEL COMMUNICATIONS INC /MN/ CENTRAL INDEX KEY: 0001031927 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 411649949 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-29969 FILM NUMBER: 97668013 BUSINESS ADDRESS: STREET 1: 9724 10TH AVE NORTH CITY: PLYMOUTH STATE: MN ZIP: 55441 MAIL ADDRESS: STREET 1: 9724 10TH AVE NORTH CITY: PLYMOUTH STATE: MN ZIP: 55441 FORMER COMPANY: FORMER CONFORMED NAME: INTELLIPHONE INC DATE OF NAME CHANGE: 19970625 SB-2/A 1 SB-2/A AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 22, 1997 REGISTRATION NO. 333-29969 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- AMENDMENT NO. 1 TO FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- CHOICETEL COMMUNICATIONS, INC. (Name of small business issuer in its charter) MINNESOTA 4813 41-1649949 (State or jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification No.)
9724 10TH AVENUE NORTH PLYMOUTH, MINNESOTA 55441 (612) 544-1260 (Address and telephone number of registrant's principal executive offices and principal place of business) JACK S. KOHLER VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 9724 10TH AVENUE NORTH PLYMOUTH, MINNESOTA 55441 PHONE: (612) 544-1260 FAX: (612) 544-1281 (Name, address and telephone number of agent for service) -------------------------- COPIES OF ALL COMMUNICATIONS, INCLUDING ALL COMMUNICATIONS SENT TO THE AGENT FOR SERVICE, SHOULD BE SENT TO: ROBERT T. MONTAGUE MICHELE D. VAILLANCOURT Robins, Kaplan, Miller & Ciresi L.L.P. Winthrop & Weinstine, P.A. 2800 LaSalle Plaza 3000 Dain Bosworth Plaza 800 LaSalle Avenue 60 South Sixth Street Minneapolis, Minnesota 55402-2015 Minneapolis, Minnesota 55402-4430 Phone: (612) 349-8500 Phone: (612) 347-0700 Fax: (612) 339-4181 Fax: (612) 347-0600 -------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. -------------------------- If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. /X/ -------------------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SUBJECT TO COMPLETION, DATED AUGUST 22, 1997 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. CHOICETEL COMMUNICATIONS, INC. 800,000 UNITS EACH UNIT CONSISTING OF ONE SHARE OF COMMON STOCK AND ONE REDEEMABLE COMMON STOCK PURCHASE WARRANT --------------------- ChoiceTel Communications, Inc. (the "Company") is offering 800,000 units (the "Units"), each Unit consisting of one share of the Company's Common Stock, par value $0.01 per share (the "Common Stock"), and one redeemable Common Stock Purchase Warrant ("Redeemable Warrant"). The Redeemable Warrants are immediately exercisable and transferable separately from the Common Stock. Each Redeemable Warrant entitles the holder to purchase, at any time until five years following the date that the Registration Statement relating to this Prospectus (the "Registration Statement") has been declared effective by the Securities and Exchange Commission (the "Effective Date"), one share of Common Stock at an exercise price of $9.50 per Redeemable Warrant, subject to adjustment. The Redeemable Warrants are subject to redemption by the Company for $0.01 per Redeemable Warrant at any time 120 or more days after the Effective Date, on 30 days' written notice, provided that the closing bid price of the Common Stock exceeds $10.00 per share (subject to adjustment) for any 10 consecutive trading days prior to such notice. See "Description of Securities." In addition to the Units offered hereby, this Prospectus also relates to the registration for issuance by the Company of an additional 800,000 shares of Common Stock upon exercise of the Redeemable Warrants. See "Description of Securities." Prior to this offering, there has been no public market for any of the Company's securities, and no assurance can be given that a market will develop or will be maintained after the offering. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price. The Company has filed an application for quotation of its Common Stock and Redeemable Warrants on The Nasdaq SmallCap Market under the symbols PHON and PHONW, respectively. -------------------------- THE SECURITIES OFFERED HEREBY ARE HIGHLY SPECULATIVE, INVOLVE A HIGH DEGREE OF RISK AND IMMEDIATE SUBSTANTIAL DILUTION, AND SHOULD BE PURCHASED ONLY BY PERSONS WHO CAN AFFORD TO LOSE THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS" BEGINNING AT PAGE 6 FOR A DISCUSSION OF RISK FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE SECURITIES OFFERED HEREBY AND "DILUTION" ON PAGE 14. --------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
UNDERWRITING PROCEEDS TO PRICE TO PUBLIC DISCOUNT(1) COMPANY(2) Per Unit................................................. $7.50 $0.675 $6.825 Total (3)................................................ $6,000,000 $540,000 $5,460,000
(1) The Company has agreed to (i) pay to the Underwriter a non-accountable expense allowance equal to 2.0% of the gross proceeds of the offering; (ii) indemnify the Underwriter against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"); and (iii) grant the Underwriter a five-year warrant, exercisable during the last four years, to purchase up to 80,000 Units at an exercise price of $9.00 per Unit (the "Underwriter's Warrant"). See "Underwriting." (2) Before deducting offering expenses payable by the Company estimated at $460,000, including the non-accountable expense allowance described in Note 1. (3) Does not include 120,000 additional Units to cover over-allotments, if any, which the Underwriter has an option to purchase from the Company for forty-five (45) days from the date of this Prospectus. See "Underwriting." If the option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to Company will be $6,900,000, $621,000, and $6,279,000, respectively. -------------------------- The Units are offered by the Underwriter on a "firm commitment" basis when, as and if delivered to and accepted by it, subject to the Underwriter's right to reject orders in whole or in part. It is expected that delivery of certificates representing the securities will be made on or about , 1997 in Minneapolis, Minnesota. EQUITY SECURITIES INVESTMENTS, INC. THE DATE OF THIS PROSPECTUS IS , 1997. In the course of making forward-looking statements about the Company's expectations for future performance, management makes assumptions which at the time are based on information deemed to be accurate and relevant. The Company's ability to achieve management's expectations is dependent upon numerous factors, many of which are outside of the Company's control. Variations from the assumptions used in making the forward-looking statements will cause the Company's performance to differ from that expressed in such statements, and those variations could be material. ------------------------ Prior to this offering, the Company has not been subject to the informational requirements of the Securities Exchange Act of 1934, as amended. After completion of this offering, the Company intends to furnish to its shareholders annual reports containing audited financial statements and quarterly reports for the first three quarters of each fiscal year containing unaudited financial information. ------------------------ CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED HEREBY, INCLUDING OVER-ALLOTMENTS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." ------------------------ INDEX OF CERTAIN DEFINED TERMS
DEFINED TERM PAGE - --------------------------------------------- --------- AT&T......................................... 6 Bank......................................... 11 CAT.......................................... 11 ChoiceTel.................................... 15 CI........................................... 15 Common Stock................................. 1 Company...................................... 1, 3 Dial-Around.................................. 6, 25 Effective Date............................... 1 FCC.......................................... 6 independent pay telephones................... 23 interLATA.................................... 23 intraLATA.................................... 8, 23 LATA......................................... 23 LEC.......................................... 6, 23 MBCA......................................... 33 MN Act....................................... 16, 28 MNPUC........................................ 16 OSP.......................................... 17 DEFINED TERM PAGE - --------------------------------------------- --------- PAL.......................................... 27 PSP.......................................... 6, 23 public pay telephones........................ 23 PUC.......................................... 7 RBOC......................................... 6, 23 Redeemable Warrant........................... 1 Registration Statement....................... 1 ROI.......................................... 19 SEC.......................................... 33 Securities Act............................... 1 Site Agreements.............................. 27 Site Providers............................... 6 smart phones................................. 24 Telco West................................... 11 Telecom Act.................................. 6 Underwriter.................................. 41 Underwriter's Warrant........................ 1 Units........................................ 1 U.S. West.................................... 16
2 PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND THE COMBINED FINANCIAL STATEMENTS OF THE COMPANY, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS HAS BEEN ADJUSTED TO REFLECT THE CONSUMMATION OF THE ACQUISITIONS DESCRIBED UNDER "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - RECENT ACQUISITIONS." IN ADDITION, AND UNLESS OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS HAS BEEN ADJUSTED TO REFLECT A TWO-FOR-ONE STOCK SPLIT WHICH OCCURRED IN APRIL 1997. AS USED IN THIS PROSPECTUS, UNLESS THE CONTEXT REQUIRES OTHERWISE, THE "COMPANY" MEANS CHOICETEL COMMUNICATIONS, INC., AND ITS WHOLLY-OWNED SUBSIDIARY, CHOICETEL, INC. UNLESS OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE OVER-ALLOTMENT OPTION GRANTED TO THE UNDERWRITER IS NOT EXERCISED. SEE "UNDERWRITING." THE COMPANY The Company is the largest independent payphone service provider in Minnesota. The Company installed its first payphones in 1990 and presently has an installed base of approximately 3,000 payphones in 10 states. Management believes that it has developed the skills and systems to operate the Company on a larger scale and intends to grow through internal expansion and acquisitions. The Company believes the outlook for the pay telephone industry is favorable because of recent legislation that has led to deregulation of the rates for local pay telephone calls and an increase in the amount of compensation for certain types of calls which previously produced little revenue for payphone service providers. The Company anticipates that the rates for local pay telephone calls will increase as a result of the deregulation. The Company also believes that the continued expansion in telecommunication services, including the rise in call waiting, voice mail and pager usage, will result in increased calling volume, thus increasing the revenue generated by payphones. Deregulation is also expected to lead to increased competition among local telephone service providers and management anticipates that the increased competition will reduce telephone line charges, one of the Company's principal operating expenses. The Company has expanded its business through the installation of pay telephones at new sites and through strategic acquisitions of payphone routes and related assets. Since 1993, the Company has completed the acquisition of four payphone routes, adding over 2,000 telephones to the Company's operations. The Company seeks to acquire payphone routes with modern equipment, long-term leases, potential for additional installations, a favorable regulatory environment, and attractive returns based upon current operating conditions. The Company believes that the pay telephone industry will continue to grow and the Company will be well positioned to capture a larger share of the market. The Company has developed a computer processing network that automates many of the operations necessary for the efficient management of payphone routes. The payphones operated by the Company are computer-based, enabling the Company to monitor payphones in the field from its central office. The network allows the Company to monitor phone call volume, identify malfunctioning equipment, dispatch repair service, schedule efficient coin collections, calculate commissions, print checks for location owners, rate and process long-distance calls, and generate reports that analyze and monitor the profitability of the phones. Management believes that as the Company grows, the network can be expanded easily with little additional investment in infrastructure. The Company was incorporated in Minnesota in 1989 as Intelliphone, Inc., and changed its name in April 1997 to ChoiceTel Communications, Inc. Its executive offices are located at 9724 10th Avenue North, Plymouth, Minnesota 55441, and its telephone number is (612) 544-1260. 3 THE OFFERING 800,000 Units, each Unit consisting of one share Securities Offered....................... of Common Stock and one Redeemable Warrant. Each Redeemable Warrant entitles the holder to purchase, at any time until five years after the Effective Date, one share of Common Stock at an exercise price of $9.50 per Redeemable Warrant, subject to adjustment. The Redeemable Warrants are subject to redemption by the Company for $0.01 per Redeemable Warrant at any time 120 or more days after the Effective Date, on 30 days' written notice, provided that the closing bid price of the Common Stock exceeds $10.00 per share (subject to adjustment) for any 10 consecutive trading days prior to such notice. See "Description of Securities." Securities Outstanding:(1) Before the Offering.................... 2,115,006 shares of Common Stock After the Offering..................... 2,915,006 shares of Common Stock Use of Proceeds.......................... To retire debt, to finance acquisitions and expansion, and for working capital and general corporate purposes. See "Use of Proceeds." Proposed Nasdaq SmallCap Market Common Stock: PHON Symbols................................ Redeemable Warrants: PHONW
- -------------------------- (1) Does not include 222,500 shares of Common Stock reserved for issuance pursuant to options, consisting of outstanding options covering 122,500 shares and options for up to 100,000 shares which may be granted pursuant to the Company's 1997 Long-Term Incentive and Stock Option Plan, or 800,000 shares of Common Stock issuable upon exercise of the Redeemable Warrants comprising part of the Units in the offering. Also does not include 80,000 shares of Common Stock comprising part of the Units issuable upon exercise of the Underwriter's Warrant or 80,000 shares reserved for issuance upon exercise of the Redeemable Warrants comprising part of the Units subject to the Underwriter's Warrant and up to 55,880 shares issuable upon conversion of a note issued in connection with a recent acquisition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions," "Management," "Certain Transactions," "Description of Securities" and "Underwriting." RISK FACTORS An investment in the securities offered hereby is highly speculative and involves a high degree of risk and immediate substantial dilution. The Units should be purchased only by persons who can afford to lose their entire investment. See "Risk Factors" beginning at page 6 for a discussion of risk factors that should be considered in connection with an investment in the Units and "Dilution" at page 14. 4 SUMMARY COMBINED FINANCIAL DATA
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, ----------------------------------------- ------------------------------------------- 1996 1997 ----------------------------- ----------------------------- 1995 ACTUAL PRO FORMA(1) 1996 ACTUAL PRO FORMA(1) ---------- ------------- ------------- ----------- ----------- ------------- (DOLLARS IN 000S, EXCEPT PER SHARE FIGURES) STATEMENT OF OPERATIONS DATA: Service revenue....................... $2,817 $3,562 $7,705 $1,618 $3,768 $3,881 Cost of service....................... 1,785 1,987 4,181 1,031 1,719 1,793 Income (loss) before income taxes..... 122 (605)(2) (375)(2) (2) 363(2) 360(2) Provision for income taxes (unaudited)(3)...................... -- -- -- -- 127 127 Pro forma provision for income taxes (credit) (unaudited)................ 43 (212) (131) 1 -- -- Net income (unaudited)(3)............. -- -- -- -- 236(2) 234(2) Pro forma net income (loss) (unaudited)......................... 79 (393) (244) 1 -- -- Per share: Net income (unaudited).............. -- -- -- -- $0.12(2) $0.11(2) Pro forma net income (loss) (unaudited)....................... $ 0.04 $(0.20)(2) $(0.11)(2) $(0.00) -- -- Shares outstanding-weighted average... 1,935,189 1,948,489 2,134,729 1,935,189 1,951,516 2,137,756
DECEMBER 31, 1996 JUNE 30, 1997 ---------------------- ------------------------------------- PRO PRO PRO FORMA AS ACTUAL FORMA(1) ACTUAL FORMA(1) ADJUSTED(1)(4) --------- ----------- --------- ----------- ------------- (DOLLARS IN 000S) BALANCE SHEET DATA: Current assets.......................................... $ 1,210 $ 1,371 $ 1,311 $ 1,468 $ 3,503 Total assets............................................ 2,969 8,440 6,756 8,923 10,958 Current liabilities..................................... 1,736 4,404 5,161 5,736 3,136 Long-term debt.......................................... 570 2,673 631 1,528 1,163 Shareholders' equity.................................... 664 1,362 964 1,659 6,659 Working capital (deficit)............................... (526) (3,033) (3,850) (4,267) 368
- -------------------------- (1) Gives effect to the acquisitions described under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions" as if they were completed acquisitions as of the beginning of the statement of operations periods presented or the balance sheet dates, as applicable. The pro forma financial information is presented for illustration purposes only and is not indicative of what the Company's actual results and financial condition would have been for the periods and as of the dates presented. (2) Reflects reserve for Minnesota sales tax contingency of $865,000 established December 31, 1996 for the years ended prior thereto and $110,140 for the six months ended June 30, 1997. See "Business - Legal Proceedings - Minnesota Sales Tax" and the Combined Financial Statements of the Company and notes thereto. (3) Reflects the termination of the Company's status as an "S" corporation effective January 1997. (4) Adjusted to reflect the sale of the 800,000 Units offered hereby and the application of the net proceeds thereof (after deducting the underwriting discount and estimated offering expenses) as described in "Use of Proceeds." 5 RISK FACTORS AN INVESTMENT IN THE SECURITIES OFFERED HEREBY IS HIGHLY SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. PRIOR TO MAKING AN INVESTMENT, A PROSPECTIVE INVESTOR SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS, AS WELL AS OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, INCLUDING THE COMBINED FINANCIAL STATEMENTS OF THE COMPANY AND NOTES THERETO CONTAINED ELSEWHERE HEREIN. RISKS ASSOCIATED WITH EXPANSION STRATEGY. The Company intends to expand its business by contracting to install payphones or acquiring assets from payphone service providers ("PSPs") in geographic areas where the Company is presently operating as well as in new areas. There can be no assurance that the Company will be able to identify and acquire businesses on a basis which permits it to satisfy its minimum rates of return and other criteria for acquisitions. Further, there can be no assurance that the Company will be able to locate favorable new sites for internal growth, obtain the capital necessary to permit it to pursue its business strategies, access developing technologies at satisfactory costs to provide those service enhancements demanded by consumers and location owners ("Site Providers") in its existing and future businesses, or hire qualified new employees to meet the requirements of its expanding business. The Company has been in business since 1989 and, therefore, has a limited history of operations. Consequently, there can be no assurance that the Company's business strategy will prove to be successful or that expansion of the Company's business will not have a material adverse effect on the operations and financial condition of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions" and "Business - Acquisition and Expansion Strategy." COMPETITION. The pay telephone business is highly competitive. The Company has no patents or exclusive rights to operate its business. The markets in which the Company operates are fragmented, but include certain large, well-capitalized providers of telecommunications services with substantially greater resources than the Company. The Company's principal competition in the pay telephone business comes from local exchange carriers ("LECs") operated by the regional Bell operating companies (the companies that were formed as a result of the 1985 divestiture of American Telephone & Telegraph Company ("AT&T"), collectively referred to herein as "RBOCs"), GTE Corporation, a number of independent providers of pay telephone services, major operator service providers and interexchange carriers. In addition to offering pay telephone service, LECs are the exclusive line service providers in certain geographical regions. The Company also competes with many other non-LEC telecommunication companies which offer services similar to those of the Company. Increased competition from these sources could cause the Company to offer higher commissions to new Site Providers. Such higher commissions could have a material adverse effect on the Company by impeding its ability to grow and by increasing its operating expenses as a percentage of revenue. Wireless and cellular communications provide an alternative to payphones and may, therefore, be a factor in slowing the rate of growth of the payphone industry. See "Business - Competition." PENDING DETERMINATION OF DIAL-AROUND COMPENSATION RATE. Pursuant to the Telecommunications Act of 1996 (the "Telecom Act"), the Federal Communications Commission (the "FCC"), which administers the interstate common carriage of telecommunications, was authorized to evaluate and adjust the amount of compensation paid by long-distance carriers to payphone companies when consumers access a long-distance carrier directly by dialing an access or an 800 number or by using a non-billable calling card and thereby "dial-around" the Company's long-distance carrier in order to reach another long-distance carrier ("Dial-Around"). The FCC's payphone order of November 6, 1996 increased the flat rate of Dial-Around compensation to approximately $45 per payphone per month on an interim basis, based on $0.35 per call times the national average of 131 monthly Dial-Around calls placed per payphone. Prior to the increase in Dial-Around compensation, the Company was receiving approximately $6 per payphone per month in Dial-Around compensation. The increase mandated by the FCC resulted in a significant increase in the amount and proportion of the Company's revenue from Dial-Around compensation, from $50,201 (or 1.8% of revenue) in the year ended December 31, 1995 to $197,456 (or 7.0% of revenue) in the year 6 ended December 31, 1996, and from $48,118 (or 3.0% of revenue) in the six months ended June 30, 1996 to $700,695 (or 18.6% of revenue) in the six months ended June 30, 1997. Pursuant to an appeal of the FCC's order, the U.S. Court of Appeals for the D.C. Circuit ruled in July 1997 that the FCC's use of $0.35 as a per call rate to determine an interim rate of monthly Dial-Around compensation per payphone, which was based on the per call rate for a local coin call in states where the local coin call rates have been deregulated, was inappropriate and instructed the FCC to re-examine the $0.35 per call rate. In its Public Notice, DA 97-1673, dated August 5, 1997 (the "Public Notice"), the FCC solicited comments on "whether the local coin rate, subject to an offset for expenses unique to those calls, is an appropriate per call compensation rate" for determining the rate of Dial-Around compensation. The comment period will expire on September 9, 1997, although there can be no assurance when the FCC will issue another order regarding the rate of Dial-Around compensation, what that order will determine, whether the order will be appealed, and what the determination would be upon any appeal. While it is not a forgone conclusion that the FCC's order on reconsideration will result in a rate of Dial-Around compensation that is less than $45 per payphone per month, that was the intent of the appeal of the FCC's 1996 order. During the pendency of the rate determination, the long-distance carriers are required to pay the payphone service providers Dial-Around compensation at the rate of approximately $45 per payphone per month. However, the FCC stated in the Public Notice that retroactive adjustments to such compensation may occur. Because the Company cannot be certain that the rate of Dial-Around compensation will not be reduced retroactively or in the future, it has established a reserve in the amount of $109,000 at June 30, 1997 to cover a potential decrease from $0.35 to $0.30 in the per call amount used to determine the Dial-Around compensation rate, retroactive to November 1996, and it will continue to accumulate this reserve until the Company believes there is a sufficient level of certainty regarding the rate of Dial-Around compensation. However, there can be no assurance that a reduction, if any, in the per call charge used to determine the rate of Dial-Around compensation will not be greater than $0.05 per call. A reduction in the rate of Dial-Around compensation that is to be paid to the Company that is greater than the Company's estimate of such reduction could have an adverse effect on the results of operations and financial condition of the Company, which could be material. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" and "Business - Government Regulation - Dial-Around Compensation." OTHER REGULATORY FACTORS. The Company's operations are significantly influenced by the regulation of pay telephone services. Authority for regulating these services is concurrently vested in the FCC, and the various state public utilities commissions ("PUCs"). Regulatory jurisdiction is determined by the interstate or intrastate character of the subject service, and the degree of regulatory oversight exercised varies among jurisdictions. Regulatory actions by these agencies have had, and are expected to continue to have, both positive and negative effects upon the Company. While most matters affecting the Company's operations fall within the administrative purview of these regulatory agencies, state and federal legislatures and the federal district court administering the AT&T divestiture are also involved in establishing certain rules and requirements governing aspects of these services. Changes in existing laws and regulations, as well as new laws and regulations, applicable to the activities of the Company or other telecommunications businesses, may materially adversely impact the operations and financial condition of the Company. See "Business - Government Regulation." The FCC has had under consideration for several years proposals that would require most interstate long-distance calls initiated by dialing "0" from pay telephones to be completed using one or more predetermined long-distance carriers, such as AT&T, MCI and Sprint, rather than through the automated pay telephone or operator service provider to whom the pay telephones are pre-subscribed ("Billed Party Preference"). Some proposals would also extend Billed Party Preference to most intrastate calls initiated by dialing 0. There is significant industry opposition to all of the proposals. Although the Company believes it is unlikely that such proposals will be implemented, if they were to be adopted and implemented as currently proposed, they could have a material adverse impact on the Company's business. 7 The FCC also has under consideration alternatives to Billed Party Preference, including rate cap and rate disclosure proposals. Although Billed Party Preference and its alternatives have been under consideration since 1987, the Company cannot predict whether or when the FCC will adopt any such proposals, or, if adopted, whether a rate cap or rate disclosure will have a material adverse impact on the Company. The FCC's November 1996 payphone order will repeal all rules regulating the cost of a local payphone call in October 1997, with the intention that the market will set the rate for local payphone calls. See "Business - Government Regulation - Deregulation of Local Pay Telephone Rates." The Company believes that deregulation of rates for local pay telephone calls will result in increased rates. However, there can be no assurance that there will be an increase in the rates for local pay telephone calls, and the absence of such an increase could have an adverse effect upon the Company's results of operations and financial condition, which could be material. State regulatory commissions are primarily responsible for regulating the rates, terms and conditions for intrastate telephone services available from pay telephones. There are several states in which it is illegal to provide certain intrastate services using non-LEC pay telephones, and such prohibitions could adversely affect the Company's ability to expand. In addition, several states have not authorized competition among intraLATA operator services (services related to calls originating and terminating in the same local access transport area) because of the exclusive franchise granted to LECs in such states. All of these barriers are expected to be eliminated as a result of the Telecom Act. See "Business - Government Regulation." TECHNOLOGICAL CHANGE AND NEW SERVICES. The telecommunications industry has been characterized by rapid technological advancements, frequent new service introductions and evolving industry standards. In the future, the Company's business could be adversely affected by the introduction of new technology, such as improved wireless communications, cellular telephone service and other personal communications systems. The Company believes that its future success will depend on its ability to anticipate and respond to changes and new technology. There can be no assurance that the Company will have sufficient resources to make the investments necessary to acquire new technology or to introduce new services that would satisfy an expanded range of customer needs. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." DEPENDENCE UPON THIRD-PARTY PROVIDERS. The Company's ability to complete operator and direct dial long-distance calls is dependent upon contractual arrangements with long-distance carriers. While the Company believes that it has access to several providers of these services at competitive rates and expects to continue to have such access in the foreseeable future, the continuing availability of these resources cannot be assured. SERVICE INTERRUPTIONS; EQUIPMENT FAILURES. The Company's long-distance operations require that the equipment of its long-distance service providers be operational 24 hours per day, 365 days per year. As is the case with other telecommunications companies, the Company's long-distance operations may experience temporary service interruptions or equipment failures, which may result from causes beyond the Company's control. Any such event could have a material adverse effect on the Company. RELIANCE ON SINGLE BRAND OF PAYPHONES. To date, the Company has installed only "INTELLICALL" brand payphones and has acquired companies using only INTELLICALL payphones. If INTELLICALL payphones were to become unavailable for some reason, or if the Company decided to acquire payphones that were not INTELLICALL brand payphones, the Company would experience delay and additional costs in adapting its proprietary software, stocking additional spare parts and training personnel to service the new brand of payphones, which could have a material adverse effect on the Company. See "Business - Acquisition and Expansion Strategy." SEASONALITY. Similar to other pay telephone companies, the Company's business is seasonal, with revenues and earnings being generally lower during the winter months and greater during the summer months since weather conditions affect outdoor pay telephone usage. 8 DIVIDEND POLICY. The Company does not intend to pay dividends following completion of this offering. See "Dividend Policy." RELIANCE ON KEY PERSONNEL. The Company is heavily dependent on the efforts of Jeffrey R. Paletz, Melvin Graf, Jack S. Kohler and certain other management personnel. Jeffrey R. Paletz, Melvin Graf and Jack S. Kohler have each entered into an employment agreement with the Company having a term that expires in April 1999. The loss of the services of one or more of these individuals could have a material adverse effect on the Company. The Company is the beneficiary under policies of life insurance in the aggregate amount of $1,800,000 covering these three officers. In addition, the failure of the Company to attract and retain additional management to support its business strategy could have a material adverse effect on the Company. See "Management." DILUTION. Purchasers of the Units will incur immediate and substantial dilution in the tangible book value of $5.46 per share of Common Stock. In addition, the Company may use shares of Common Stock to consummate acquisitions, and any such issuance of Common Stock or the issuance of Common Stock upon the exercise of options or warrants would cause further dilution to existing shareholders. See "Dilution." NO PRIOR PUBLIC MARKET; SECURITIES ELIGIBLE FOR FUTURE SALE. Prior to this offering, there has been no public market for any securities of the Company, and there can be no assurance that an active trading market for the Common Stock or Redeemable Warrants will develop or continue after this offering. The Company has filed an application for quotation of its Common Stock and Redeemable Warrants on The Nasdaq SmallCap Market, and no assurance can be given that such application will be accepted. The initial public offering price was determined by negotiations between the Company and the Underwriter based upon several factors and may not be indicative of the market prices for the Common Stock and Redeemable Warrants after this offering. See "Underwriting." The market prices of the Company's Common Stock and Redeemable Warrants could be significantly affected by factors such as variations in the Company's operating results and regulatory developments. Although as a condition of the underwriting, the Company's existing shareholders must agree with the Underwriter not to sell Common Stock for periods of six months to two years from the date of this Prospectus, the market prices of the Common Stock and Redeemable Warrants after this offering could thereafter be adversely affected by sales of Common Stock by those shareholders. See "Securities Eligible for Future Sale." POSSIBLE VOLATILITY OF PRICES FOR SECURITIES. The market prices for the Common Stock and Redeemable Warrants may be highly volatile depending on various factors including, among others, the Company's operating results, general conditions in the pay telephone industry, announcements of business developments by the Company or its competitors, and the market for similar securities, which market is subject to various pressures. In addition, the securities market is subject to price and volume fluctuations unrelated to the operating performance of the Company. CURRENT PROSPECTUS AND STATE REGISTRATION REQUIRED TO EXERCISE WARRANTS; POSSIBLE REDEMPTION OF WARRANTS. Purchasers of Units will be able to exercise the Redeemable Warrants only if a current prospectus relating to the shares of Common Stock underlying the Redeemable Warrants is then in effect and only if such securities are qualified for sale or exempt from qualification under the applicable securities laws of the states in which the various holders of Redeemable Warrants reside. Although the Company will use its best efforts to maintain the effectiveness of a current prospectus covering the shares of Common Stock underlying the Redeemable Warrants, there can be no assurance that the Company will be able to do so, or that any required amendments will be declared effective by federal or state authorities in a timely manner. The Company will be unable to issue shares of Common Stock to those persons desiring to exercise their Redeemable Warrants if a current prospectus covering the securities issuable upon the exercise of the Redeemable Warrants is not kept effective or if such securities are not qualified or exempt from qualification in the states in which the holders of the Redeemable Warrants reside. The Redeemable Warrants are subject to redemption by the Company at $0.01 per Redeemable Warrant at any time 120 or more days after the Effective Date, on 30 days' written notice, if the closing bid price of the 9 Common Stock exceeds $10.00 per share (subject to adjustment) for 10 consecutive trading days prior to such notice. If the Redeemable Warrants are redeemed, holders of Redeemable Warrants will lose their right to exercise the Redeemable Warrants except during such 30-day redemption period. Redemption of the Redeemable Warrants could force the holders to exercise the Redeemable Warrants at a time when it may be disadvantageous for the holders to do so or to sell the Redeemable Warrants at the then market price or accept the redemption price, which is likely to be substantially less than the market value of the Redeemable Warrants at the time of redemption. See "Description of Securities - Redeemable Warrants." CONTROL BY MANAGEMENT; ANTI-TAKEOVER PROVISIONS. Upon completion of this offering, officers and directors of the Company will beneficially own approximately 60% of the outstanding shares of Common Stock and, accordingly, will be in a position to control the affairs of the Company, including the election of the Board of Directors. If these shareholders vote together as a group, they will be able to substantially influence the business and affairs of the Company, including the election of individuals to the Company's Board of Directors, and to otherwise affect the outcome of certain actions that require shareholder approval, such as adopting amendments to the Company's articles of incorporation and approving certain mergers, sales of assets and other business acquisitions and dispositions. See "Principal Shareholders." The Company is subject to the provisions of the Minnesota Business Corporation Act which includes provisions relating to "control share acquisitions" and restricting "business combinations" with "interested shareholders." Such provisions could have the effect of deterring or delaying a takeover or other change in control of the Company and could have a depressive effect on the market prices of the Common Stock and Redeemable Warrants. Accordingly, shareholders may be denied the opportunity to participate in a transaction which offers a premium to the prevailing market prices of the Common Stock or Redeemable Warrants. See "Description of Securities - Provisions of the Company's Articles and Bylaws and the Minnesota Business Corporation Act." DISCRETIONARY USE OF PROCEEDS. Approximately $2,035,000, or 40.7%, of the net proceeds to be received by the Company in the offering have been designated for acquisitions and expansion, and for working capital and general corporate purposes which may be utilized for one or more alternative purposes in the discretion of the Company. See "Use of Proceeds." UNDESIGNATED PREFERRED STOCK. The Board of Directors is authorized, without any action by the Company's shareholders, to issue up to 5,000,000 shares of authorized but undesignated Preferred Stock and to fix the powers, preferences, rights and limitations of any such Preferred Stock or any class or series thereof. Persons acquiring Preferred Stock could have preferential rights with respect to voting, liquidation, dissolution or dividends over existing shareholders, including purchasers of Units in this offering. This ability of the Board would permit the Company to adopt a shareholders' rights plan or to take other action that could deter a hostile takeover of the Company, entrench the Board of Directors or deter an unsolicited tender offer. See "Description of Securities." 10 USE OF PROCEEDS The net proceeds to the Company from the sale of the Units are estimated to be approximately $5,000,000 (or approximately $5,801,000 if the Underwriter's over-allotment option is exercised in full) after deducting underwriting discounts and estimated expenses of this offering. The Company intends to apply the net proceeds approximately as follows:
DOLLARS ------------ Retirement of bank debt......................................................... $ 2,600,000 Retirement of acquisition debt.................................................. 365,000 Acquisitions and expansion...................................................... 2,000,000 Working capital and general corporate purposes.................................. 35,000 ------------ Total....................................................................... $ 5,000,000 ------------ ------------
RETIREMENT OF BANK DEBT. Approximately $2,600,000 of the proceeds from this offering will be used to retire the balance of the Company's outstanding obligation to National City Bank (the "Bank"), which obligation arose in January 1997 and matures in January 1998. The Company used $2,200,000 of the proceeds from such loan to finance the acquisition of assets from Telco West, Inc. ("Telco West"). See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions." The Company makes principal payments to the Bank on a monthly basis, together with interest on the outstanding loan balance accruing at the rate of two points over the "reference" rate announced from time to time by the Bank. RETIREMENT OF ACQUISITION DEBT. Approximately $365,000 of the proceeds from this offering will be used to retire a portion of the Company's outstanding obligation to Telco West, due in April 1998, which arose in connection with the acquisition of site contracts and related assets in Colorado, Idaho, Oregon, Washington and Wyoming. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions." ACQUISITIONS AND EXPANSION. The Company will reserve approximately $2,000,000 of the proceeds from this offering for acquisitions and expansion. The Company anticipates expanding its business through the acquisition of site contracts and related assets from PSPs. The Company completed the Telco West acquisition in January 1997 and the acquisition of assets of Computer Assisted Technologies, Inc. ("CAT") in August 1997. Although the Company routinely explores acquisition opportunities, no acquisitions are pending as of the date hereof. If the Company does not use the full amount of proceeds allocated for acquisitions and expansion, it may use such proceeds for further debt reduction and general corporate purposes. WORKING CAPITAL AND GENERAL CORPORATE PURPOSES. The remainder of the proceeds, estimated to be $35,000, will be retained as working capital and used for general corporate purposes. If the Underwriter exercises the over-allotment option in full, the Company will realize additional net proceeds of approximately $801,000, which may be used for further debt reduction, to finance acquisitions or for general corporate purposes. In addition, the Company may derive up to $8,740,000 from the exercise of the Redeemable Warrants included in the Units. Any amounts that the Company derives from the exercise of the Redeemable Warrants are expected to be used for further debt reduction, to finance acquisitions or for general corporate purposes. The Company has the right, under certain circumstances, to redeem the Redeemable Warrants for a total cost of up to $9,200. See "Risk Factors - Current Prospectus and State Registration Required to Exercise Warrants; Possible Redemption of Warrants." The foregoing use of proceeds is based upon the Company's expectations with respect to its projected business operations and anticipated revenue from such operations. If such expectations are not met, the 11 Company may have to reallocate the proceeds in such manner as it deems appropriate under the circumstances. Pending such uses, the net proceeds of this offering will be invested in bank certificates of deposit, investment-grade securities and short-term, income-producing investments, including government obligations and other money market instruments. The Company believes that the net proceeds of this offering, together with funds generated from operations, will be sufficient to conduct its operations for two years. DIVIDEND POLICY The Company intends to retain future earnings to fund the development and growth of its business and, therefore, does not anticipate paying cash dividends on the Common Stock for the foreseeable future. The Company has paid a $0.01 per quarter dividend on its outstanding shares of Common Stock since mid-1995. The Company's credit arrangement with the Bank includes covenants which prohibit the Company from paying dividends at a higher rate. Any future payment of dividends will be determined by the Board of Directors of the Company and will depend on its financial condition, results of operations, restrictions in financing agreements and other factors the Board of Directors deems relevant. 12 CAPITALIZATION The following table sets forth the capitalization of the Company as of June 30, 1997, and as adjusted to give effect to the sale of the Units offered hereby and the application of the net proceeds from such sale as set forth under "Use of Proceeds." This material should be read in conjunction with the Combined Financial Statements of the Company and the notes thereto included elsewhere in this Prospectus.
JUNE 30, 1997 ----------------------------------------- PRO FORMA AS ACTUAL PRO FORMA(1) ADJUSTED(2) ------------ ------------ ------------- Short-term debt....................................................... $ 3,686,178 $ 4,260,558 $ 1,295,558 Long-term debt, net of current maturities............................. 630,942 1,528,462 1,528,462 Shareholders' equity:(3) Preferred Stock, par value $0.01 per share, 5,000,000 shares authorized; none outstanding Common Stock, par value $0.01 per share, 15,000,000 shares authorized; 1,928,766 shares issued and outstanding; 2,115,006 shares pro forma; 2,915,006 shares as adjusted.................... 1,479,892 2,178,292 7,178,292 Paid-in capital..................................................... 0 (515,679) (515,679) Accumulated deficit................................................. (515,679) 0 0 ------------ ------------ ------------- Total shareholders' equity........................................ 964,213 1,662,613 6,662,613 ------------ ------------ ------------- Total capitalization............................................ $ 5,281,333 $ 7,451,633 $ 9,486,633 ------------ ------------ ------------- ------------ ------------ -------------
- -------------------------- (1) Gives effect to the acquisition of assets from CAT as described under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions" as if it had been completed as of June 30, 1997. The pro forma financial information is presented for illustration purposes only and is not indicative of what the Company's actual financial condition would have been as of such date. (2) Adjusted to reflect the sale of the 800,000 Units offered hereby and the application of the net proceeds thereof (after deducting the underwriting discount and estimated offering expenses) as described in "Use of Proceeds." (3) Does not include 186,240 shares of Common Stock issued in August 1997 in connection with a recent acquisition and up to 55,880 shares of Common Stock issuable upon conversion of a note issued in connection therewith, 222,500 shares of Common Stock reserved for issuance pursuant to options, consisting of outstanding options covering 122,500 shares and options for up to 100,000 shares which may be granted pursuant to the Company's 1997 Long-Term Incentive and Stock Option Plan, or 800,000 shares of Common Stock issuable upon exercise of the Redeemable Warrants comprising part of the Units in the offering. Also does not include 80,000 shares of Common Stock comprising part of the Units issuable upon exercise of the Underwriter's Warrant or 80,000 shares reserved for issuance upon the exercise of the Redeemable Warrants comprising part of the Units subject to the Underwriter's Warrant. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions," "Management," "Certain Transactions," "Description of Securities" and "Underwriting." 13 DILUTION For purposes of the following discussion, it is assumed that the entire amount of each Unit's offering price is allocable to the share of Common Stock included therein and that no amount is allocable to the Redeemable Warrant included therein. The Company's net tangible book value as of June 30, 1997 was $575,020, or $0.30 per share of Common Stock. "Net tangible book value" per share is determined by dividing the tangible net worth of the Company (tangible assets minus total liabilities) by the number of outstanding shares of Common Stock. Without giving effect to changes in net tangible book value after June 30, 1997, except for the sale by the Company of the Units offered hereby (after deduction of the underwriting discount and estimated offering expenses), the Company's net tangible book value at June 30, 1997 would have been $5,575,020, or $2.04 per share. This represents an immediate increase in the net tangible book value per share of Common Stock to the present shareholders of $1.74 and an immediate dilution of $5.46 per share to investors purchasing Units in this offering. The following table illustrates this dilution per share: Initial public offering price................................. $ 7.50 Net tangible book value at June 30, 1997.................... $ 0.30 Increase in net tangible book value attributable to new investors................................................. 1.74 --------- Pro forma net tangible book value after the offering.......... 2.04 --------- Dilution to new investors..................................... $ 5.46 --------- ---------
The following table provides a comparison of the total number of shares of Common Stock purchased from the Company, the total consideration paid, and the average price per share paid by the current holders of Common Stock and by the investors purchasing Units in this offering:
SHARES PURCHASED TOTAL CONSIDERATION(1) AVERAGE --------------------- ----------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- --------- ------------ --------- ----------- Existing shareholders................................ 1,928,766 70.7% $ 1,443,473 19.4% $ 0.75 New investors........................................ 800,000 29.3 6,000,000 80.6 $ 7.50 ---------- --------- ------------ --------- Total............................................ 2,728,766 100.00% $ 7,443,473 100.00% $ 2.73 ---------- --------- ------------ --------- ---------- --------- ------------ ---------
- -------------------------- (1) Does not reflect deduction of any underwriting discounts or other expenses incurred in connection with the issuance of the Units. The above tables assume no exercise of the Underwriter's over-allotment option. If such option is exercised in full, the new investors will have paid $6,900,000 for 920,000 shares of Common Stock, representing 82.7% of the total consideration for 32.3% of the total number of shares outstanding. The foregoing calculations do not include 186,240 shares of Common Stock issued in August 1997 in connection with a recent acquisition or up to 55,880 shares issuable upon conversion of a note issued in connection therewith, 222,500 shares reserved for issuance pursuant to options, consisting of outstanding options covering 122,500 shares and options for up to 100,000 shares which may be granted pursuant to the Company's 1997 Long-Term Incentive and Stock Option Plan, or 800,000 shares of Common Stock issuable upon exercise of the Redeemable Warrants. The calculations also do not include 80,000 shares of Common Stock comprising part of the Units issuable upon exercise of the Underwriter's Warrant or 80,000 shares reserved for issuance upon exercise of the Redeemable Warrants comprising part of the Units subject to the Underwriter's Warrant. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions," "Management," "Certain Transactions," "Description of Securities" and "Underwriting." 14 SELECTED COMBINED FINANCIAL DATA The selected combined financial data presented below for, and as of the end of, the years ended December 31, 1995 and 1996, have been derived from the financial statements of ChoiceTel Communications, Inc. ("ChoiceTel"), and its wholly-owned subsidiary, Choicetel, Inc. ("CI"), which financial statements have been audited by Schechter Dokken Kanter Andrews & Selcer, Ltd., independent certified public accountants. The selected combined financial data presented below for, and as of the end of, the six month periods ended June 30, 1996 and 1997, have been derived from the unaudited financial statements of ChoiceTel and CI which, in the opinion of the Company's management, include all adjustments necessary for a fair presentation of financial position and the results of operations. The operating results for the six months ended June 30, 1997, are not necessarily indicative of the operating results to be expected for the full year or for any other period. The selected combined financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Combined Financial Statements of the Company and notes thereto included elsewhere in this Prospectus.
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, -------------------------------------- -------------------------------------- 1996 1997 ------------------------- ------------------------- 1995 ACTUAL PRO FORMA(1) 1996 ACTUAL PRO FORMA(1) --------- --------- ------------ --------- --------- ------------ (DOLLARS IN 000S, EXCEPT PER SHARE FIGURES) STATEMENT OF OPERATIONS DATA: Service revenue............... $2,817 $3,562 $7,705 $1,618 $3,768 $3,891 Cost of service............... 1,785 1,987 4,181 1,031 1,719 1,793 --------- --------- ------------ --------- --------- ------------ Gross margin.................. 1,032 1,575 3,524 587 2,049 2,098 --------- --------- ------------ --------- --------- ------------ Selling, general and administrative expenses...... 573 830 1,911 358 814 823 --------- --------- ------------ --------- --------- ------------ Income (loss) before income taxes........................ 122 (605)(2) (375)(2) 2 363(2) 360(2) --------- --------- ------------ --------- --------- ------------ Provision for income taxes (unaudited)(3)............... -- -- -- -- 127 127 --------- --------- ------------ --------- --------- ------------ Pro forma provision for income taxes (credit) (unaudited)... 43 (212) (131) 1 -- -- --------- --------- ------------ --------- --------- ------------ Net income (unaudited)(3)..... -- -- -- -- 236(2) 234(2) Pro forma net income (loss) (unaudited).................. $ 79 $ (393) $ (244) $ 1 -- -- Per share: Net income (unaudited)...... -- -- -- -- $ 0.12(2) $ 0.11(2) Pro forma net income (loss) (unaudited)............... $ 0.04 $ (0.20)(2) $ (0.11)(2) $ 0.00 -- -- --------- --------- ------------ --------- --------- ------------ --------- --------- ------------ --------- --------- ------------ Shares outstanding-weighted average...................... 1,935,189 1,948,489 2,134,729 1,935,189 1,951,516 2,137,756 OPERATING DATA (AT END OF PERIOD): Number of phones in service... 1,013 1,219 2,824 1,133 3,047 3,047
15
JUNE 30, 1997 --------------------------------------- DECEMBER 31, 1996 PRO FORMA ------------------------ AS ACTUAL PRO FORMA(1) ACTUAL PRO FORMA(1) ADJUSTED(1)(4) --------- ------------- --------- ------------- ------------- (DOLLARS IN 000S) BALANCE SHEET DATA: Current assets................................... $ 1,210 $ 1,371 $ 1,311 $ 1,468 $ 3,503 Total assets..................................... 2,969 8,440 6,756 8,923 10,958 Current liabilities.............................. 1,736 4,404 5,161 5,736 3,136 Long-term debt................................... 570 2,673 631 1,528 1,163 Total liabilities................................ 2,305 7,077 5,792 7,264 4,299 Shareholders' equity............................. 664 1,362 964 1,659 6,659 Working capital (deficit)........................ (526) (3,033) (3,850) (4,267) 368
- -------------------------- (1) Gives effect to the acquisitions described under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions" as if they were completed acquisitions as of the beginning of the statement of operations periods presented or the balance sheet dates, as applicable. The pro forma financial information is presented for illustration purposes only and is not indicative of what the Company's actual results and financial condition would have been for the periods and as of the dates presented. (2) Reflects reserve for Minnesota sales tax contingency of $865,000 established December 31, 1996 for the years prior thereto and $110,140 for the six months ended June 30, 1997. See "Business - Legal Proceedings - Minnesota Sales Tax" and the Combined Financial Statements of the Company and notes thereto. (3) Reflects the termination of the Company's status as an "S" corporation effective January 1997. (4) Adjusted to reflect the sale of the 800,000 Units offered hereby and the application of the net proceeds thereof (after deducting the underwriting discount and estimated offering expenses) as described in "Use of Proceeds." REORGANIZATION In 1995, CI was incorporated to operate as a competitive LEC under the Minnesota Telecommunications Act of 1995 (the "MN Act"), which allows companies, upon approval of the Minnesota Public Utilities Commission ("MNPUC"), to buy and competitively resell non-residential telephone service provided by U.S. West Communications, Inc. ("U.S. West"). CI was formed separately from ChoiceTel in order to more efficiently facilitate MNPUC approval, which approval was obtained on April 19, 1996. The stock ownership of CI was substantially identical to the ownership of ChoiceTel at the time of CI's formation. In addition to the telephone lines CI sells to ChoiceTel, CI also sells pay telephone lines to several other pay telephone companies in Minnesota. In March 1997, a corporate reorganization was effected in which the shareholders of CI transferred their common stock to ChoiceTel as an additional contribution to its capital and, as a result, CI became a wholly-owned subsidiary of ChoiceTel. 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company derives revenue from three principal sources: coin calls, non-coin calls and Dial-Around calls. Coin calls represent calls paid for with coins deposited in the telephone. The Company recognizes coin revenue in the amount deposited. Non-coin calls are calls charged to a customer credit card or billed to the called party (collect calls). These calls are processed by the payphone's computer using "store and forward" technology or, if a live operator is requested, the call is processed by an operator service provider ("OSP") such as, for example, AT&T, MCI or Sprint. 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 an 800 number or by using a non-billable calling card. See "Business - Operations" and "- Government Regulation." The principal costs related to ongoing operation of the Company's payphones include telephone line charges, consisting of payments made by the Company to LECs and long-distance carriers for access charges and use of their networks; commission payments to Site Providers; and collection, repair and maintenance costs. RESULTS OF OPERATIONS The following table presents certain items in the combined statements of operations as a percentage of revenue for the years ended December 31, 1994 through 1996, and the six month periods ended June 30, 1996 and 1997, as well as the average number of phones in service during such periods:
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED JUNE 30, ---------------------------------- -------------------- 1994 1995 1996 1996 1997 --------- --------- ------------ --------- --------- REVENUE: Coin revenue.............................................. 81.4% 83.3% 78.9% 83.0% 67.3% Non-coin revenue.......................................... 17.2 14.9 14.1 14.0 13.0 Dial-Around compensation.................................. 1.4 1.8 7.0 3.0 18.6 Competitive LEC revenue................................... -- -- 1.6 -- 0.3 --------- --------- ----- --------- --------- Total service revenue................................. 100.0% 100.0% 100.0% 100.0% 100.0% --------- --------- ----- --------- --------- --------- --------- ----- --------- --------- SERVICE COSTS AND EXPENSES: Telephone line charges.................................... 43.0% 42.5% 36.2% 43.1% 26.3% Commissions............................................... 18.3 18.0 16.3 17.6 15.5 Collection, repair and maintenance(1)..................... 7.1 7.5 8.5 10.6 10.0 --------- --------- ----- --------- --------- Total cost of service................................. 68.4% 68.0% 61.0% 71.3% 51,8% --------- --------- ----- --------- --------- --------- --------- ----- --------- --------- Gross margin.............................................. 31.6% 32.0% 39.0% 28.7% 48.2% Selling, general and administrative expenses(1)........... 15.9 15.7 18.1 14.5 15.4 Interest.................................................. 3.7 3.2 3.4 9.5 11.6 Depreciation and amortization............................. 8.2 8.8 10.2 8.7 12.2 Sales tax contingency..................................... 0.0 0.0 24.3 0.0 2.9 --------- --------- ----- --------- --------- Net income (loss) before pro forma income tax provision..................................... 3.8% 4.3% (17.0)% 0.1% 9.6% --------- --------- ----- --------- --------- --------- --------- ----- --------- --------- Average phones in service................................. 730 865 1,123 1,070 2,811
- -------------------------- (1) A portion of the expenses classified as "Collection, repair and maintenance" are classified as "Selling, general and administrative expenses" in the Combined Financial Statements of the Company and notes thereto. 17 The following table presents items in the combined statements of operations on a per phone in service basis for the years ended December 31, 1994 through 1996, and the six month periods ended March 31, 1996 and 1997, based on the average number of phones in service during such periods:
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ------------------------------- -------------------- 1994 1995 1996 1996 1997 --------- --------- --------- --------- --------- (DOLLARS PER PHONE) REVENUE PER PHONE: Coin revenue..................................................... $ 2,744 $ 2,714 $ 2,504 $ 1,290 953 Non-coin revenue................................................. 577 485 447 217 184 Dial-Around compensation......................................... 48 58 176 46 263 Competitive LEC revenue.......................................... 0 0 45 0 15 --------- --------- --------- --------- --------- Total service revenue.......................................... $ 3,369 $ 3,257 $ 3,172 $ 1,554 $ 1,415 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- SERVICE COSTS AND EXPENSES PER PHONE: Telephone line charges........................................... $ 1,448 $ 1,384 $ 1,149 $ 670 $ 372 Commissions...................................................... 616 586 516 274 219 Collection, repair and maintenance(1)............................ 240 244 271 165 142 --------- --------- --------- --------- --------- Total cost of service.......................................... 2,304 2,214 1,936 1,109 733 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Gross margin..................................................... $ 1,065 $ 1,043 $ 1,236 $ 445 $ 682 Selling, general and administrative expenses(1).................. 535 512 573 225 219 Interest......................................................... 125 104 107 70 122 Depreciation and amortization.................................... 275 286 325 148 164 Sales tax contingency............................................ 0 0 770 0 41 --------- --------- --------- --------- --------- Net income (loss) before pro forma income tax provision.......... $ 130 $ 141 $ (539) $ 2 $ 136 --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
- ------------------------ (1) A portion of the expenses classified as "Collection, repair and maintenance" are classified as "Selling, general and administrative expenses" in the Combined Financial Statements of the Company and notes thereto. SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996. Total revenue for the six months ended June 30, 1997, increased approximately $2,150,082, or 132.9%, compared to the six months ended June 30, 1996. This growth was primarily attributable to the increase in the average number of pay telephones in service from 1,070 during the 1996 period to 2,811 (including 586 phones in service pursuant to an agreement with CAT, which effectively resulted in the Company realizing all of CAT's operating revenue and expenses beginning February 1, 1997) during the 1997 period and the increased Dial-Around compensation. Of the increase in revenue, $652,500, or 30.3%, is attributable to an increase in the rate of Dial-Around compensation which occurred on November 6, 1996. On that date, Dial-Around compensation increased from approximately $6 per phone per month to approximately $45 per phone per month. See "Business - Government Regulation - Dial-Around Compensation." Coin revenue increased $1,193,000, but declined to $953 per phone for the period compared to $1,290 in the previous year, as a result of the seasonal nature of the phones acquired in Oregon, Idaho and Washington, which generate most of their revenue from May through October. Telephone and long-distance charges decreased to 26.3% of total revenue for the 1997 period, as compared to 43.1% the previous year, due to the increase in Dial-Around compensation and a reduction in line charges in Minnesota in June 1996 from approximately $90 per line to $52 per line. Site Provider commissions and collection, service and repair costs decreased from 17.6% and 10.6% of revenue, 18 respectively, in 1996, to 15.5% and 10.0% of revenue, respectively, in 1997. Selling, general and administrative ("SG&A") expenses increased by $347,555 but, when expressed per phone in service, declined from $225 for the 1996 period to $219 for the same period in 1997. Interest expense for the first six months in 1997 increased to 8.6% of revenue as compared to 4.5% of revenue in the prior year due to increased borrowing to finance the acquisition of a route in the Pacific Northwest and new installations. Depreciation and amortization for the 1997 period increased to 11.6% of revenue from 9.5% of revenue as a result of the depreciation and amortization associated with the acquired routes. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995. For the year ended December 31, 1996, total revenue increased approximately $745,000, or 26.4%, compared to the year ended December 31, 1995. This growth was primarily attributable to the increase in the average number of pay telephones in service from 865 during 1995 to 1,123 during 1996, the increase in Dial-Around compensation and the initiation of operations as a competitive LEC. Of the increase in revenue, $147,000, or 19.7%, of the increase, was attributable to the increase in the Dial-Around compensation rate on November 6, 1996, and $50,700, or 6.8%, of the increase in revenue was attributable to sales of telephone service to non-affiliated companies. Telephone and long-distance charges decreased in 1996 to 36.2% of total revenue, compared to 42.5% of total revenue the prior year. The decrease was primarily attributable to CI receiving authorization to act as a reseller of telephone service in April 1996, which ultimately reduced the Company's line charges in Minnesota to $52 per line. Commissions paid to Site Providers decreased to 16.3% of total revenue in 1996, compared to 18.0% in the prior year. This was attributable to increased Dial-Around compensation revenue (which is not included in commission calculations for Site Providers) and to the phones added in 1996 which generated less revenue and, therefore, lower Site Provider commissions than the phones placed into service in prior years. As part of its growth strategy and in order to take advantage of lower line rates, the Company was able to install pay telephones that previously had insufficient revenue to meet the Company's return on investment ("ROI") objectives. Service, collection, repair and maintenance costs increased in 1996 over the prior year by approximately $94,000, or 44.4%, due to the start-up costs associated with adding phones in new geographic areas, as well as the increased number of phones in service. In 1996, SG&A expenses increased approximately $200,000, or 45.1%, from the prior year. This was attributable, in part, to higher marketing costs associated with the Company's growth strategy. Interest expense increased to 3.4% of revenue compared to 3.2% of revenue in the prior year due to increased borrowing to finance an acquisition of 85 phones in December 1995. Depreciation and amortization increased in 1996 to 10.2% of revenue from 8.8% of revenue in the prior year, attributable to amortization associated with the acquired contracts. YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994. For the year ended December 31, 1995, total revenue increased approximately $358,000, or 14.6%, compared to the prior year. This growth was primarily attributable to an increase in the average number of pay telephones in service from 730 in 1994 to 865 in 1995. Long-distance revenue decreased to 14.9% of total revenue compared to 17.2% in the previous year due to Dial-Around calls replacing revenue producing calls at the Company's payphones. Telephone and long-distance charges remained relatively unchanged as a percentage of revenue. Such charges represented 42.5% of total revenue in 1995 compared to 43.0% of revenue in the prior year. Commissions paid to Site Providers and collection, repair and maintenance costs remained relatively constant. 19 SG&A expenses increased approximately $52,000 in 1995, or 13.3%, from the prior year. As a percentage of revenues, SG&A expenses decreased to 15.7% of total revenues, compared to 15.9% in the prior year. Interest expenses remained stable. Depreciation and amortization increased approximately $46,000, or 23.1%, from the prior year. SALES TAX CONTINGENCY. The Company, based on its analysis of the published regulations of the Minnesota Department of Revenue, has not remitted any sales tax payments to the State of Minnesota. In 1996, the Company learned that the opinion of the Department was that calls from payphones were subject to state sales tax. Management is of the view that the payphone service it provides is not subject to sales tax and the Company is challenging the imposition of the tax. Nonetheless, on December 31, 1996, the Company established a reserve of $865,000 for the years prior thereto and has reserved an additional $110,140 for the six months ended June 30, 1997. LIQUIDITY AND CAPITAL RESOURCES For the six months ended June 30, 1997, the Company's operating activities provided $131,600, net long- and short-term financing provided $3,123,000, and the sale of shares of Common Stock and the collection of subscription receivables provided $64,000. The Company invested $4,136,000 in acquisitions and new installations, resulting in a $819,000 decrease in cash balances. Operating activities in the year ended December 31, 1996 provided $600,400 and sales of shares of Common Stock during the year provided $920,000. During the year, the Company invested $462,200 in new installations, reduced debt by $68,500 and paid $143,700 in dividends. The overall impact was an $846,000 increase in cash balances. For the year ended December 31, 1995, the Company's operating activities provided $161,000 and long-term financing provided $778,000. During the year, $623,000 was invested in acquisitions and new installations, $320,000 of short-term debt was retired and $33,000 was paid as dividends, resulting in a $37,000 decrease in cash balances for the year. In January 1997, the Company entered into an Amended and Restated Loan Agreement with the Bank pursuant to which the Company can borrow up to $3,000,000. The Company has granted the Bank a first lien on all of its assets to secure its obligations to the Bank. The agreement provides for the payment of interest on the amount outstanding from time to time at an annual rate equal to 2.0% over the "reference" rate announced from time to time by the Bank and expires in January 1998. The Company intends to repay all of its obligations to the Bank with the proceeds from this offering. See "Use of Proceeds." The Company has also borrowed $453,000 in the aggregate from certain individuals and intends to repay the individual lenders out of cash generated from operations as and when their promissory notes mature. Management believes that the proceeds from the sale of the Units hereby, together with cash generated from operations, will be adequate to fund the Company's operations for the foreseeable future. RECENT ACQUISITIONS In January 1997, the Company completed its acquisition from Telco West of site contracts for 1,020 payphones located in Colorado, Idaho, Oregon, Washington and Wyoming and all equipment located at the respective sites, as well as the tradename "Telco Northwest." The purchase price for the acquired assets was $3,374,745, with the Company paying $2,173,245 in cash (financed with a short-term loan from the Bank) and the balance by delivery of a 10% secured subordinated note in the principal amount of $365,000, with the principal due on April 1, 1998, and a second 10% secured subordinated note in the principal amount of $841,500, which amortizes over a 54-month period. The promissory notes are collateralized by a security interest granted in substantially all of the Company's pay telephone assets, which security interest is subordinate to the senior secured position of the Bank as the Company's primary lender. In connection with the acquisition, Telco West and its principal shareholder entered into a five-year non-compete agreement covering the states of Colorado, Idaho, Oregon, Washington and Wyoming. In 20 1996, Telco West's payphone division earned $366,538 on revenues of $3,426,00. The Company expects results to improve due to the increase in Dial-Around compensation. In January 1997, the Company entered into an agreement to acquire from CAT 586 pay telephone site contracts and related assets, as well as site contracts only for the installation of an additional 98 pay telephones, all located in Minnesota and Wisconsin. Pending approval of the acquisition by the MNPUC and the satisfaction of other conditions of closing, the parties entered into a Route Service Agreement effective as of February 1, 1997, pursuant to which the Company managed and serviced the CAT payphones in Minnesota and Wisconsin for a monthly fee equal to the operating revenue therefrom less equipment leasing costs and certain other expenses payable by CAT to third parties. The MNPUC entered an order on June 27, 1997, approving the Company's acquisition of CAT's assets and the transaction was consummated as of August 14, 1997. The purchase price for the assets was $2,270,300, consisting of $100,000 payable in cash at closing, $350,000 pursuant to a convertible note payable to CAT as described below, the Company's assumption of $1,121,900 of debt to two equipment leasing companies, and the balance of $698,400 by delivery to CAT of 186,240 shares of unregistered Common Stock. The convertible note bears interest at the rate of 8.5% per annum with interest only payable monthly and the entire principal balance and any unpaid interest thereon is due on September 30, 1997. The note is convertible at any time prior to payment into Common Stock on the basis of one share of stock for each $6.33 of principal and accrued interest due. In connection with the transaction, CAT and its principal shareholder entered into a two-year non-compete agreement with the Company covering the states of Minnesota and Wisconsin. The president of CAT, Dustin Elder, now a Vice President of the Company, also entered into employment, non-compete and stock option agreements with the Company. In 1996, CAT had a net loss of $166,000 on revenues of $1,479,337. The Company expects results to improve due to lower line rates in Minnesota and the increase in Dial-Around compensation. The pro forma statements of operations and balance sheets below reflect the acquisitions from Telco West and CAT as if they had been completed as of the beginning of the statement of operations periods presented or the balance sheet dates, as applicable. The pro forma financial information is presented for illustration purposes only and is not indicative of what the Company's actual results and financial condition would have been for the periods and as of the dates presented.
SIX MONTHS ENDED JUNE YEAR ENDED DECEMBER 31, 1996 30, 1997 ------------------------------------------------ ------------------------ COMPANY TELCO WEST CAT COMBINED COMPANY CAT(1) ----------- ----------- --------- ----------- ----------- ----------- (DOLLARS IN 000S) STATEMENT OF OPERATIONS DATA: Service revenue.................................. $ 3,562 $ 2,664 $ 1,479 $ 7,705 $ 3,768 $ 123 Cost of service.................................. 1,987 1,486 825 4,298 1,719 73 ----------- ----------- --------- ----------- ----------- ----- Gross margin..................................... 1,575 1,178 654 3,407 2,049 50 ----------- ----------- --------- ----------- ----------- ----- Selling, general and administrative expenses..... 830 393 487 1,710 814 9 Depreciation and amortization.................... 365 307 158 830 437 12 Interest expense................................. 120 95 180 395 325 23 Sales tax contingency............................ 865 0 84 949 110 10 ----------- ----------- --------- ----------- ----------- ----- Income (loss) before income taxes................ (605) 383 (255) (477) 363 (4) Provision for income taxes....................... -- -- -- -- 127 -- Pro forma provision for income taxes (credit).... (212) 134 (89) (167) -- (1) ----------- ----------- --------- ----------- ----------- ----- Pro forma net income (loss)...................... $ (393) $ 249 $ (166) $ (310) $ 236 $ (2) ----------- ----------- --------- ----------- ----------- ----- ----------- ----------- --------- ----------- ----------- ----- COMBINED ----------- STATEMENT OF OPERATIONS DATA: Service revenue.................................. $ 3,891 Cost of service.................................. 1,792 ----------- Gross margin..................................... 2,099 ----------- Selling, general and administrative expenses..... 823 Depreciation and amortization.................... 449 Interest expense................................. 347 Sales tax contingency............................ 120 ----------- Income (loss) before income taxes................ 360 Provision for income taxes....................... 127 Pro forma provision for income taxes (credit).... (1) ----------- Pro forma net income (loss)...................... $ 234 ----------- -----------
21
JUNE 30, 1997 ------------------------------------------------------ PRO FORMA COMPANY CAT ADJUSTMENTS(2) COMBINED ----------- --------- ----------------- ----------- (DOLLARS IN 000S) BALANCE SHEET DATA: Current assets........................................................... $ 1,310 $ (100) $ 1,211 Property................................................................. 4,936 1,725 6,661 Other assets............................................................. 510 545 1,055 ----------- --------- --- ----------- Total assets........................................................... $ 6,756 $ 2,170 $ 0 $ 8,927 ----------- --------- --- ----------- ----------- --------- --- ----------- Current liabilities...................................................... 5,161 574 5,736 Long-term debt net of current portion.................................... 631 897 1,528 Shareholders' equity Common stock........................................................... 1,480 699 2,179 Paid-in capital........................................................ 0 (516) (516) Accumulated deficit.................................................... (516) (516) 0 ----------- --------- --- ----------- Total shareholders' equity........................................... 964 699 0 1,663 ----------- --------- --- ----------- Total liabilities and shareholders' equity......................... $ 6,756 $ 2,170 $ 0 $ 8,927 ----------- --------- --- ----------- ----------- --------- --- -----------
- -------------------------- (1) Does not include CAT's operating revenues or expenses for the period February 1, 1997 to June 30, 1997, which are included in the Company's operating revenues and expenses pursuant to the Route Service Agreement. (2) Reflects the reclassification of accumulated deficit to paid-in capital. RECENTLY ISSUED ACCOUNTING STANDARDS - NEW ACCOUNTING PRONOUNCEMENT The Company will adopt in the fiscal year ending December 31, 1997, Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"), which was issued in February 1997. SFAS No. 128 requires disclosure of basic earnings per share ("EPS") and diluted EPS, which replaces the existing primary EPS and fully diluted EPS, as defined by APB No. 15. Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Dilutive EPS is computed similar to EPS as previously reported provided that, when applying the treasury stock method to common equivalent shares, the Company must use its average share price for the period rather than the more dilutive greater of the average share price or end-of-period share price required by APB No. 15. 22 BUSINESS GENERAL The Company is the largest independent payphone service provider ("PSP") in Minnesota. The Company installed its first payphones in early 1990 and presently has an installed phone base of approximately 3,000 payphones in 10 states. The Company has grown its business through the installation of pay telephones in new areas and through strategic asset acquisitions of payphone routes and related assets, including 270 payphones located in Minnesota acquired from American Amusement Arcade in 1993; 85 payphones acquired in Nevada from Telco West in 1995; an additional 1,020 payphones acquired from Telco West in 1997 in Oregon, Idaho, Colorado, Washington and Wyoming; and 586 payphones located in Minnesota and Wisconsin acquired from CAT, together with site contracts only for the installation of an additional 98 payphones. 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 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 have resulted in the creation of new business segments in the telecommunications industry. As a result of the AT&T divestiture, pay telephones may now be owned and operated independently. 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. Local exchange carriers ("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." 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 had 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 Site 23 Providers. Therefore, most of the Company's pay telephones are placed with Site Providers under leases having terms of five years or more. The Company's objective is to grow through additional acquisitions and internally, thereby achieving economies of scale. There are approximately 1,500 independent PSPs nationally. The Company believes that there is a significant opportunity to consolidate the highly fragmented independent segment of the public payphone industry. Further, independent PSPs, as compared to the RBOCs, generally have a larger percentage of computer-based, or "smart," phones in their inventory of pay telephones and their payphones are placed in locations that generate higher revenue per phone. The Company intends to use the proceeds from this offering to become a more active consolidator of the independent payphone market. Management believes that the Company's experience in completing acquisitions will be instrumental in identifying, negotiating and ultimately integrating additional acquisitions. The Company also intends to expand through internal growth. The Company actively seeks to contract and install additional payphones to increase its sales in existing markets. The installation of new payphone locations is generally less expensive, though less predictable, than acquiring existing PSPs. ACQUISITION AND EXPANSION STRATEGY The Company believes that the existence of many small independent PSPs presents acquisition opportunities for the Company. The Company further believes that management's experience in identifying and negotiating potential acquisitions and integrating acquired companies into the Company's ongoing operations will enable it to grow and benefit from the associated economies of scale. In reviewing potential acquisition candidates, the Company considers various factors, including: 1. HISTORICAL AND PRO FORMA FINANCIAL PERFORMANCE The Company reviews the historical revenues, mix between coin and non-coin revenue and cash flows of the telephones to be acquired and analyzes their prospective profitability based upon pro forma considerations such as lower service and collection expenses, lower general and administrative expenses, and the more favorable terms and conditions which the Company may be able to obtain from long-distance service providers. 2. LOCATION AGREEMENTS The Company seeks to acquire payphone contracts that are long-term (five or more years) with automatic renewals at the end of the term, that are assignable to another company, and which cannot be canceled by the Site Provider but give the Company the right to remove the phone if the revenues are insufficient. 3. EQUIPMENT IN SERVICE There are three primary suppliers of smart phones to PSPs. To date, the Company has installed only "INTELLICALL" brand payphones and has acquired only companies using INTELLICALL payphones. This has allowed the Company to quickly integrate acquired phones into daily operations. The Company could acquire routes using another brand's smart phones but it would have to factor in the additional costs associated with adapting proprietary software, stocking additional spare parts and training personnel for proficiency on new equipment. 24 4. LOCATION AND ECONOMIES OF SCALE The Company considers the geographic proximity of the payphones to be acquired to the Company's existing service areas, and the extent to which the acquisition would provide the Company with economies of scale through more efficient utilization of coin collection and service personnel. The Company seeks to enter new geographic areas that will result in similar economies of scale through one or more acquisitions. Installations at new locations are an important part of the Company's expansion strategy in that pay telephones placed directly with Site Providers, rather than through acquisition, have historically provided the Company with its highest returns. The Company has generally been able to add pay telephones at the rate of 100 phones per year in Minnesota, and anticipates that this rate of expansion will increase as the Company enters additional markets. Because the Company's Site Provider base is primarily businesses, the Company regularly obtains additional pay telephone locations as the Site Providers' respective businesses grow. OPERATIONS The Company operates, services and maintains a system of approximately 3,000 pay telephones in the midwestern and western United States, with approximately 60% of its payphones located in Minnesota. 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. In all of the states in which the Company's pay telephones are located, the Company charges the same rates for local coin calls as does the relevant LEC; in most states that charge is $0.25. The maximum rate LECs and independent pay telephone companies may charge for local calls is typically set by state regulatory authorities. 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. This rate is well below U.S. West's rates for coin long-distance and is significantly less expensive than credit card or collect long-distance rates. The Company offers these rates to create a better value for price sensitive consumers and to discourage Dial-Around calling from its phones (as the Company receives no incremental revenue from users who place long-distance calls through such services as "1-800-COLLECT" and the many other long-distance providers that can be accessed through the Company's payphones). However, beginning in October 1997, the Company is scheduled to receive incremental revenue from Dial-Around calling. See "Government Regulation - Dial-Around Compensation." 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 LEC competitors. NON-COIN CALLS 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 payphone's computer using store and forward technology, or, if a live operator is requested, then the call is transferred to the Company's designated 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 10ATT, and thereby dials around the Company's long- 25 distance carrier in order to reach another long-distance carrier. 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. 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, rate and process long-distance calls using store and forward technology, and generate necessary reports that analyze and monitor profitability of the phones. Management believes that as the Company grows, this network can be expanded easily with little additional investment in infrastructure. The Company installs pay telephones which it believes incorporate the latest technology. The equipment makes use of microprocessors to provide voice synthesized calling instructions, 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 or theft. 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. The Company's smart phones utilize store and forward technology which enables the Company to sell credit card, calling card and collect calls through its own OSP. The store and forward software program provides callers with instructions communicated by a digitized human voice for entering billing information, such as a calling card number or a terminating phone number for a collect call, prior to connecting a call. For example, for a collect call, a synthesized voice directs the caller to speak his name into the payphone handset, the caller's response is digitally recorded and played back when the call is answered at its destination, and the called party is instructed to press "1" on his telephone to accept the call. The software program also minimizes fraudulent charges for calling card or credit card calls by automatically communicating with a credit bureau to verify that the card has not been identified as a lost, stolen or delinquent card. For a collect call, the software program can also verify that the number being called is not delinquent. After verifying the call, the payphone will complete the connection using a long-distance carrier. When the call is concluded, the software program directs the billing information, including the date, time and length of the call, the billed-to-number and the charges for the call, to the Company's computer. Later, the billing records are sent to a processing agent that bills and collects the charges. The processing agent keeps a percentage of the billed amount as its processing fee and remits the balance to the Company. The Company books the net amount received as non-coin revenue. The Company is billed by the long-distance carrier for long-distance charges, which charges are only a small percentage of the amount billed to the customer. Some of the Company's payphones, primarily those placed in locations that are not high generators of long-distance calls, do not have store and forward capability. In addition, customers occasionally request a live operator even with phones that have the store and forward technology. Examples of calls requiring live operator assistance include person-to-person calls and calls billed to a third party. In these situations, the calls are transferred to an OSP which completes and bills the calls and pays the Company a commission based on the amount billed. The Company contracts with several OSPs for this 24-hour a day service. The 26 Company routes all of these calls to a single OSP to maximize the commission revenue it receives. There are numerous OSPs available to the Company and the terms offered by them are highly competitive. In selecting an OSP, the Company considers numerous factors including the commission offered, the quality of service and the pricing of calls to customers. PLACEMENT OF PAY TELEPHONES. As of May 31, 1997, the Company's pay telephone system consisted of approximately 3,000 telephones located in 10 states. 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
DECEMBER 31, --------------------------------- MAY 31, STATE 1994 1995 1996 1997(1) - ------------------------------------------------------------------------ ----- --------- --------- ----------- Minnesota............................................................... 792 910 1,074 1,741 Oregon.................................................................. -- -- 10 596 Idaho................................................................... -- -- -- 316 Nevada.................................................................. -- 84 112 110 Washington.............................................................. -- -- -- 57 Wisconsin............................................................... 7 7 32 46 New York................................................................ -- -- 12 36 Wyoming................................................................. -- -- -- 33 Colorado................................................................ -- -- -- 23 North Dakota............................................................ -- -- 5 5 --- --------- --------- ----- Total............................................................... 799 1,013(2) 1,219 2,963 --- --------- --------- ----- --- --------- --------- -----
- -------------------------- (1) Includes 586 phones owned by CAT, from which the Company derived revenue pursuant to a Route Service Agreement. The Company acquired such phones in August 1997. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions." (2) Does not include 12 phones located in Indiana and removed from service in 1996. 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, gas stations and schools. The Company's pay telephone lease mix includes indoor phones, walk-up outdoor phones and drive-up payphones. While no single Site Provider accounted for more than 5% of the Company's pay telephones or revenue in the six months ended June 30, 1997, the Company had a single Site Provider that accounted for more than 5% of its pay telephones and revenue in the years ended December 31, 1995 and 1996. 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 five-year or greater 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. The Site Provider does 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. The Company's business model has always been based on ROI and thus is highly influenced by the line rate charged by LECs, primarily U.S. West. Pay telephones are regulated by state PUCs and generally can be connected only to a Public Access Line ("PAL"). When the Company commenced operations, the PAL rate in effect resulted in 27 an average phone bill of about $130 per month per phone. In order to achieve its ROI objective, the Company targeted high volume phones. In 1992, the MNPUC reduced the tariff for PALs, which resulted in an average cost reduction of about $20 per phone per month, allowing the Company to include slightly lower volume phones in its network and still achieve its ROI objective. In April 1996, CI was approved to purchase telephone lines which U.S. West sells at a monthly rate of $52 per phone including tax. CI resells those lines to ChoiceTel at this lower rate which has allowed the Company to increase the profitability of its existing phones and to reduce the minimum call volume it needs from new phones to achieve its ROI objective. In May 1997, CI entered into an agreement with U.S. West that provides CI with a 21.5% reseller discount on the pre-tax cost of telephone lines in Minnesota, which results in a monthly rate for the Company of $42.50 per phone in such state. MARKETING. Four of the Company's employees devote substantially all of their time to locating and contracting with new Site Providers in Minnesota. In addition, the Company has engaged two independent contractors in Oregon to locate new sites for payphone installations. 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 repair and collection services during evenings and on weekends and providing 24-hour a day 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 lower commissions and do not monitor payphone performance. The Company monitors its payphones electronically and offers evening and weekend repair service for its Minnesota payphones. The Company uses 29 full- and part-time field service technicians, each of whom collects money, cleans phones and responds to trouble calls made by either a consumer or by the telephone itself as part of its internal diagnostic procedures. Many 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. GOVERNMENT REGULATION In 1995, the State of Minnesota passed comprehensive legislation for the telecommunications industry (the "MN Act"). One provision of the legislation created the ability for companies to compete with U.S. West in providing local telephone service. The effect of the legislation for the Minnesota payphone industry was to immediately decrease the cost of telephone lines. The Company believes that the increased competition to provide local telephone service may further reduce the cost of telephone lines. 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 28 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 (primarily, U.S. West) 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 and, ultimately, may result in the RBOCs raising prices for pay telephone calls when allowable under price deregulation (see "- Deregulation of Local Pay Telephone Rates" below). 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 "10ATT") 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 does not currently exist, 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 (the per call rate for a local coin call in deregulated states) times the national average of 131 monthly Dial-Around calls placed per payphone. In October 1997, the method of compensating payphone companies is scheduled to switch to a per call charge of $0.35 to be tracked and paid by the long-distance carriers and, in November 1998, the per call charge is scheduled to equal the cost of a local pay telephone call. While the Company is unable to estimate the number of Dial- Around calls made from its payphones, management believes that there will not be a material change in the total amount of Dial-Around compensation it receives when the basis for compensation is switched to a per call rate. The FCC order implementing the increased Dial-Around compensation was appealed, with the intent, in part, of decreasing the amount of Dial-Around compensation mandated by the FCC's 1996 order. The appellate court remanded the matter to the FCC for reconsideration of the rate of Dial-Around compensation. The Court of Appeals for the D.C. Circuit found that the per call charge of $0.35 (which was multiplied by 131 calls to determine the interim rate of monthly Dial-Around compensation per payphone) was inappropriate because the FCC did not consider evidence of the differences in the cost of coin calls and Dial-Around calls. The FCC has solicited comments on the cost differences between coin calls and Dial-Around calls, and whether the local coin rate, subject to an offset for expenses unique to those calls, is an appropriate per call compensation rate for determining the rate of Dial-Around compensation. The comment period will expire on September 9, 1997. The Company has established a reserve of $109,000 as of June 30, 1997 to cover a potential decrease in the per call charge from $0.35 to $0.30 retroactive to November 1996; however, there can be no assurance that a reduction, if any, in the per call charge used to determine the rate of Dial-Around compensation will not be greater than $0.05 per call. See "Risk Factors - Pending Determination of Dial-Around Compensation Rate." DEREGULATION OF LOCAL PAY TELEPHONE RATES. The FCC also adopted rules pursuant to the Telecom Act which will repeal on October 7, 1997, all rules regulating the cost of a local call placed at a payphone and allow the market to set the rate for local coin calls, unless the state can demonstrate to the satisfaction of the FCC that there are market failures within the state that would not allow market-based rates. Management anticipates that when this deregulation goes into effect, the per call price of pay telephone service will rise to $0.35 or more. Management bases its belief on the experience in Iowa in 1989 when the price of pay telephone calls was deregulated and U.S. West raised its price to $0.35. Given the prohibitions on the RBOCs subsidizing their pay telephone business, and given the large number of low volume RBOC pay telephones in the marketplace, management believes the RBOCs will have a strong desire to raise pay 29 telephone rates. However, there can be no assurance that the per call price of pay telephone service will increase. COMPETITION The Company competes for pay telephone locations with LECs and other independent pay telephone operators. The Company also competes indirectly with long-distance carriers, which can offer Site Providers commissions on long-distance calls made from LEC-owned payphones. Most LECs and long-distance carriers 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 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 the opportunity for a Site Provider to obtain commissions on both local and long-distance calls from the same company, (iii) the quality of service and the availability of specialized services provided to a Site Provider and telephone users, and (iv) the ability to serve accounts with locations in several LATAs or states. The Company believes that independent pay telephone operators have an advantage over LECs in that they can offer Site Providers commissions on coin and cashless local and long-distance calls. Most LECs are prohibited from obtaining revenues or commissions on interLATA long-distance telephone calls and, consequently, generally only pay commissions to Site Providers for local and intraLATA calls. Under the Telecom Act, this prohibition will be removed at such time as sufficient competition for local telephone service has been established. Opening the local telephone markets to competition will likely reduce telephone line charges, the Company's largest operating expense. In most of the areas where the Company operates, it must purchase local telephone service from a single regulated monopoly (primarily, U.S. West). As AT&T, MCI, Sprint and others compete to offer local telephone service, telephone line charges are expected to decline. In addition, the Company expects that its high number of telephone lines will give it the ability to negotiate additional volume discounts. Technological advances and cost efficiencies underlie a continuing increase in the transmission of voice messages. More telephone calls are being made because the manner, means and cost of completing a call have improved. With the advent of call waiting and caller I.D., and as the number of answering machines, voice mail systems, pagers and cellular phones increases, the likelihood of a telephone call being made also increases due to the perceived certainty that a message can be communicated even if the intended recipient may not be reached directly. Accordingly, as the means and desire to communicate by telephone increase, the Company anticipates that its payphones will experience increased usage. EMPLOYEES As of May 31, 1997, the Company had 31 employees, 26 of whom were full-time. No employees are covered by a collective bargaining agreement. The Company believes that its relationships with employees are good. PROPERTIES The Company's corporate offices are located in approximately 5,000 square feet of leased space in Plymouth, Minnesota. The lease for this property expires in May 2000 and the Company has two successive options to extend the lease for additional one-year periods. The Company also leases approximately 2,250 square feet of warehouse and office space in Lake Oswego, Oregon, pursuant to a lease which expires in July 1998, subject to the exercise by the Company of two successive options to extend the lease for 30 additional one-year periods. The Company believes that its current facilities are sufficient for its needs for the foreseeable future. LEGAL PROCEEDINGS MINNESOTA SALES TAX. The Company, based on an analysis of the published regulations of the Minnesota Department of Revenue, has not remitted any sales tax payments to the State of Minnesota. In 1996, the Company learned that the opinion of the Department was that coin-operated payphone receipts were subject to state sales tax. Despite the Department's position, management is still of the view that the Company is not subject to sales tax, and the Company is challenging the imposition of the tax. The Company retained special tax counsel to contest the Department's position that coin-operated payphone receipts are subject to sales tax. Nonetheless, the Company has established a reserve of $975,140 as of June 30, 1997, to provide for the potential sales tax liability. See the Combined Financial Statements of the Company and notes thereto set forth elsewhere in this Prospectus. CLAIM FOR REFUND OF OVERPAYMENT. Prior to enactment of the MN Act which facilitated increased competition in the telecommunications industry, U.S. West had required, with MNPUC approval, that PSPs purchase PALs at approximately twice the cost of business lines even though business lines and PALs were essentially the same. Beginning in August 1995, LECs could no longer restrict the resale of its products, and the Company, along with other Minnesota independent PSPs, requested to purchase for resale from U.S. West regular business lines for its payphones. U.S. West refused the request on the grounds that its requirement that PSPs use PALs had, prior to the enactment of the law, been approved by the MNPUC. In November 1996, the MNPUC concluded that the law did entitle PSPs to use business lines in place of PALs and ordered U.S. West to convert the lines to business lines within 60 days. The MNPUC, however, did not require U.S. West to refund the difference in costs collected during the period from August 1995 until October 1996. Even though the Company was able to purchase business lines through CI starting in the summer of 1996, it estimates that it has overpaid U.S. West approximately $450,000. In April 1997, the Company, together with other Minnesota independent PSPs, initiated an action in the Minnesota Court of Appeals requesting the Court to order the MNPUC to order U.S. West to refund the overpayment. 31 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information concerning the Company's executive officers and directors as of August 15, 1997.
NAME AGE POSITION - ----------------------- --- ----------------------------------------------------- Gary S. Kohler 40 Chairman of the Board of Directors Jeffrey R. Paletz 41 President and Director Melvin Graf 42 Executive Vice President and Director Jack S. Kohler 42 Vice President and Chief Financial Officer Dustin Elder 28 Vice President Robert A. Hegstrom 55 Director
GARY S. KOHLER is a founder and has served as Chairman of the Board of Directors of the Company since its inception in 1989. Mr. Kohler joined Tarmachan Capital Management, an investment management firm, in July 1997. Prior to that and since 1984, he was employed as Vice President of Okabena Company, a private holding company. Mr. Kohler serves on the board of Northwest Mortgage Services, Inc. Mr. Kohler has an M.B.A. from Cornell University and a B.A. 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 1993, overseeing all operations of the Company. 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. MELVIN GRAF is a founder of the Company, has been a director since its inception and has been Executive Vice President since 1993, overseeing all marketing and leasing activities. Mr. Graf served as President of the Company until 1993. Prior to founding the Company in 1989, Mr. Graf was President of Network Travel, a Minneapolis travel agency, for five years. Mr. Graf has a B.S. degree in Business from the University of Minnesota. 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., where he most recently served in the internal audit division. Mr. Kohler has a B.S. degree in Accounting from the University of Minnesota. Mr. Kohler is the brother of Gary S. Kohler. DUSTIN ELDER became a Vice President of the Company in August 1997. Mr. Elder had been President of CAT for three years prior to joining the Company. Prior to that, he was a student at the University of Iowa. ROBERT A. HEGSTROM became a director of the Company in June 1997. In January 1997, Mr. Hegstrom joined Northwest Mortgage Services, Inc. as Chairman, President and Chief Executive Officer. Prior to that, he was a private investor for two years and, from December 1991 to January 1995, he was Executive Vice President of Green Tree Financial Corporation. DIRECTORS' COMPENSATION. No cash compensation is paid to the Company's directors. Upon the completion of this offering, each independent, non-employee director (currently, only Robert A. Hegstrom) will receive an option to purchase $75,000 of Common Stock, valued as of the date of grant, at the first meeting thereafter of the Company's Board of Directors and upon each subsequent annual re-election. The dollar value of the options was determined by the Company to be the amount necessary to attract and retain qualified independent directors. The options will be issued pursuant to the Company's 1997 Long-Term Incentive and Stock Option Plan, will be exercisable upon grant and will have five-year terms and exercise prices 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. 32 LIMITATION OF LIABILITY AND INDEMNIFICATION. The Company's Articles of Incorporation limit the liability of its directors to the fullest extent permitted by the Minnesota Business Corporation Act ("MBCA"). Specifically, directors of the Company will not be personally liable for monetary damages for breach of fiduciary duty as directors, except for (i) any breach of the duty of loyalty to the Company or its shareholders, (ii) acts or omissions not in good faith or that involved intentional misconduct or a knowing violation of law, (iii) dividends or other distributions of corporate assets that are in contravention of certain statutory or contractual restrictions, (iv) violations of certain Minnesota securities laws, or (v) any transaction from which the director derives an improper personal benefit. Liability under federal securities law is not limited by the Articles of Incorporation. The MBCA requires that the Company indemnify any director, officer or employee made or threatened to be made a party to a proceeding, by reason of the former or present official capacity of the person, against judgments, penalties, fines, settlements and reasonable expenses incurred in connection with the proceeding if certain statutory standards are met. "Proceeding" means a threatened, pending or completed civil, criminal, administrative, arbitration or investigative proceeding, including a derivative action in the name of the Company. Reference is made to the detailed terms of the Minnesota indemnification statute (Section 302A.521 of the MBCA) for a complete statement of such indemnification right. The Company's Bylaws also require the Company to provide indemnification to the fullest extent of the Minnesota indemnification statute. Indemnification under the foregoing arrangements may be available for liabilities arising in connection with this offering. Insofar as indemnification for liabilities arising under the Securities Act may be permitted for directors, officers or persons controlling the Company pursuant to the foregoing provisions, the Company is aware that in the opinion of the Securities and Exchange Commission (the "SEC") such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. OFFICERS' COMPENSATION. The following table summarizes the compensation for services rendered by the Company's President paid or accrued by the Company during 1996. No executive officer of the Company earned or was paid salary and bonus exceeding $100,000 in any fiscal year. The Company did not grant any restricted stock awards or stock appreciation rights or make any long-term incentive plan payouts to the named officer during 1996. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION --------------------------------- NAME AND POSITION FISCAL YEAR SALARY BONUS - ---------------------------------------------------------------- ----------- --------- --------- Jeffrey R. Paletz, President.................................... 1996 $ 70,000 $ 10,000
BONUS PROGRAM. The Company has implemented the 1997 Incentive Compensation Plan to provide an opportunity for executive officers and other Company employees to receive a bonus based on individual and Company performance. The maximum bonus for any executive officer will be 40% of annual salary. The bonus opportunity for Jeffrey R. Paletz, the Company's President, depends on the completion of this offering and achieving the Company's target earnings per share. The bonus opportunities for other executive officers also depend on the completion of this offering, as well as the success rate for new installations of payphones and the number of completed acquisitions. The bonus opportunity for other Company employees is discretionary and not subject to specific criteria. STOCK OPTION PLAN. Under the terms of the Company's 1997 Long-Term Incentive and Stock Option Plan (the "Stock Option Plan"), all of the directors, officers, other employees and consultants of the Company are eligible to receive options to purchase shares of the Company's Common Stock as part of their compensation package. No such options had been granted as of July 31, 1997. 33 The Board of Directors adopted the Stock Option Plan on April 17, 1997, and the shareholders approved it on April 18, 1997. The Stock Option Plan provides for the grant both of incentive stock options intended to qualify for preferential tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended, and nonqualified stock options that do not qualify for such treatment. The exercise price of incentive stock options must equal or exceed the fair market value of the Common Stock at the time of grant. The Stock Option Plan also provides for grants of stock appreciation rights, restricted stock awards and performance awards and allows for the grant of restoration options. The Compensation Committee of the Board of Directors will administer the Stock Option Plan, subject to approval of the Board. A total of 100,000 shares of Common Stock are reserved for issuance under the Stock Option Plan. Incentive stock options may be granted under the Stock Option Plan only to any full or part-time employee of the Company (including officers and directors who are also employees). Full or part-time employees, directors who are not employees, and consultants and independent contractors to the Company are eligible to receive options which do not qualify as incentive stock options, as well as other awards. In determining the persons to whom options and awards shall be granted and the number of shares subject to each, the Board of Directors may take into account the nature of services rendered by the respective employees or consultants, their present and potential contributions to the success of the Company, and such other factors as the Board of Directors in its discretion shall deem relevant. The Board of Directors may amend or discontinue the Stock Option Plan at any time but may not, without shareholder approval, make any revisions or amendments to the Stock Option Plan that increase the number of shares subject to the Stock Option Plan, decrease the minimum exercise price, extend the maximum exercise term, or modify the eligibility requirements. The Board of Directors may not alter or impair any award granted under the Stock Option Plan without the consent of the holder of the award. The Stock Option Plan will expire April 15, 2007. Pursuant to the terms of the Stock Option Plan, appropriate adjustments to the Stock Option Plan and outstanding options will be made in the event of changes in the Common Stock through merger, consolidation, reorganization, recapitalization, stock dividend, stock split, or other change in corporate structure. EMPLOYMENT AGREEMENTS. The Company has entered into employment agreements with Jeffrey R. Paletz, Melvin Graf and Jack S. Kohler effective April 15, 1997, and an employment agreement with Dustin Elder effective August 14, 1997, all of which provide for an initial term expiring in April 1999, with automatic one-year renewals. The agreements provide a base salary and the right to receive additional compensation in the form of salary, bonus and other benefits as the Board of Directors shall determine in its sole discretion. The agreements prohibit each officer from competing against the Company for a period of one year after employment ceases and from communicating with a Site Provider until six months following expiration of the Site Agreement. In the event of termination of the officer's employment, except a termination for cause, the terminated officer is entitled to receive full compensation and benefits for a six-month period. CERTAIN TRANSACTIONS 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, 1996, totaled $16,000. Currently, the monthly fee paid for Mr. Kohler's consulting services is $2,000. The Company has borrowed money from members of the Topp family (or a trust for the benefit thereof), who are in-laws of Gary S. Kohler. The two outstanding loans are evidenced by promissory notes dated July 7 and 27, 1996, respectively, copies of which are filed as exhibits to the Registration Statement. The notes, in the aggregate principal amount of $114,669.45, bear interest at the rate of 12% per annum and mature on February 7, 1998, and September 27, 1997, respectively. 34 It is the Company's policy that it not engage in any future material transactions and loans with officers, directors or beneficial holders of 5% or more of the Company's Common Stock, or affiliates of such persons, unless the terms of any such transaction are no less favorable to the Company than those that could be obtained from unaffiliated third parties and are approved by a majority of the Company's independent directors who do not have an interest in the transaction. PRINCIPAL SHAREHOLDERS The following table sets forth certain information as of July 31, 1997 with respect to the beneficial ownership of the Company's Common Stock by (i) each director of the Company, (ii) all directors and executive officers of the Company as a group, and (iii) each shareholder who owns more than 5% of the outstanding shares of the Company's Common Stock. Except as otherwise indicated, the Company believes each of the persons listed below possesses sole voting and investment power with respect to the shares indicated. Beneficial ownership means the shareholder has voting or investment power with respect to the shares. Shares of the Company's Common Stock subject to options or warrants currently exercisable or exercisable within 60 days are deemed outstanding for computing the percentage of the person holding such options or warrants, but are not deemed outstanding for computing the percentage of any other person.
NUMBER OF SHARES BENEFICIALLY PERCENTAGE OF SHARES BENEFICIALLY OWNED OWNED(1) --------------- ---------------------------------- NAME AND ADDRESS OF BENEFICIAL OWNER(2)(3) BEFORE OFFERING AFTER OFFERING - ------------------------------------------------ ----------------- --------------- Gary S. Kohler(4)(5)............................ 1,032,784 53.5% 37.8% Jeffrey R. Paletz............................... 347,398 18.0% 12.7% Melvin Graf(6).................................. 213,334 11.1% 7.8% Jack S. Kohler(5)(7)............................ 327,500 17.0% 12.0% Robert A. Hegstrom.............................. 0 -- -- All directors and executive officers as a group (5 persons)(4)(5)(6)(7)............. 1,721,016 87.0% 61.9%
- -------------------------- (1) Based on 1,928,766 shares of Common Stock outstanding prior to the offering and 2,728,766 shares outstanding after the offering. Does not include 186,240 shares issued in August 1997 in connection with the CAT acquisition or up to 55,880 shares issuable upon converision of a note issued in connection with such acquisition, or the 800,000 additional shares of Common Stock issuable upon exercise of the Redeemable Warrants. (2) The address of each shareholder listed is c/o ChoiceTel Communications, Inc., 9724 10th Avenue North, Plymouth, Minnesota 55441. (3) Does not include Dustin Elder, who became an executive officer of the Company after the date as of which information is presented. In August 1997, in connection with the CAT acquisition, Mr. Elder acquired 39,240 shares of the Company's Common Stock and options to purchase 50,000 shares, 20,000 of which are exercisable within 60 days. (4) The figure includes 40,000 shares held by Gary S. Kohler as custodian for the benefit of his children. (5) The figure includes 200,000 shares currently owned by Gary S. Kohler, who has granted an option to Jack S. Kohler, available for exercise within 60 days, to purchase such shares. (6) The figure includes 13,334 shares of Common Stock held in the name of the wife of Melvin Graf. (7) The figure includes options granted to Jack S. Kohler by the Company, available for exercise within 60 days, to purchase 50,000 shares. 35 SECURITIES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, the Company will have 2,915,006 shares of Common Stock outstanding not including the additional 800,000 shares of Common Stock issuable upon exercise of the Redeemable Warrants or up to 55,880 shares issuable upon conversion of a note issued in connection with the CAT acquisition in August 1997. In addition, the Company has reserved 222,500 shares of Common Stock for issuance pursuant to options (consisting of outstanding options covering 122,500 shares and options for up to 100,000 shares which may be granted pursuant to the Stock Option Plan), 80,000 shares of Common Stock comprising part of the Units issuable upon exercise of the Underwriter's Warrant and 80,000 shares issuable upon exercise of the Redeemable Warrants comprising part of the Units subject to the Underwriter's Warrant. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions," "Management - Stock Option Plan" and "Underwriting." Of the outstanding shares of Common Stock after this offering, the 800,000 shares of Common Stock included in the Units offered hereby may be resold without restriction under the Securities Act, except that any of such shares purchased in the offering by "affiliates" of the Company, as the term is defined in Rule 144 adopted under the Securities Act ("Affiliates"), may generally be resold only in compliance with applicable provisions of Rule 144. The remaining 2,115,006 shares of Common Stock held by the existing shareholders are "restricted" securities within the meaning of Rule 144. Restricted securities and securities held by Affiliates of the Company may not be sold unless the sale is registered under the Securities Act or is made pursuant to an applicable exemption from registration, including an exemption pursuant to Rule 144. In general, under Rule 144, beginning 90 days after the date of this Prospectus, a shareholder, including an Affiliate, who has beneficially owned his or her restricted securities for at least one year from the later of the date such securities were acquired from the Company, or (if applicable) the date they were acquired from an Affiliate, is entitled to sell, within any three-month period, a number of such shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock (approximately 29,150 shares immediately after this offering) or (ii) the average weekly trading volume in the Common Stock during the four calendar weeks preceding the date on which notice of such sale is filed under Rule 144. Sales under Rule 144 are also subject to certain manner of sale provisions, notice requirements and the availability of current public information about the Company. In addition, under Rule 144(k), if a period of at least two years has elapsed between the later of the date restricted securities were acquired from the Company or the date they were acquired from an Affiliate, a shareholder who is not an Affiliate of the Company at the time of sale and has not been an Affiliate of the Company for at least three months prior to the sale would be entitled to sell the shares immediately without compliance with the volume limitations, manner of sale provisions, notice or public information requirements. Beginning 90 days after the date of this Prospectus, 1,693,016 shares of Common Stock will be eligible for sale in the public market under Rule 144, of which 1,676,016 are subject to the volume limitations and other requirements described above. Notwithstanding the above, Gary S. Kohler, Jeffrey R. Paletz, Melvin Graf, Jack S. Kohler and Dustin Elder, who in the aggregate beneficially own 1,710,256 outstanding shares of Common Stock and options to acquire an additional 300,000 shares (which includes 200,000 shares that are currently outstanding), have agreed that, without the Underwriter's prior written consent, they will not sell or transfer any shares of Common Stock during the period ending one year after the date of this Prospectus nor sell or transfer more than 10% of the shares of Common Stock which they own during the period beginning one year and ending two years after the date of this Prospectus. As a condition of the underwriting, the Company's other shareholders, who own 404,750 shares of Common Stock, must agree that they will not, without the Underwriter's prior written consent, sell or transfer any shares of Common Stock during the period ending six months after the date of this Prospectus. Additional shares of Common Stock may also become available for sale in the public market from time to time in the future, including the shares of Common Stock issuable upon exercise of the Redeemable Warrants. Prior to this offering, there has been no public market for the Common Stock, and no predictions can be made of the effect, if any, that sales of shares or the availability of shares for sale will have on the market price prevailing from time to time. Nevertheless, sales of substantial amounts of Common Stock in the public market or the perception that such sales could occur may adversely affect prevailing market prices and may impair the Company's future ability to raise capital through the public sale of its Common Stock. 36 DESCRIPTION OF SECURITIES GENERAL The Company's authorized capital stock consists of 15,000,000 shares of Common Stock, par value $0.01 per share, and 5,000,000 shares of undesignated Preferred Stock, par value $0.01 per share (the "Preferred Stock"). As of July 31, 1997, there were issued and outstanding 1,928,766 shares of Common Stock which were held by 16 shareholders of record, and 72,500 shares of Common Stock reserved for issuance upon exercise of outstanding options (not including an option to purchase 50,000 shares issued in August 1997 in connection with the CAT acquisition). In addition, 100,000 shares were reserved for issuance under the Stock Option Plan, 186,240 shares were reserved for issuance in connection with the CAT acquisition which was completed in August 1997 and up to 55,880 shares were reserved for issuance upon conversion of a note issued in connection therewith, 80,000 shares of Common Stock comprising part of the Units issuable upon exercise of the Underwriter's Warrant were reserved for issuance in connection therewith and 80,000 shares were reserved for issuance upon exercise of the Redeemable Warrants comprising part of the Units subject to the Underwriter's Warrant. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions," "Management - Stock Option Plan" and "Underwriting." No shares of Preferred Stock were outstanding as of July 31, 1997. There will be 2,728,766 shares of Common Stock issued and outstanding upon completion of this offering (not including 186,240 shares issued in August 1997 in connection with the CAT acquisition) and an additional 800,000 shares will be issuable upon exercise of the Redeemable Warrants (assuming the over-allotment option is not exercised). The exercise prices for the Company's outstanding options range from $1.50 to $4.00 per share (not including the exercise price of $6.75 per share for vested options issued in August 1997 in connection with the CAT acquisition or the exercise prices of non-vested options issued in connection therewith which will be determined as of the vesting dates). COMMON STOCK There are no preemptive, subscription, conversion or redemption rights pertaining to the shares of Common Stock and no sinking fund provisions applicable thereto. The absence of preemptive rights could result in the dilution of the interests of existing shareholders should additional shares of Common Stock be issued. Subject to preferences that may be applicable to any outstanding Preferred Stock, holders of shares of Common Stock are entitled to receive such dividends as may be declared by the Board of Directors out of assets legally available therefor, and to share ratably, in proportion to the number of shares held, in the assets of the Company available upon liquidation, dissolution or winding up of the affairs of the Company after payment of all prior claims. Each share of Common Stock is entitled to one vote for all purposes, and cumulative voting is not permitted in the election of directors. Accordingly, the holders of more than fifty percent of all of the outstanding shares of Common Stock can elect all of the directors. Significant corporate transactions such as amendments to the articles of incorporation, mergers, sales of assets and dissolution or liquidation require approval by the affirmative vote of the majority of the outstanding shares of Common Stock. Other matters to be voted upon by the holders of Common Stock normally require the affirmative vote of a majority of the shares present at the particular shareholders meeting. Officers and directors will own approximately 60% of the outstanding Common Stock upon completion of this offering and, therefore, will continue to be able to elect all of the directors of the Company and to control the Company's affairs, including, without limitation, the sale of equity or debt securities of the Company and the appointment of officers. The outstanding shares of Common Stock are, and the shares of Common Stock included in the Units offered hereby and the shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Units offered hereby will be, fully paid and non-assessable. 37 PREFERRED STOCK The Articles of Incorporation authorize the Company's Board of Directors, without further shareholder action, to issue up to 5,000,000 shares of Preferred Stock in one or more series and to fix the voting rights, liquidation preferences, dividend rights, repurchase rights, conversion rights, redemption rights and terms, including sinking fund provisions, and certain other rights and preferences, of the Preferred Stock. Although there is currently no intention to do so, the Board of Directors of the Company may, without prior shareholder approval, issue shares of a class or series of Preferred Stock with voting and conversion rights which could adversely affect the voting power or dividend rights of the holders of Common Stock and may have the effect of delaying, deferring or preventing a change in control of the Company. REDEEMABLE WARRANTS WARRANT AGREEMENT. The Redeemable Warrants included as part of the Units offered hereby will be issued under and governed by the provisions of the Warrant Agreement between the Company and Norwest Bank Minnesota, National Association, as Warrant Agent. A copy of the Warrant Agreement has been filed as an exhibit to the Registration Statement. The following statements are summaries of certain provisions contained therein, are not complete, and are qualified in their entirety by reference to the Warrant Agreement. The shares of Common Stock and the Redeemable Warrants offered as part of the Units are detachable and are separately transferable following their issuance. One Redeemable Warrant entitles the holder ("Warrantholder") thereof to purchase one share of Common Stock during the five years following the Effective Date of this Prospectus. Each Redeemable Warrant will be exercisable at a price equal to $9.50 per share, subject to adjustment as a result of certain events. Any time 120 or more days after the Effective Date of this Prospectus, the Redeemable Warrants are redeemable, in whole but not in part, by the Company at a redemption price of $0.01 per Redeemable Warrant on not less than 30 days' written notice, provided that the closing bid price of the Common Stock exceeds $10.00 per share (subject to adjustment) for any 10 consecutive trading days prior to such notice. Holders of Redeemable Warrants may exercise their rights until the close of business on the date fixed for redemption, unless extended by the Company. Warrantholders as such are not entitled to vote, receive dividends or exercise any of the rights of holders of shares of Common Stock for any purpose until such Redeemable Warrants have been duly exercised and payment of the purchase price has been made. The Redeemable Warrants are in registered form and may be presented for transfer, exchange or exercise at the corporate office of the Warrant Agent. Although the Company has applied for listing of the Redeemable Warrants on The Nasdaq SmallCap Market, there is currently no established market for the Redeemable Warrants, and there is no assurance that any such market will develop. The Warrant Agreement provides for adjustment of the exercise price and the number of shares of Common Stock purchasable upon exercise of the Redeemable Warrants to protect Warrantholders against dilution in certain events, including stock dividends, stock splits and any combination of Common Stock. In the event of the merger, consolidation, reclassification or disposition of substantially all the assets of the Company, the holders of the Redeemable Warrants are entitled to receive, upon payment of the exercise price therefor, the securities or property of the Company or the successor corporation resulting from such transaction that such holders would have received had they exercised such Redeemable Warrants immediately prior to such transaction. REGISTRATION. The Company has sufficient shares of Common Stock authorized and reserved for issuance upon exercise of the Redeemable Warrants, and such shares when issued will be fully paid and nonassessable. The Company must have a current registration statement on file with the SEC and, unless exempt therefrom, with the securities authority of the state in which the Warrantholder resides, in order for the Warrantholder to exercise his or her Redeemable Warrants and obtain shares of Common Stock 38 free of any transfer restrictions. The shares so reserved for issuance upon exercise of the Redeemable Warrants are registered pursuant to the Registration Statement. Furthermore, the Company has agreed to use its best efforts to maintain the effectiveness of the Registration Statement (by filing any necessary post-effective amendments or supplements thereto) throughout the term of the Redeemable Warrants with respect to the shares of Common Stock issuable upon exercise thereof. The Company will incur significant legal and other related expenses in order to keep the Registration Statement current. However, there can be no assurance that the Company will be able to keep the Registration Statement current or that the Registration Statement will be effective at the time a Warrantholder desires to exercise his or her Redeemable Warrants. Additionally, the Company has agreed to use it best efforts to maintain qualifications in those states where the Units were originally qualified for sale to permit exercise of the Redeemable Warrants and issuance of shares of Common Stock upon such exercise in such states. However, there can be no assurance that any such qualification will be effective at the time a Warrantholder desires to exercise his or her Redeemable Warrants. If for any reason the Registration Statement is not kept current, or if the Company is unable to maintain the qualification of the Common Stock underlying the Redeemable Warrants for sale in particular states, Warrantholders in those states, absent an applicable exemption, must either sell such Redeemable Warrants or let them expire. EXERCISE. The Redeemable Warrants may be exercised upon surrender of the certificate therefor on or prior to the expiration date (or earlier redemption date) at the corporate office of the Warrant Agent, with the form of "Election to Purchase" on the reverse side of the certificate filled out and executed as indicated, accompanied by payment of the full exercise price (by certified or cashier's check payable to the order of the Company) for the number of Redeemable Warrants being exercised. For the term of the Redeemable Warrants, the Warrantholders are given the opportunity to profit from a rise in the market price of the Company's Common Stock with a resulting dilution in the interest of the Company's shareholders. During such term, the Company may be deprived of opportunities to sell additional equity securities at a favorable price. The Warrantholders may be expected to exercise their Redeemable Warrants at a time when the Company would, in all likelihood, be able to obtain equity capital by a sale or a new offering on terms more favorable to the Company than the terms of the Redeemable Warrants. TAX CONSIDERATIONS. The following summary is based on present federal income tax law and interpretations thereof, all of which are subject to change or modification. The discussion is limited to the federal income tax matters discussed below and does not include all of the federal income tax considerations relevant to each investor's personal tax situation. Investors should consult their own tax advisers with respect to the matters discussed below and with respect to other federal and state tax considerations that may be applicable to their own personal tax situation. The cost basis of the Units will be the purchase price paid by each investor. Purchasers of Units will be required to allocate the price paid for such Units between the shares of Common Stock and the Redeemable Warrants based on their relative fair market values on the date of purchase. Upon exercise of the Redeemable Warrants, the Warrantholder's cost basis in the shares of Common Stock thus acquired will be the original purchase price allocable to the Redeemable Warrants plus any additional amount paid upon the exercise. No gain or loss will be recognized by such holder upon exercise of the Redeemable Warrants. However, gain or loss will be recognized upon the subsequent sale or exchange of the shares of Common Stock acquired upon exercise of the Redeemable Warrants. Gain or loss also will be recognized upon the sale or exchange of the Redeemable Warrants. Generally, gain or loss will be long- or short-term capital gain or loss, depending on how long the shares of Common Stock or the Redeemable Warrants are held. If the Redeemable Warrants are exercised, the holding period of the Common Stock will not include the period during which the Redeemable Warrants were held. 39 CERTAIN EFFECTS OF AUTHORIZED BUT UNISSUED STOCK Under the Company's Articles of Incorporation, upon completion of this offering and assuming no exercise of the Redeemable Warrants, there will be 12,084,994 shares of Common Stock available for future issuance without shareholder approval. These additional shares may be utilized for a variety of corporate purposes, including future public offerings to raise additional capital or to facilitate corporate acquisitions. Except for the up to 55,880 shares of Common Stock issuable upon conversion of a note issued in connection with a recent acquisition, the Company does not currently have any plans to issue additional shares of Common Stock (other than shares that may be issued upon exercise of the Redeemable Warrants, the Underwriter's Warrant, outstanding options and options which may be granted to the Company's officers, directors and employees pursuant to the Stock Option Plan). See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Acquisitions," "Management - Stock Option Plan" and "Underwriting." One of the effects of the existence of unissued and unreserved Common Stock is that the Board of Directors could issue shares to persons likely to support current management and thereby protect the continuity of the Company's management. Such additional shares could also be used to dilute the stock ownership of persons seeking to obtain control of the Company. PROVISIONS OF THE COMPANY'S ARTICLES AND BYLAWS AND THE MINNESOTA BUSINESS CORPORATION ACT The existence of authorized but unissued stock, as described above, and certain provisions of the Company's Articles of Incorporation and Bylaws and of Minnesota law, as described below, could have anti-takeover effects. These provisions are intended to provide management flexibility, to enhance the likelihood of continuity and stability in the composition of the Board of Directors and in the policies formulated by the Board of Directors and to discourage an unsolicited takeover of the Company if the Board of Directors determines that such a takeover is not in the best interests of the Company and its shareholders. However, these provisions could have the effect of discouraging certain attempts to acquire the Company, which could deprive the Company's shareholders of opportunities to sell their shares of Common Stock at prices higher than prevailing market prices. Such provisions may also have the effect of preventing changes in the management of the Company. Section 302A.671 of the MBCA applies, with certain exceptions, to any acquisition of voting stock of the Company (from a person other than the Company, and other than in connection with certain mergers and exchanges to which the Company is a party) resulting in the beneficial ownership of 20% or more of the voting stock then outstanding. Section 302A.671 requires approval of any such acquisitions by a majority vote of the shareholders of the Company prior to its consummation. In general, shares acquired in the absence of such approval are denied voting rights and are redeemable at their then fair market value by the Company within 30 days after the acquiring person has failed to give a timely information statement to the Company or the date the shareholders voted not to grant voting rights to the acquiring person's shares. Section 302A.673 of the MBCA generally prohibits any business combination by the Company, or any subsidiary of the Company, with any shareholder which purchases 10% or more of the Company's voting shares (an "interested shareholder") within four years following such interested shareholder's share acquisition date, unless the business combination or the acquisition of shares is approved by the affirmative vote of a majority of a committee of all the disinterested members of the Board of Directors, before the interested shareholder's share acquisition date. The Bylaws permit the Board to create new directorships and to elect new directors to serve for the full term of the directorship created. The Board (or its remaining members, even though less than a quorum) is also empowered to fill vacancies on the Board occurring for any reason for the remainder of the term of the directorship in which the vacancy occurred. TRANSFER AGENT The Company currently serves as its own transfer agent and registrar with respect to its Common Stock and does not utilize the services of an independent transfer agent such as a bank or trust company. The Company has appointed Norwest Bank Minnesota, National Association, to act upon completion of this offering as its transfer agent and registrar for the Common Stock and its warrant agent for the Redeemable Warrants. 40 UNDERWRITING Subject to the terms and conditions to be set forth in an underwriting agreement (the "Underwriting Agreement"), the Company has agreed to sell to Equity Securities Investments, Inc. (the "Underwriter"), and the Underwriter has agreed to purchase from the Company, the 800,000 Units offered hereby at the Price to Public set forth on the cover page of this Prospectus, less the Underwriting Discount of $0.675 per Unit. The Underwriting Agreement provides that the obligations of the Underwriter are subject to certain conditions precedent. The nature of the Underwriter's obligation is that it is committed to purchase all Units offered hereby if any of the Units are purchased. The Company has been advised by the Underwriter that the Underwriter proposes to offer the Units directly to the public at the Price to Public set forth on the cover page of this Prospectus and to certain selected securities dealers who are members of the National Association of Securities Dealers, Inc. at such price less usual and customary commissions. The Company has granted to the Underwriter an option, exercisable not later than 45 days after the date of this Prospectus, and subject to the terms and conditions set forth in the Underwriting Agreement, to purchase up to 120,000 additional Units at the Price to Public, less the underwriting discount of $0.675 per Unit. The Underwriter may exercise such option only to cover over-allotments made in connection with the sale of the 800,000 Units offered hereby. To the extent the Underwriter exercises the over-allotment option, it will have a firm commitment to purchase the number of Units to be purchased by it, and the Company will be obligated pursuant to the option to sell such Units to the Underwriter. The Company has agreed to pay the Underwriter a non-accountable expense allowance equal to 2.0% of the aggregate public offering price of the Units, or $120,000 ($138,000 if the over-allotment option is exercised in full). Such allowance is included in the expenses of the offering set forth on the cover page of this Prospectus. The Underwriter has informed the Company that the Underwriter does not intend to confirm sales of Units to any accounts over which it exercises discretionary authority. The Company has agreed to sell to the Underwriter upon the closing of this offering, for $100.00, the Underwriter's Warrant to purchase up to 80,000 Units. The Underwriter's Warrant is not exercisable during the first year after the date of this Prospectus and, thereafter, is exercisable at a price per Unit of $9.00 (or 120% of the per Unit Price to Public) for a period of four years. The Underwriter's Warrant contains customary antidilution provisions and obligates the Company to register the shares of Common Stock and the Redeemable Warrants comprising the Units issuable upon exercise of the Underwriter's Warrant under the Securities Act once at the election of the holders and at any other time the Company has a registration statement pending under the Securities Act. The Underwriter's Warrant also includes "cashless" exercise provisions entitling the holder to apply the difference between the exercise price of the Underwriter's Warrant and the higher fair market value of the Units underlying the Underwriter's Warrant to the payment of the exercise price without paying cash to exercise the Underwriter's Warrant. The Underwriter's Warrant is not transferable during the first year after the date of this Prospectus (other than by will, pursuant to the operation of law, or where directed by a court of competent jurisdiction upon the dissolution of a corporate holder thereof), except to a person who is both an officer and a shareholder of the Underwriter, a successor in interest to the business of the Underwriter, a person who is both an officer and a shareholder of a successor, or a person who is an employee of the Underwriter or a successor, but only if such employee is also an officer of the Underwriter or successor. Any profits realized upon the sale of the Underwriter's Warrant, the Units issuable upon exercise of the Underwriter's Warrant, or the shares of Common Stock or Redeemable Warrants comprising such Units may be deemed to constitute additional underwriting compensation. The Underwriter will not receive any commissions, expense reimbursement or other compensation as a result of the exercise of the Redeemable Warrants included in the Units offered hereby. 41 The Company and the Underwriter have agreed in the Underwriting Agreement to indemnify each other or provide contribution with respect to certain liabilities, including liabilities under the Securities Act and liabilities arising from breaches of representations and warranties contained in the Underwriting Agreement. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions or otherwise, the Company has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. Gary S. Kohler, Jeffrey R. Paletz, Melvin Graf, Jack S. Kohler and Dustin Elder, who in the aggregate beneficially own 1,710,016 outstanding shares of Common Stock and options to acquire an additional 300,000 shares (which includes 200,000 outstanding shares that are currently owned by Gary S. Kohler), have agreed that they will not, without the Underwriter's prior written consent, offer, sell or contract to sell or otherwise dispose of any shares of Common Stock during the period ending one year after the date of this Prospectus; and that they will not offer, sell or contract to sell or otherwise dispose of more than 10% of the shares of Common Stock which they own during the period beginning one year and ending two years after the date of this Prospectus. As a condition of the underwriting, the Company's other shareholders, who in the aggregate own 404,750 shares of Common Stock, must agree that they will not, without the Underwriter's prior written consent, offer, sell or contract to sell or otherwise dispose of any shares of Common Stock during the period ending six months after the date of this Prospectus. In addition, unless waived by the Underwriter, the Company's shareholders must agree that any sale of shares of the Company's Common Stock which is made by such shareholders during the period ending two years after the date of this Prospectus will be made through the Underwriter. The Company has agreed in the Underwriting Agreement that it will not, without the prior written consent of the Underwriter, file a registration statement relating to any shares of the Company's capital stock (other than a registration statement on Form S-8 relating to shares issuable under a stock option plan), whether such shares are to be sold by the Company or by shareholders of the Company, until at least six months after the date of this Prospectus. The Underwriting Agreement provides that, for a period of three years from the date of this Prospectus, the Underwriter will have a right of first refusal to (i) serve as the managing underwriter or selling agent for any public or private offering of the Company's equity or debt securities and (ii) act as the Company's investment banker or financial advisor in connection with any strategic partnership, sale of the Company or its assets, merger, acquisition of stock or assets of another entity, or similar transaction. The Underwriting Agreement also provides that, for a period of three years from the date of this Prospectus, the Underwriter will have the right to nominate one person to serve on the Company's Board of Directors, and the Company has agreed to use its best efforts to secure the election of such nominee to the Board of Directors upon request of the Underwriter. The Underwriter intends to exercise its right to nominate a person to sit on the Company's Board of Directors by approving a nominee to be identified by the Company. It is expected that such right will be exercised prior to the end of 1997. Prior to this offering, there has been no public market for any of the Company's securities. The Price to Public has been determined by negotiation between the Company and the Underwriter. The factors considered in determining the Price to Public include prevailing market and economic conditions, estimates of the business potential and prospects for the Company, the state of the Company's business operations, an assessment of the Company's management, and the consideration of the above factors in relation to market valuations of companies in related businesses. There can be no assurance that the per Unit Price to Public is indicative of the prices at which the Common Stock and Redeemable Warrants will sell in the public market after this offering. The foregoing is a summary of the provisions of the Underwriting Agreement, the Underwriter's Warrant and related documents and does not purport to be a complete statement of their terms and conditions. A copy of the Underwriting Agreement, including the Underwriter's Warrant, has been filed as an exhibit to the Registration Statement. 42 LEGAL MATTERS The validity of the securities offered hereby will be passed upon for the Company by Robins, Kaplan, Miller & Ciresi L.L.P., Minneapolis, Minnesota. Winthrop & Weinstine, P.A., Minneapolis, Minnesota, has acted as counsel to the Underwriter in connection with certain legal matters relating to the securities offered hereby. EXPERTS The Combined Financial Statements of the Company as of and for the years ended December 31, 1995 and 1996, and the Financial Statements for the pay telephone division of TelcoWest and the Financial Statements for CAT for the periods ended December 31, 1995 and 1996, included herein and in the Registration Statement, have been included in reliance upon the reports of Schechter Dokken Kanter Andrews & Selcer, Ltd., Minneapolis, Minnesota, independent certified public accountants, appearing elsewhere herein and upon the authority of said firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the SEC a Registration Statement under the Securities Act with respect to the securities offered hereby. This Prospectus, filed as a part of the Registration Statement, does not contain certain information set forth in or annexed as exhibits to the Registration Statement. For further information regarding the Company and the securities offered hereby, reference is made to the Registration Statement and to the exhibits filed as a part thereof. Statements contained in this Prospectus and the contents of any contract or other document are not necessarily complete, and in each instance reference is made to the copy of such a contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. Copies of the Registration Statement may be inspected without charge and copied at the public reference facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's regional offices at Northwestern Atrium Center, 500 West Madison, Suite 1400, Chicago, Illinois 60661 and 75 Park Place, 14th Floor, New York, New York 10048. Copies of such materials may be obtained from the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of the prescribed fee. In addition, the SEC maintains a Web site that contains reports, proxy and information statements and other information regarding registrants, including the Company, that file electronically with the SEC. The Web site's address is http://www.sec.gov. 43 INDEX TO FINANCIAL STATEMENTS
PAGE --------- COMBINED FINANCIAL STATEMENTS FOR INTELLIPHONE, INC. AND CHOICETEL, INC. Independent Auditors' Report............................................................................. F-2 Combined Balance Sheets as of December 31, 1995 and 1996 and June 30, 1997 (unaudited)................... F-3 Combined Statements of Operations for the Years Ended December 31, 1995 and 1996 and for the Six Month Periods Ended June 30, 1996 and 1997 (unaudited)....................................................... F-4 Combined Statements of Shareholders' Equity for the Years Ended December 31, 1995 and 1996 and the Six Month Period Ended June 30, 1997 (unaudited)........................................................... F-5 Combined Statements of Cash Flows for the Years Ended December 31, 1995 and 1996 and the Six Month Periods Ended June 30, 1996 and 1997 (unaudited)....................................................... F-6 Notes to Combined Financial Statements for the Years Ended December 31, 1995 and 1996 and the Six Month Period Ended June 30, 1997 (unaudited)................................................................. F-7 FINANCIAL STATEMENTS FOR TELCO WEST, INC. - PAY TELEPHONE DIVISION Independent Auditors' Report............................................................................. F-12 Statements of Revenue and Direct Expenses for the Years Ended December 31, 1995 and 1996................. F-13 Statement of Assets Acquired by Intelliphone, Inc. on January 2, 1997.................................... F-14 Notes to Financial Statements for the Years Ended December 31, 1995 and 1996............................. F-15 FINANCIAL STATEMENTS FOR COMPUTER ASSISTED TECHNOLOGIES, INC. Independent Auditors' Report............................................................................. F-16 Statements of Operations for the Years Ended December 31, 1995 and 1996.................................. F-17 Statement of Assets to be Acquired and Liabilities to be Assumed by ChoiceTel Communications, Inc........ F-18 Notes to Financial Statements for the Years Ended December 31, 1995 and 1996............................. F-19
F-1 INDEPENDENT AUDITORS' REPORT Board of Directors Intelliphone, Inc. and Choicetel, Inc. Minneapolis, Minnesota We have audited the accompanying combined balance sheets of Intelliphone, Inc. and Choicetel, Inc. ("S" Corporations) as of December 31, 1995 and 1996, and the related combined 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 combined financial position of Intelliphone, Inc. and Choicetel, Inc. as of December 31, 1995 and 1996, and the combined results of their operations and cash flows for the years then ended, in conformity with generally accepted accounting principles. /s/ Schechter Dokken Kanter Andrews & Selcer, Ltd. -------------------------------------------------------------------- SCHECHTER DOKKEN KANTER ANDREWS & SELCER, LTD. Minneapolis, Minnesota March 20, 1997, except for Note 7 for which the date is July 31, 1997 F-2 INTELLIPHONE, INC. AND CHOICETEL, INC. COMBINED BALANCE SHEETS DECEMBER 31, 1995 AND 1996 AND JUNE 30, 1997 (UNAUDITED)
DECEMBER 31, -------------------------- JUNE 30, 1995 1996 1997 ------------ ------------ ------------- ASSETS Current assets: Cash................................................................. $ 29,146 $ 875,150 $ 55,923 Accounts receivable, net of an allowance for revenue adjustments of $109,000 at June 30, 1997.......................................... 35,289 172,934 828,269 Prepaid: Rent............................................................... 90,285 78,732 105,027 Other.............................................................. 62,851 82,874 321,352 ------------ ------------ ------------- Total current assets............................................. 217,571 1,209,690 1,310,571 ------------ ------------ ------------- Property and equipment: Phones and related equipment......................................... 1,964,289 2,373,199 6,135,888 Accumulated depreciation............................................. (594,959) (845,176) (1,244,576) ------------ ------------ ------------- 1,369,330 1,528,023 4,891,312 ------------ ------------ ------------- Office equipment and improvements.................................... 60,174 66,548 79,265 Accumulated depreciation............................................. (23,739) (36,239) (34,484) ------------ ------------ ------------- 36,435 30,309 44,781 ------------ ------------ ------------- 1,405,765 1,558,332 4,936,093 ------------ ------------ ------------- Other assets: Prepaid rents........................................................ 197,232 134,443 120,566 Rental agreements, net of accumulated amortization of $75,719 in 1995, $111,073 in 1996 and $139,970 at June 30, 1997............... 91,914 65,632 389,193 Deferred financing, net of accumulated amortization of $4,975 in 1995, $33,870 in 1996 and $35,252 at June 30, 1997................. 30,277 1,382 0 ------------ ------------ ------------- 319,423 201,457 509,759 ------------ ------------ ------------- $ 1,942,759 $ 2,969,479 $ 6,756,423 ------------ ------------ ------------- ------------ ------------ ------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Notes payable........................................................ $ 335,000 $ 360,000 $ 3,475,864 Current portion of long-term debt.................................... 100,572 265,931 210,314 Accounts payable..................................................... 183,800 136,298 431,513 Accrued expenses..................................................... 2,127 957,242 1,039,997 Unearned line charge received........................................ 0 16,218 3,580 ------------ ------------ ------------- Total current liabilities........................................ 621,499 1,735,689 5,161,268 Long-term debt, net of current portion................................. 828,530 569,702 630,942 Shareholders' equity................................................... 492,730 664,088 964,213 ------------ ------------ ------------- $ 1,942,759 $ 2,969,479 $ 6,756,423 ------------ ------------ ------------- ------------ ------------ -------------
See notes to combined financial statements. F-3 INTELLIPHONE, INC. AND CHOICETEL, INC. COMBINED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 (UNAUDITED)
FISCAL YEAR ENDED SIX MONTHS ENDED DECEMBER 31, JUNE 30, -------------------------- -------------------------- 1995 1996 1996 1997 ------------ ------------ ------------ ------------ Service revenue.......................................... $ 2,817,446 $ 3,561,902 $ 1,617,720 $ 3,767,801 Cost of service.......................................... 1,785,062 1,986,985 1,030,640 1,719,284 ------------ ------------ ------------ ------------ Gross margin............................................. 1,032,384 1,574,917 587,080 2,048,517 ------------ ------------ ------------ ------------ Selling, general and administrative expenses: Salary and benefits.................................... 402,268 559,494 263,716 586,585 Travel and related..................................... 38,895 58,351 28,991 61,992 Office and overhead.................................... 132,331 212,506 65,123 165,205 ------------ ------------ ------------ ------------ 573,494 830,351 357,830 813,782 Depreciation and amortization............................ 247,039 364,849 154,370 436,390 Interest................................................. 90,276 119,649 72,918 324,920 Sales tax contingency.................................... 0 865,000 0 110,140 ------------ ------------ ------------ ------------ 337,315 1,349,498 585,118 1,684,232 ------------ ------------ ------------ ------------ Income (loss) before income taxes........................ 121,575 (604,932) 1,962 363,285 Provision for income taxes (unaudited)................... -- -- -- 127,150 Pro forma provision for income taxes (credit) (unaudited)............................................ 42,550 (211,725) 687 0 ------------ ------------ ------------ ------------ Net income (unaudited)................................... -- -- -- $ 236,135 Pro forma net income (loss) (unaudited).................. $ 79,055 $ (393,207) $ 1,275 -- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Per share: Net income (unaudited)................................. -- -- -- $ .12 Pro forma net income (loss) (unaudited)................ $ .04 $ (.20) $ .00 -- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Shares outstanding-weighted average...................... 1,935,189 1,948,489 1,935,189 1,951,516 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
See notes to combined financial statements. F-4 INTELLIPHONE, INC. AND CHOICETEL, INC. COMBINED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED)
COMMON STOCK -------------------------------------- CHOICETEL, INC. --------------- INTELLIPHONE, INC. --------------------- 10,000,000 SHARES 2,000,000 AUTHORIZED SHARES AUTHORIZED --------------- --------------------- ACCUMULATED SUBSCRIPTIONS SHARES AMOUNT SHARES AMOUNT DEFICIT RECEIVABLE TOTAL ------- ------ --------- ---------- ----------- ------------- ---------- Balance, January 1, 1995................ 1,622,016 $ 474,473 $ (91,627) $ (28,571) $ 354,275 Stock issued in exchange for retirement of debt at $2.00 a share, February 1995.................................. 25,000 25,000 25,000 Stock issued in exchange for retirement of debt at $5.00 a share, December 1995.................................. 10,000 25,000 25,000 Dividends............................... (33,120) (33,120) Net income.............................. 121,575 121,575 ------- ------ --------- ---------- ----------- ------------- ---------- Balance, December 31, 1995.............. 1,657,016 524,473 (3,172) (28,571) 492,730 Collection of subscription receivable... 10,000 10,000 Issuance of stock for: Cash.................................. 256,000 910,000 910,000 Subscriptions receivable.............. 846,508 $1,000 6,250 25,000 (26,000) Dividends............................... (143,710) (143,710) Net loss................................ (604,932) (604,932) ------- ------ --------- ---------- ----------- ------------- ---------- Balance, December 31, 1996.............. 846,508 1,000 1,919,266 1,459,473 (751,814) (44,571) 664,088 Collection of subscription receivable... 25,990 25,990 Issuance of stock....................... 9,500 38,000 38,000 Dividends............................... Net income.............................. 236,135 236,135 ------- ------ --------- ---------- ----------- ------------- ---------- Balance, June 30, 1997.................. 846,508 $1,000 1,928,766 $1,497,473 $ (515,679) $ (18,581) $ 964,213 ------- ------ --------- ---------- ----------- ------------- ---------- ------- ------ --------- ---------- ----------- ------------- ----------
See notes to combined financial statements. F-5 INTELLIPHONE, INC. AND CHOICETEL, INC. COMBINED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 (UNAUDITED)
FISCAL YEAR ENDED SIX MONTHS ENDED DECEMBER 31, JUNE 30, -------------------------- -------------------------- 1995 1996 1996 1997 ------------ ------------ ------------ ------------ Cash flows from operating activities: Net (loss) income...................................... $ 121,575 $ (604,932) $ (1,962) $ 236,135 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation and amortization........................ 247,039 364,849 154,370 436,390 Changes in operating assets and liabilities: (Increase) decrease in: Accounts receivable.............................. (1,257) (137,645) 20,020 (655,335) Prepaid rent and other........................... (184,901) 54,319 39,594 (250,896) Increase (decrease) in: Accounts payable................................. (13,594) (47,502) 36,505 295,215 Accrued expenses................................. (8,258) 955,115 0 82,755 Unearned line charge received.................... 0 16,218 0 (12,638) ------------ ------------ ------------ ------------ Net cash provided by operating activities................ 160,604 600,422 252,451 131,626 ------------ ------------ ------------ ------------ Cash flows used in investing activities, purchase of equipment and rental contracts......................... (623,008) (462,239) (230,402) (4,136,331) ------------ ------------ ------------ ------------ Cash flows from financing activities: Proceeds from Issuance of: Long-term debt..................................... 813,102 7,103 0 630,942 Common stock....................................... 0 910,000 20,000 38,000 Payments of subscription receivable.................. 0 10,000 0 25,990 Principal payments on long-term debt................. (324,026) (100,572) (50,281) (625,319) Dividends paid....................................... (33,120) (143,710) (16,690) 0 Net change in notes payable.......................... 5,000 25,000 61,152 3,115,864 Deferred financing costs............................. (35,252) 0 0 0 ------------ ------------ ------------ ------------ Net cash provided by financing activities............ 425,704 707,821 14,181 3,185,477 ------------ ------------ ------------ ------------ Net increase (decrease) in cash.......................... (36,700) 846,004 (36,230) (819,228) Cash, beginning balance.................................. 65,846 29,146 29,146 875,150 ------------ ------------ ------------ ------------ Cash, ending balance..................................... $ 29,146 $ 875,150 $ 65,376 $ 55,923 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Supplemental disclosure of cash flow information: Cash paid for interest................................. $ 96,486 $ 121,530 $ 60,391 $ 310,642 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Supplemental schedule of noncash investing and financing activities: Refinanced debt from notes payable to long-term debt... $ 15,000 ------------ ------------ Retirement of debt through issuance of stock........... $ 50,000 ------------ ------------ Issuance of stock in exchange for subscription receivable........................................... $ 26,000 ------------ ------------
See notes to combined financial statements. F-6 INTELLIPHONE, INC. AND CHOICETEL, INC. NOTES TO COMBINED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF COMBINATION: The combined financial statements for 1995 and 1996 include the accounts of Intelliphone, Inc. combined with Choicetel, Inc., after elimination of all material intercompany transactions. The combined companies are commonly owned. NATURE OF BUSINESS: Intelliphone was incorporated in October 1989 to provide coin operated telephone service throughout Minnesota. Since inception, Intelliphone has expanded to other states; however, revenue is generated predominantly in the Minneapolis/St. Paul area. Choicetel, Inc. was incorporated in 1995 and was dormant until June 1996 when operations began. Choicetel is a reseller of telephone local line charge to pay telephone owners in Minnesota. PROPERTY AND EQUIPMENT AND DEPRECIATION METHODS: Property and equipment, consisting principally of coin operated telephones, are stated at cost. Depreciation is being provided by the straight-line method over the estimated useful lives, principally seven years, of the related assets. Phone locations are evaluated by management to determine if their carrying amounts had been impaired. No reductions for impaired assets have occurred. PREPAID RENTS: Prepaid rents represent incentives paid to phone location merchants and property owners to secure long term contracts at such sites and are being amortized as consumed per the rental agreement. RENTAL AGREEMENTS: Rental agreements consist of the purchase price paid for phone location agreements in excess of the purchase price of the related equipment on site and is being amortized over a sixty month period on a straight line basis. DEFERRED FINANCING: Deferred financing costs are being amortized over the life of the related note on a straight-line basis. UNEARNED LINE CHARGE RECEIVED: Collections of the line charge revenue in advance of providing service are deferred until the month the service is provided. INCOME TAXES: Intelliphone, Inc. and Choicetel, Inc., with the consent of their shareholders, have elected to be "S" corporations under the Internal Revenue Code. Instead of paying corporate income taxes, the F-7 INTELLIPHONE, INC. AND CHOICETEL, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) shareholders of an "S" corporation are taxed individually on their proportionate share of the Company's taxable income or loss. Effective January 1997, Intelliphone's "S" corporation status terminated and it became subject to federal and state income taxes. The accompanying statements of operations include an unaudited pro forma provision for income taxes (credit), using a rate of 35 percent, to reflect estimated income tax expense (credit) of the Companies as if they had been subject to corporate income taxes in 1995 and 1996. PRO FORMA EARNING PER SHARE (UNAUDITED): Pro forma earnings per share for the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997 are computed on the basis of the number of shares of common stock outstanding during 1995 and 1996 and the six months ended June 30, 1997. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, stock issued by the Company at prices less than the initial offering price during the twelve months immediately preceding the initial public offering, plus common stock equivalents granted at exercise prices less than the initial public offering price during the same period, have been included in the determination of shares used in the calculation of historical earnings (loss) per share as if they were outstanding for all periods. USE OF ESTIMATES: The timely 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. Actual results could differ from those estimates. F-8 INTELLIPHONE, INC. AND CHOICETEL, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED) 2. NOTES PAYABLE:
DECEMBER 31, JUNE 30, ---------------------- ------------ 1995 1996 1997 ---------- ---------- ------------ Line of credit, bank, $300,000, interest at 1.0% above the bank's prime rate (9.25% at December 31, 1996) guaranteed by shareholders and secured by equipment. The line was paid off in January 1997................ $ 300,000 $ 275,000 $ 0 Term note, bank, $3,000,000, interest at 2.0% above the bank's prime rate (10.5% at June 30, 1997) guaranteed by shareholders and secured by equipment. Due January 1998................................................. 0 0 2,700,000 Note payable, interest only payable monthly at 8.75%. Due on demand........................................ 0 50,000 100,000 Note payable, interest only payable monthly at 12%. Due on demand............................................ 35,000 35,000 35,000 Note payable, Telco West, interest only payable monthly at 10% through March 1998. Principal due April 1998(A).............................................. 0 0 364,896 Note payable, interest on payable monthly at 12% through April 1997. Thereafter due in monthly installments of $2,354 including interest to April 1999................................................. 0 0 46,293 Notes payable, interest only payable monthly at 12% with various maturing dates from March 1997 through December 1997........................................ 0 0 158,849 Note payable, interest at 12% compounded quarterly. Interest due on demand, prinicpal due February 1998................................................. 0 0 70,826 ---------- ---------- ------------ $ 335,000 $ 360,000 $ 3,475,864 ---------- ---------- ------------ ---------- ---------- ------------
- ------------------------ (A) Notes are secured by certain assets of Intelliphone and guaranteed by certain of its shareholders. F-9 INTELLIPHONE, INC. AND CHOICETEL, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED) 3. LONG-TERM DEBT:
DECEMBER 31, JUNE 30, ---------------------- ---------- 1995 1996 1997 ---------- ---------- ---------- Note payable, interest only payable monthly at 12% through April 1997. Thereafter due in monthly installments of $2,354 including interest to April 1999................................................................ 50,000 50,000 0 Notes payable, interest only payable monthly at 12% with various maturing dates from March 1997 through December 1997.............................. 150,000 150,000 0 Note payable, interest at 12% compounded quarterly. Interest due on demand, principal due February 1998.............................................. 60,823 67,926 0 Note payable, bank, due in monthly installments of $6,000 plus interest at 1.25% above bank's prime rate (9.5% at December 31, 1996) to August 2000 at which time remaining principal is due(A).............................. 468,279 396,279 0 Note payable, bank, due in monthly installments of $2,381 plus interest at 1.25% above prime rate (9.5% at December 31, 1996) to December 2000 at which time remaining principal is due(A)................................. 200,000 171,428 0 Note payable, Telco West, interest only payable monthly at 10% through June 1997. Thereafter due in monthly installments of $21,343 including interest to June 2001(B)................................................. 0 0 841,256 ---------- ---------- ---------- 929,102 835,633 841,256 Less current portion....................................................... 100,572 265,931 210,314 ---------- ---------- ---------- $ 828,530 $ 569,702 $ 630,942 ---------- ---------- ---------- ---------- ---------- ----------
- ------------------------ (A) Notes are secured by all assets of Intelliphone and guaranteed by certain of its shareholders. The loan agreement requires the Company to maintain certain financial ratios and limits compensation and dividends. (B) Notes are secured by certain assets of Intelliphone and guaranteed by certain of its shareholders. At December 31, 1995 and 1996, and June 30, 1997, notes with shareholders and shareholder family members included in long-term debt and notes payable amounted to $135,000 at an interest rate of 12%. F-10 INTELLIPHONE, INC. AND CHOICETEL, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED) 3. LONG-TERM DEBT: (CONTINUED) Future maturities of long-term debt as of December 31, 1996, and June 30, 1997, are as follows:
AMOUNT AT YEAR ENDING DECEMBER 31, DECEMBER 31, 1996 - --------------------------------------------------------------------------- ----------------- 1997....................................................................... $ 265,931 1998....................................................................... 193,955 1999....................................................................... 109,756 2000....................................................................... 265,991 -------- $ 835,633 AMOUNT AT TWELVE MONTHS ENDING JUNE 30, JUNE 30, 1997 - --------------------------------------------------------------------------- ----------------- 1998....................................................................... $ 210,314 1999....................................................................... 210,314 2000....................................................................... 210,314 2001....................................................................... 210,314 -------- $ 841,256
4. COMMITMENTS AND CONTINGENCY: PHONE LOCATIONS: Intelliphone, Inc. rents phone locations from merchants and property owners under varying lease terms, usually five or more years, generally cancelable by the Company upon 15 days notice. SALES TAX CONTINGENCY: After an original contact by Intelliphone, Inc., the Minnesota Department of Revenue conducted an audit of the Company's revenues for calculation of sales taxes the department asserts are due on telephone receipts. While the Company does not believe its coin receipts are subject to sales tax and has notified the Minnesota Department of Revenue of its position, it may have to assert its position in the Minnesota courts in order to prevail. The financial statements include an accrual management believes is sufficient to cover this contingency. 5. CONCENTRATION OF CREDIT RISK: Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash in excess of FDIC insurance limits. At December 31, 1996, Intelliphone, Inc. had cash of approximately $765,000 in excess of FDIC insurance limits in one financial institution. No losses have been experienced from such deposits. 6. STOCK AND STOCK OPTIONS: Intelliphone intends to make a public offering of its securities. The proceeds of the offering will be used to retire debt, to finance acquisitions and expansion and for working capital. F-11 INTELLIPHONE, INC. AND CHOICETEL, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995 AND 1996 AND SIX MONTH PERIOD ENDED JUNE 30, 1997 (UNAUDITED) 6. STOCK AND STOCK OPTIONS: (CONTINUED) Intelliphone has issued stock options to a member of management providing for the issuance of up to 50,000 shares of common stock at a price of $1.50 per share expiring October 31, 1998. Subsequent to December 31, 1996, Intelliphone declared a 2 for 1 stock split. This stock split has been reflected in all share and per share amounts as if the split had occurred on January 1, 1995. 7. SUBSEQUENT EVENTS: In January 1997, Intelliphone purchased a route of pay telephones in the Northwestern United States. The route consists of approximately 1,020 pay phones. The purchase price was approximately $3,300,000 and was accounted for under the purchase method and financed primarily with bank and seller financing. In February 1997, Intelliphone reached an agreement to purchase another provider of pay telephones in Minnesota and Wisconsin. The purchase would add approximately 685 additional pay telephones and would be financed through the issuance of stock and assumption of debt. Closing is subject to approval by the Minnesota Public Utilities Commission. A condensed pro forma balance sheet as if these transactions had closed on December 31, 1996 is as follows:
DECEMBER 31, PRO FORMA 1996 PURCHASE DECEMBER 31, ACTUAL ADJUSTMENTS 1996 ------------ ------------ ------------ Current assets......................................................... $1,209,690 $ (160,000) $1,049,690 Property and equipment, net............................................ 1,558,332 4,691,956 6,250,288 Other assets........................................................... 201,457 878,344 1,079,801 ------------ ------------ ------------ $2,969,479 $ 5,410,300 $8,379,779 ------------ ------------ ------------ ------------ ------------ ------------ Liabilities............................................................ $2,305,391 $ 4,711,900 $7,017,291 Shareholders' equity................................................... 664,088 698,400 1,362,488 ------------ ------------ ------------ $2,969,479 $ 5,410,300 $8,379,779 ------------ ------------ ------------ ------------ ------------ ------------
In March 1997, Choicetel, Inc. became a wholly owned subsidiary of Intelliphone, Inc. In April 1997, Intelliphone, Inc. changed its name to ChoiceTel Communications, Inc. Also, in April 1997, the Company adopted the 1997 Long-Term Incentive and Stock Option Plan (the "Plan") which allows for the granting of options to purchase up to 100,000 shares of common stock to directors, officers, other employees and consultants. Options under the Plan may be either incentive stock options (intended to qualify for preferential tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended) or non-qualified stock options. As of July 31, 1997, no options had been granted under the Plan. F-12 INDEPENDENT AUDITORS' REPORT Board of Directors ChoiceTel Communications, Inc. Minneapolis, Minnesota We have audited the accompanying statements of revenue and direct expenses of the pay telephone division of Telco West, Inc. for the years ended December 31, 1995 and 1996 and the statement of assets acquired by Intelliphone, Inc. on January 2, 1997. These financial statements are the responsibility of the Telco West management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations of the pay telephone division of Telco West, Inc. for the years ended December 31, 1996 and 1995, and the assets acquired by Intelliphone, Inc. on January 2, 1997, in conformity with generally accepted accounting principles. The statements of revenue and direct expenses are intended to be part of a filing for ChoiceTel Communications, Inc. for sale of its securities under Regulation S-B and are presented on a basis that is required for the filing with the Securities and Exchange Commission as more fully described in Note 1. /s/ Schechter Dokken Kanter Andrews & Selcer, Ltd. -------------------------------------------------------------------- SCHECHTER DOKKEN KANTER ANDREWS & SELCER, LTD. Minneapolis, Minnesota April 30, 1997 F-13 TELCO WEST, INC. PAY TELEPHONE DIVISION STATEMENTS OF REVENUE AND DIRECT EXPENSES YEARS ENDED DECEMBER 31, 1995 AND 1996
1995 1996 ------------ ------------ Revenues: Coin collection..................................................................... $ 1,624,187 $ 1,308,067 Intellicall......................................................................... 1,268,073 807,793 Long distance....................................................................... 250,182 224,888 Other phone......................................................................... 93,342 174,630 Gain on sale of equipment........................................................... 184,090 146,730 Other operating income.............................................................. 6,299 1,886 ------------ ------------ 3,426,173 2,663,994 ------------ ------------ Direct expenses: Depreciation........................................................................ 414,924 307,331 Interest............................................................................ 133,273 95,323 Other direct expenses............................................................... 2,314,103 1,878,802 ------------ ------------ 2,862,300 2,281,456 ------------ ------------ Income from pay telephone operations before pro forma income tax provision............ 563,873 382,538 Pro forma provision for income taxes (unaudited)...................................... 197,355 133,888 ------------ ------------ Pro forma net income from pay telephone operations (unaudited)........................ $ 366,538 $ 248,650 ------------ ------------ ------------ ------------
See notes to financial statements. F-14 TELCO WEST, INC. PAY TELEPHONE DIVISION STATEMENT OF ASSETS ACQUIRED BY INTELLIPHONE, INC. JANUARY 2, 1997
Assets acquired (at cost to Intelliphone, Inc.): Phones and equipment.............................................................................. $ 3,005,031 Rental agreements and goodwill.................................................................... 336,744 ------------ Total assets acquired............................................................................... $ 3,391,785 ------------ ------------
See notes to financial statements. F-15 TELCO WEST, INC. PAY TELEPHONE DIVISION NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995 AND 1996 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS AND BASIS OF PRESENTATION: The Company provides telecommunications services to the hospitality and direct consumer markets in the Pacific Northwest. In January of 1997, Intelliphone, Inc. purchased the pay telephone division of Telco West, Inc. The financial statements include the results of operations of the pay telephone division only and include any direct revenues and expenses of the division. The revenues and expenses of Telco Hospitality division and Central Office expenses of Telco West are not included in the financial statements. DEPRECIATION EXPENSE: Pay telephones and other assets are depreciated using an accelerated method over their estimated useful lives of seven years. USE OF ESTIMATES: The timely 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. Actual results could differ from those estimates. INCOME TAXES: The Company's shareholders have elected to have the corporation taxed under Subchapter "S" of the Internal Revenue Code. Therefore, no provision for income taxes has been made on its earnings. The taxes, if any, are the liability of the Company's shareholders. 2. LEASES: The Company leases certain pay phones under two capital leases which expire in 1997. Amortization expense for this equipment is included with depreciation expense. Future minimum lease payments under the capital leases and the net present value of future minimum lease payments are as follows:
AMOUNT ---------- Year ending December 31, 1997..................................................... $ 331,380 Less amounts representing interest................................................ 13,637 ---------- Net present value of future minimum lease payments................................ $ 317,743 ---------- ----------
3. COMMITMENTS: PHONE LOCATIONS: The Company has entered into various contracts with merchants and property owners of the pay phone locations with terms ranging from one to ten years, cancelable upon 30 days notice by either party. F-16 INDEPENDENT AUDITORS' REPORT Board of Directors ChoiceTel Communications, Inc. Minneapolis, Minnesota We have audited the accompanying statements of operations of Computer Assisted Technologies, Inc. for the years ended December 31, 1995 and 1996 and the statement of assets to be acquired and liabilities to be assumed by ChoiceTel Communications, Inc. 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 audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations of Computer Assisted Technologies, Inc. for the years ended December 31, 1996 and 1995, and the assets to be acquired and liabilities to be assumed by ChoiceTel Communications, Inc. in conformity with generally accepted accounting principles. /s/ Schechter Dokken Kanter Andrews & Selcer, Ltd. -------------------------------------------------------------------- SCHECHTER DOKKEN KANTER ANDREWS & SELCER, LTD. Minneapolis, Minnesota May 16, 1997 F-17 COMPUTER ASSISTED TECHNOLOGIES, INC. STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995 AND 1996
1995 1996 ---------- ------------ Revenues: Coin collection....................................................................... $ 866,425 $ 1,374,286 Long distance......................................................................... 89,005 48,010 Other operating income................................................................ 3,292 57,041 ---------- ------------ 958,722 1,479,337 ---------- ------------ ---------- ------------ Expenses: Depreciation and amortization......................................................... 59,000 158,044 Interest.............................................................................. 95,577 180,000 Other operating expenses.............................................................. 779,045 1,396,344 ---------- ------------ 933,622 1,734,388 ---------- ------------ Income (loss) before pro forma income tax provision..................................... 25,100 (255,051) Pro forma provision for income tax (credit) (unaudited)................................. 8,785 (89,267) ---------- ------------ Pro forma net income (loss) (unaudited)................................................. $ 16,315 $ (165,784) ---------- ------------ ---------- ------------
See notes to financial statements. F-18 COMPUTER ASSISTED TECHNOLOGIES, INC. STATEMENT OF ASSETS TO BE ACQUIRED AND LIABILITIES TO BE ASSUMED BY CHOICETEL COMMUNICATIONS, INC. Assets acquired (at cost to ChoiceTel Communications, Inc.): Phones........................................................................ $1,725,165 Rental agreements and goodwill................................................ 545,135 --------- Total assets acquired........................................................... $2,270,300 --------- --------- Liabilities assumed: Note payable at 8.5%.......................................................... $ 350,000 Lease payable................................................................. 1,121,900 --------- Total liabilities assumed....................................................... $1,471,900 --------- ---------
See notes to financial statements. F-19 COMPUTER ASSISTED TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995 AND 1996 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS AND BASIS OF PRESENTATION: The Company provides pay phone services to direct consumer markets mainly in Minnesota. In January of 1997, the Company reached an agreement to sell its pay telephone operations to ChoiceTel Communications, Inc. The statement of operations includes all revenues and expenses of the Company. The statement of assets to be acquired and liabilities to be assumed by ChoiceTel Communications, Inc. is based upon the terms of the agreement for sale and purchase of assets dated March 14, 1997. DEPRECIATION EXPENSE: Pay telephones and other assets are depreciated using a straight-line method over their estimated useful lives of seven years. USE OF ESTIMATES: The timely 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. Actual results could differ from those estimates. INCOME TAXES: The Company's shareholders have elected to have the corporation taxed under Subchapter "S" of the Internal Revenue Code. Therefore, no provision for income taxes has been made on the earnings of the Company. The taxes, if any, are the liability of the Company's shareholders. 2. LEASES: The Company leases certain pay phones under three capital leases which expire in 1999, 2000, and 2001. Amortization expense for this equipment is included with depreciation expenses. Net present value of future minimum lease payments under the capital leases are as follows:
AMOUNT ------------ 1997............................................................................ $ 345,396 1998............................................................................ 345,396 1999............................................................................ 341,011 2000............................................................................ 85,221 2001............................................................................ 80,301 ------------ 1,197,325 Less amounts representing interest.............................................. (276,979) ------------ Net present value of future minimum lease payments.............................. $ 920,346 ------------ ------------
The leases are to be assumed by ChoiceTel Communications, Inc. upon the completion of the acquisition. F-20 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER MADE HEREBY. IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO PURCHASE BY ANY PERSON IN ANY JURISDICTION IN WHICH SUCH AN OFFER WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------------ TABLE OF CONTENTS
PAGE ---- Index of Certain Defined Terms............................................ 2 Prospectus Summary........................................................ 3 Risk Factors.............................................................. 6 Use of Proceeds........................................................... 11 Dividend Policy........................................................... 12 Capitalization............................................................ 13 Dilution.................................................................. 14 Selected Combined Financial Data.......................................... 15 Reorganization............................................................ 16 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 17 Business.................................................................. 23 Management................................................................ 32 Certain Transactions...................................................... 34 Principal Shareholders.................................................... 35 Securities Eligible for Future Sale....................................... 36 Description of Securities................................................. 37 Underwriting.............................................................. 41 Legal Matters............................................................. 43 Experts................................................................... 43 Additional Information.................................................... 43 Index to Financial Statements............................................. F-1
------------------------ UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS AND SALESPERSONS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES OFFERED HEREBY, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. 800,000 UNITS EACH UNIT CONSISTING OF ONE SHARE OF COMMON STOCK AND ONE REDEEMABLE COMMON STOCK PURCHASE WARRANT CHOICETEL COMMUNICATIONS, INC. --------------------- PROSPECTUS --------------------- EQUITY SECURITIES INVESTMENTS, INC. , 1997 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the estimated costs and expenses of the Registrant in connection with the offering described in the Registration Statement other than the Underwriting Discount set forth on the cover page of the Prospectus. All of the amounts shown are estimates except the SEC registration fee, the NASD filing fee, and the Underwriter's non-accountable expense allowance. SEC filing fee................................................. $ 4,740.00 NASD filing fee................................................ 2,064.00 NASDAQ filing fee.............................................. 8,000.00 Transfer Agent fee............................................. 7,500.00 Legal fees and expenses........................................ 110,000.00 Accounting fees and expenses................................... 40,000.00 Printing and engraving expenses................................ 85,000.00 Blue Sky fees and expenses..................................... 20,000.00 Underwriter's non-accountable expense allowance................ 120,000.00(1) Miscellaneous expenses......................................... 62,696.00 ---------- Total...................................................... $460,000.00 ---------- ----------
- ------------------------ (1) If the Underwriter's over-allotment option is exercised in full, the Underwriter's non-accountable expense allowance will be $138,000.00 and total expenses will be $478,000.00 ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES. Since June 1, 1994, the Registrant has issued or sold the securities described below without registration under the Act. The transactions described below are claimed to be exempt from registration pursuant to Section 4(2) of the Securities Act as they were isolated transactions and did not involve any public offering, and, in the case of the private placement described in Paragraph 7 below, under Rule 506 under Regulation D under the Act. 1. FEBRUARY 21, 1995 CONVERSION OF DEBT TO EQUITY: On February 21, 1995, an officer and director of the Registrant converted $25,000 of the principal balance of the Registrant's Promissory Note, issued to him in connection with a loan made to the Registrant, into 25,000 shares of Common Stock. 2. FEBRUARY 21, 1995 ISSUANCE OF COMMON STOCK: On February 21, 1995, the Registrant issued 6,000 shares of Common Stock valued at $6,000 to an officer of the Registrant as compensation, in part, for services rendered. 3. OCTOBER 19, 1995 ISSUANCE OF COMMON STOCK: On October 15, 1995, the Registrant issued 6,000 shares of Common Stock valued at $6,000 to an officer of the Registrant as compensation, in part, for services rendered. 4. DECEMBER 27, 1995 CONVERSION OF DEBT TO EQUITY: On December 27, 1995, a shareholder of the Registrant converted $25,000 of the principal balance of the Registrant's Promissory Note, issued to him in connection with a loan made to the Registrant, into 10,000 shares of Common Stock. 5. MARCH 1, 1996 ISOLATED SALE OF COMMON STOCK: On March 1, 1996, the Registrant sold 8,000 shares of Common Stock to an officer and director of the Registrant for $20,000. II-1 6. OCTOBER 15, 1996 ISSUANCE OF COMMON STOCK: On October 15, 1996, the Registrant issued 6,000 shares of Common Stock valued at $15,000 to an officer of the Registrant as compensation, in part, for services rendered. 7. DECEMBER 16, 1996 ISSUANCE OF STOCK OPTION: On December 16, 1996, the Registrant granted to an employee an option to purchase 10,000 shares of Common Stock with an exercise price of $4.00 per share. 8. JANUARY 15, 1997 PRIVATE PLACEMENT OF COMMON STOCK: On January 15, 1997, the Registrant sold 223,750 shares of Common Stock to five accredited investors for aggregate consideration of $895,000. 9. MARCH 1,1997 ISSUANCE OF STOCK OPTION: On March 1, 1996, the Registrant granted to a consultant an option to purchase 12,500 shares of Common Stock with an exercise price of $4.00 per share. 10. MAY 29, 1997 ISSUANCE OF COMMON STOCK: On May 29, 1997, the Registrant issued 12,000 shares of Common Stock valued at $48,000 to an officer of the Registrant as compensation, in part, for services rendered. 11. AUGUST 14, 1997 ISSUANCE OF COMMON STOCK: On August 14, 1997, in connection with an acquisition of assets, the Registrant issued 186,240 shares of Common Stock representing $698,400 of the purchase price for the assets and an option to purchase 50,000 shares of Common Stock, with the options for 20,000 shares having an exercise price of $6.75 per share and the exercise prices of the remaining options to be determined as of the date the options vest. The purchasers of the securities described above represented that they acquired them for their own account and not with a view to any distribution thereof to the public. The Registrant made inquiries of purchasers of securities in these transactions and obtained representations from such purchasers to establish that such issuances qualified for an exemption from the registration requirements of the Securities Act. The certificates representing the securities bear legends stating that the shares are not to be offered, sold or transferred other than pursuant to an effective registration statement under the Securities Act or an exemption from such registration requirements. ITEM 27. EXHIBITS.
EXHIBIT NO. DESCRIPTION MANNER OF FILING - ------------- ----------------------------------------------------------------------------------- ---------------- 1.1 Revised Form of Underwriting Agreement, including Underwriter's Warrant Filed herewith 5 Opinion of Robins, Kaplan, Miller & Ciresi L.L.P. Filed herewith 10.21 Employment and Non-Competition Agreement with Dustin Elder, dated August 14, 1997 Filed herewith 10.22 Lease Filed herewith 23.1 Consent of Robins, Kaplan, Miller & Ciresi L.L.P. (included in Exhibit 5) Filed herewith 23.2 Consent of Schechter Dokken Kanter Andrews & Selcer, Ltd. Filed herewith
II-2 SIGNATURES In accordance with the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements of filing on Form SB-2 and authorized this Amendment No. 1 to Registration Statement to be signed on its behalf by the undersigned, in the City of Minneapolis, State of Minnesota, on August 22, 1997. CHOICETEL COMMUNICATIONS, INC. By: /s/ JACK S. KOHLER ----------------------------------------- Jack S. Kohler VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Pursuant to the requirements of the Securities Act of 1933, as amended, this Amendment No. 1 to Registration Statement has been signed below by the following persons in the capacities indicated on August 22, 1997. SIGNATURE TITLE - ------------------------------ -------------------------- * President and Director - ------------------------------ (principal executive Jeffrey R. Paletz officer) Vice President and Chief /s/ JACK S. KOHLER Financial Officer - ------------------------------ (principal financial and Jack S. Kohler accounting officer) * - ------------------------------ Director Gary S. Kohler * - ------------------------------ Director Melvin Graf - ------------------------------ Director Robert A. Hegstrom *By: /s/ JACK S. KOHLER ------------------------- Jack S. Kohler Attorney-in-Fact II-3 EXHIBIT INDEX DOCUMENT DESCRIPTION
FORM OF FILING ---------------- 1.1 Revised Form of Underwriting Agreement, including Underwriter's Warrant Filed herewith 5 Opinion of Robins, Kaplan, Miller & Ciresi L.L.P. Filed herewith 10.21 Employment and Non-Competition Agreement with Dustin Elder, dated August 14, 1997 Filed herewith 10.22 Lease Filed herewith 23.1 Consent of Robins, Kaplan, Miller & Ciresi L.L.P. (included in Exhibit 5) Filed herewith 23.2 Consent of Schechter Dokken Kanter Andrews & Selcer, Ltd. Filed herewith
EX-1.1 2 EXHIBIT 1.1 -- UNDERWRITING AGREEMENT CHOICETEL COMMUNICATIONS, INC. 800,000 UNITS(1) CONSISTING OF 800,000 SHARES OF COMMON STOCK AND 800,000 REDEEMABLE COMMON STOCK PURCHASE WARRANTS UNDERWRITING AGREEMENT , 1997 ------------ Equity Securities Investments, Inc. 2820 IDS Center 80 South Eighth Street Minneapolis, MN 55402 Ladies/Gentlemen: ChoiceTel Communications, Inc., a Minnesota corporation (the "Company"), hereby confirms its agreement to issue and sell to Equity Securities Investments, Inc. (the "Underwriter") an aggregate of 800,000 units (the "Units"), each Unit consisting of one share of the Company's common stock, $0.01 par value per share ("Common Stock"), and one redeemable Common Stock purchase warrant of the Company (the "Redeemable Warrants"). (Such 800,000 Units are collectively referred to in this Agreement as the "Firm Units.") The Company also hereby confirms its agreement to grant to the Underwriter an option to purchase up to 120,000 additional Units (the "Option Units") on the terms and for the purposes set forth in Section 2(b) hereof. (As used in this Agreement, the term "Units" shall consist of the Firm Units and the Option Units.) The Company also hereby confirms its agreement to issue to the Underwriter warrants for the purchase of a total of 80,000 Units as described in Section 6 hereof (the "Underwriter's Warrants"), assuming purchase by the Underwriter of the Firm Units. The Units issuable upon exercise of the Underwriter's Warrants are referred to in this Agreement as the "Warrant Units." 1. REPRESENTATIONS, WARRANTIES AND AGREEMENTS OF THE COMPANY. (a) The Company represents and warrants to and agrees with the Underwriter as follows: (i) A registration statement on Form SB-2 (File No. 333-29969) with respect to the Units, including a prospectus subject to completion, has been prepared by the Company in conformity with the requirements of the Securities Act of 1933, as amended (the "Securities Act"), and the rules and regulations (the "Rules and Regulations") of the Securities and Exchange Commission (the "SEC") thereunder and has been filed with the SEC under the Securities Act; one or more amendments to such registration statement have also been so prepared and have been, or will be, so filed. Copies of the registration statement and amendments and each related preliminary prospectus to date have been delivered by the Company to the Underwriter, and, to the extent applicable, were identical to the electronically transmitted copies thereof filed with the SEC pursuant to the SEC's Electronic Data Gathering Analysis and Retrieval System ("EDGAR"), except to the extent permitted by Regulation S-T under the Securities Act. If the Company has elected not to rely upon Rule 430A of the Rules and Regulations, the Company has prepared and will promptly file an amendment to the registration statement and an amended prospectus. If the Company has elected to rely upon Rule 430A of the Rules and Regulations, it will prepare and file a prospectus pursuant to Rule 424(b) that discloses the information previously omitted from the prospectus in reliance upon Rule - ------------------------ (1) Plus an option to purchase up to 120,000 additional Units to cover over-allotments. 430A. Such registration statement as amended at the time it is or was declared effective by the SEC and, in the event of any amendment thereto after the effective date and prior to the "First Closing Date" (as hereinafter defined), such registration statement as so amended (but only from and after the effectiveness of such amendment), including the information deemed to be part of the registration statement at the time of effectiveness pursuant to Rule 430A(b), if applicable, is hereinafter called the "Registration Statement." The prospectus included in the Registration Statement at the time it is or was declared effective by the SEC is hereinafter called the "Prospectus," except that if any prospectus filed by the Company with the SEC pursuant to Rule 424(b) of the Rules and Regulations or any other prospectus provided to the Underwriter by the Company for use in connection with the offering of the Units (whether or not required to be filed by the Company with the SEC pursuant to Rule 424(b) of the Rules and Regulations) differs from the prospectus on file at the time the Registration Statement is or was declared effective by the SEC, the term "Prospectus" shall refer to such differing prospectus from and after the time such prospectus is filed with the SEC or transmitted to the SEC for filing pursuant to such Rule 424(b) or from and after the time it is first provided to the Underwriter by the Company for such use. The term "Preliminary Prospectus" as used herein means any preliminary prospectus included in the Registration Statement prior to the time it becomes or became effective under the Securities Act and any prospectus subject to completion as described in Rule 430A of the Rules and Regulations. For purposes of this Agreement, all references to the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement to any of the foregoing shall be deemed to include the respective copies thereof filed with the SEC pursuant to EDGAR. (ii) At the time the Registration Statement is or was declared effective by the SEC and at all times subsequent thereto up to the "First Closing Date" and the "Second Closing Date" (as such terms are hereinafter defined), the Registration Statement and Prospectus, and all amendments thereof and supplements thereto, will comply or complied with the provisions and requirements of the Securities Act and the Rules and Regulations. Neither the SEC nor any state securities authority has issued any order preventing or suspending the use of any Preliminary Prospectus or requiring the recirculation of a Preliminary Prospectus, or issued a stop order with respect to the offering of the Units (if the Registration Statement has been declared effective), or instituted or, to the Company's knowledge, threatened the institution of, proceedings for any of such purposes. When the Registration Statement shall become effective and when any post-effective amendment thereto shall become effective, the Registration Statement (as amended, if the Company shall have filed with the SEC any post-effective amendments thereto) will not or did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading. When the Registration Statement is or was declared effective by the SEC and at all times subsequent thereto up to the First Closing Date and the Second Closing Date, the Prospectus (as amended or supplemented, if the Company shall have filed with the SEC any amendment thereof or supplement thereto) will not or did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances in which they were made, not misleading. When any Preliminary Prospectus was first filed with the SEC and when any amendment thereof or supplement thereto was first filed with the SEC, such Preliminary Prospectus and any amendment thereof and supplement thereto complied in all material respects with the applicable provisions of the Securities Act and the Rules and Regulations and did not contain an untrue statement of a material fact and did not omit to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading. None of the representations and warranties in this Subsection 1(a) shall apply to statements in, or omissions from, the Registration Statement or the Prospectus, or any amendment thereof or supplement thereto, which are based upon and conform to written information relating to the Underwriter furnished to the Company by the Underwriter specifically for use in the preparation of the Registration Statement or the Prospectus, or any such amendment or supplement. -2- (iii) The Company has no subsidiaries other than those identified in Exhibit 21.1 to the Registration Statement (each one a "Subsidiary" and collectively the "Subsidiaries") and is not affiliated with any other company or business entity, except as disclosed in the Prospectus. The Company and each Subsidiary has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation, with full power and authority (corporate and other) to own, lease and operate its properties and conduct its business as described in the Registration Statement and Prospectus; the Company owns all of the outstanding capital stock of each of the Subsidiaries free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; the Company and each Subsidiary is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction in which the ownership or lease of its properties or the conduct of its business requires such qualification and in which the failure to be qualified or in good standing would have a material adverse effect on the condition (financial or otherwise), earnings, operations or business of the Company; and no proceeding has been instituted in any such jurisdiction revoking, limiting or curtailing, or seeking to revoke, limit or curtail, such power and authority or qualification. (iv) The Company and each Subsidiary has operated and is operating in material compliance with all authorizations, licenses, certificates, consents, permits, approvals and orders of and from all state, federal and other governmental regulatory officials and bodies necessary to own its properties and to conduct its business as described in the Registration Statement and Prospectus, all of which are, to the Company's knowledge, valid and in full force and effect; the Company and each Subsidiary is conducting its business in substantial compliance with all applicable laws, rules and regulations of the jurisdictions in which it is conducting business; and neither the Company nor any Subsidiary is in material violation of any applicable law, order, rule, regulation, writ, injunction, judgment or decree of any court, government or governmental agency or body, domestic or foreign, having jurisdiction over the Company or any Subsidiary or over their respective properties. Except as set forth in the Registration Statement and Prospectus, (A) the Company is in material compliance with all material rules, laws and regulations relating to the use, treatment, storage and disposal of toxic substances and protection of health or the environment (the "Environmental Laws") which are applicable to its business, (B) the Company has received no notice from any governmental authority or third party of an asserted claim under Environmental Laws, which claim is required to be disclosed in the Registration Statement and the Prospectus, (C) the Company will not be required to make any future material capital expenditures to comply with Environmental Laws, and (D) no property which is owned, leased or occupied by the Company has been designated as a Superfund site pursuant to the Comprehensive Response, Compensation and Liability Act of 1980, as amended (42 U.S.C. Section 9601, ET SEQ.), or otherwise designated as a contaminated site under applicable state or local law. (v) Neither the Company nor any Subsidiary is in violation of its respective articles of incorporation or bylaws or in default in the performance or observance of any obligation, agreement, covenant or condition contained in any bond, debenture, note or other evidence of indebtedness or in any contract, lease, indenture, mortgage, loan agreement, joint venture or other agreement or instrument to which it is a party or by which it or its respective properties are bound, which default is material to the business of the Company and its Subsidiaries taken as a whole. (vi) The Company has full requisite power and authority to enter into this Agreement and perform the transactions contemplated hereby. This Agreement has been duly authorized, executed and delivered by the Company and is a valid and binding agreement on the part of the Company, enforceable against the Company in accordance with its terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance, and except as the enforceability of the indemnification or contribution provisions hereof may be affected by applicable law or the public policies underlying such law. The performance of this Agreement and the consummation of the -3- transactions herein contemplated will not result in a material breach or violation of any of the terms and provisions of, or constitute a material default under, (A) any indenture, mortgage, deed of trust, loan agreement, bond, debenture, note, agreement or other evidence of indebtedness, any lease, contract, joint venture or other agreement or instrument to which the Company or any Subsidiary is a party or by which the Company or any Subsidiary or their respective properties may be bound, (B) the respective articles of incorporation or bylaws of the Company or any Subsidiary, or (C) any material applicable law, order, rule, regulation, writ, injunction, judgment or decree of any court, government or governmental agency or body, domestic or foreign, having jurisdiction over the Company or any Subsidiary or over their respective properties. No consent, approval, authorization or order of or qualification with any court, governmental agency or body, domestic or foreign, having jurisdiction over the Company or any Subsidiary or over their respective properties is required for the execution and delivery of this Agreement and the consummation by the Company of the transactions herein contemplated, except such as may be required under the Securities Act, the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or under state or other securities or Blue Sky laws, all of which requirements have been satisfied. (vii) Except as is otherwise expressly described in the Registration Statement or Prospectus, there is neither pending nor, to the best of the Company's knowledge, threatened, any action, suit, claim or proceeding against the Company, any Subsidiary, or any of their respective officers or any of their respective properties, assets or rights before any court, government or governmental agency or body, domestic or foreign, having jurisdiction over the Company or any Subsidiary or over their respective officers or properties or otherwise which (i) might result in any material adverse change in the condition (financial or otherwise), earnings, operations or business of the Company and its Subsidiaries taken as a whole or might materially and adversely affect their properties, assets or rights, or (ii) might prevent consummation of the transactions contemplated hereby. (viii) The Company has, and at the First Closing Date and Second Closing Date (collectively, the "Closing Dates") will have, the duly authorized and outstanding capitalization set forth in the Prospectus. All outstanding shares of capital stock of the Company are duly authorized and validly issued, fully paid and non-assessable, have been issued in compliance with all federal and state securities laws, were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities, and the authorized and outstanding capital stock of the Company conforms in all material respects with the statements relating thereto contained in the Registration Statement and the Prospectus; the shares of Common Stock included in the Units to be sold hereunder by the Company and the shares of Common Stock issuable upon exercise of the Redeemable Warrants have been duly authorized for issuance and sale to the Underwriter pursuant to this Agreement and, when issued and delivered by the Company against payment therefor in accordance with the terms of this Agreement, will be duly and validly issued and fully paid and non-assessable and will be sold free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; and no preemptive right, co-sale right, registration right, right of first refusal or other similar right of shareholders exists with respect to any of the shares of Common Stock included in the Units to be sold hereunder by the Company or the shares of Common Stock issuable upon exercise of the Redeemable Warrants or the issuance and sale thereof, or the issuance and sale or exercise of the Redeemable Warrants, or the issuance and sale or exercise of the Underwriter's Warrants and of the Common Stock and Redeemable Warrants included in the Underwriter's Warrants, or the issuance of the Common Stock issuable upon exercise of the Redeemable Warrants included in the Underwriter's Warrants, other than those that have been expressly waived prior to the date hereof. Except as disclosed in the Prospectus, the Company has no outstanding options to purchase, or any preemptive rights or other rights to subscribe for or to purchase, any securities or obligations convertible into, or any contracts or commitments to issue or sell, shares of its capital stock or any such options, rights, convertible securities or obligations. The certificates evidencing the shares of Common Stock and the Redeemable Warrants comply as to form with all applicable provisions of the laws of the State of Minnesota. -4- (ix) The Redeemable Warrants included in the Units to be sold by the Company have been duly and validly authorized and, when authenticated by Norwest Bank Minnesota, National Association (the "Warrant Agent") and issued, delivered and sold in accordance with this Agreement and the Warrant Agreement dated as of the date hereof, between the Company and the Warrant Agent, will have been duly and validly executed, authenticated, issued, and delivered and will constitute valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance. A sufficient number of shares of Common Stock of the Company has been reserved for issuance by the Company upon exercise of the Redeemable Warrants. (x) The Underwriter's Warrants and the Common Stock and Redeemable Warrants included in the Warrant Units have been duly authorized. The Underwriter's Warrants, when issued and delivered to the Underwriter, will constitute valid and binding obligations of the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance and except insofar as the indemnification provisions thereof may be limited by applicable law and the policies underlying such law. The Common Stock included in the Warrant Units, when issued in accordance with the terms of this Agreement and pursuant to the Underwriter's Warrants, will be fully paid and non-assessable and subject to no preemptive rights or similar rights on the part of any person or entity. The Redeemable Warrants included in the Warrant Units, when authenticated by the Warrant Agent and issued, delivered and sold in accordance with this Agreement, the Warrant Agreement between the Company and the Warrant Agent, and the Underwriter's Warrants, will have been duly and validly executed, authenticated, issued and delivered and will constitute valid and binding obligations of the Company, enforceable by the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance. The Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units has been duly authorized and, when issued and delivered upon such exercise, will be validly issued, fully paid and non-assessable, and subject to no preemptive rights or similar rights on the part of any person or entity. A sufficient number of shares of Common Stock of the Company has been reserved for issuance by the Company upon exercise of the Underwriter's Warrants. (xi) Schechter Dokken Kanter Andrews & Selcer, Ltd., which has expressed its opinion with respect to the financial statements filed as part of the Registration Statement and included in the Registration Statement and Prospectus, are independent accountants within the meaning of the Securities Act and the Rules and Regulations. The financial statements of the Company set forth in the Registration Statement and Prospectus comply in all material respects with the requirements of the Securities Act and fairly present the financial position and the results of operations of the Company and the Subsidiaries at the respective dates and for the respective periods to which they apply in accordance with generally accepted accounting principles consistently applied throughout the periods involved (subject, in the case of unaudited financial statements, to normal year-end adjustments which in the opinion of management of the Company are not material, and except as otherwise stated therein); and the supporting schedules included in the Registration Statement present fairly the information required to be stated therein. The selected and summary financial and statistical data included in the Registration Statement present fairly the information shown therein and have been compiled on a basis consistent with the audited financial statements presented therein. No other financial statements or schedules are required by the Securities Act or the Rules and Regulations to be included in the Registration Statement. -5- (xii) Subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus, and at each Closing Date, except as is otherwise disclosed in the Registration Statement or Prospectus, there has not been: (A) any change in the capital stock or long-term debt (including any capitalized lease obligation) or material increase in the short-term debt of the Company or any Subsidiary (other than issuances of Common Stock upon the exercise of options outstanding as of the Effective Date and options granted under the Company's 1997 Long-Term Incentive and Stock Option Plan (the "Stock Plan")); (B) any issuance of options, warrants, convertible securities or other rights to purchase the capital stock of the Company (other than options granted under the Stock Plan); (C) any material adverse change, or any development involving a material adverse change, in or affecting the condition (financial or otherwise), earnings, operations, business, or business prospects, management, financial position, stockholders' equity, results of operations or general condition of the Company; (D) any transaction entered into by the Company or any Subsidiary that is material to the Company; (E) any obligation, direct or contingent, incurred by the Company or any Subsidiary, except obligations incurred in the ordinary course of business that, in the aggregate, are not material; (F) any dividend or distribution of any kind declared, paid or made on the capital stock of the Company; or (G) any loss or damage (whether or not insured) to the property of the Company or any Subsidiary which has been sustained which has a material adverse effect on the condition (financial or otherwise), earnings, operations or business of the Company or a Subsidiary. (xiii) Except as is otherwise expressly disclosed in the Registration Statement or Prospectus, (A) the Company and each Subsidiary has good and marketable title to all of the property, real and personal, and assets described in the Registration Statement or Prospectus as being owned by it, free and clear of any and all pledges, liens, security interests, encumbrances, equities, charges or claims, other than such as would not have a material adverse effect on the condition (financial or otherwise), earnings, operations or business of the Company, (B) the agreements to which the Company or any Subsidiary is a party described in the Registration Statement and Prospectus are valid agreements, enforceable by the Company or the Subsidiary (as applicable), except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by judicial limitations on the right of specific performance, and (C) each of the Company and the Subsidiaries has valid and enforceable leases for all properties described in the Registration Statement and Prospectus as leased by it, except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by judicial limitations on the right of specific performance. Except as set forth in the Registration Statement and Prospectus, the Company owns or leases all such properties as are necessary to its operations as now conducted. (xiv) The Company and each Subsidiary has timely filed (or has timely requested an extension of time to file) all necessary federal and state income and franchise tax returns and has paid all taxes shown thereon as due; there is no tax deficiency that has been or, to the best of the Company's knowledge, could be asserted against the Company or any Subsidiary that might have a material adverse effect on the condition (financial or otherwise), earnings, operations, business or properties of the Company or a Subsidiary; and all tax liabilities are adequately provided for in the books of the Company and each Subsidiary. (xv) No labor disturbance by the employees of the Company or any Subsidiary exists or, to the best of the Company's knowledge, is imminent. No collective bargaining agreement exists with any of the employees of the Company or any Subsidiary and, to the best of the Company's knowledge, no such agreement is imminent. (xvi) The Company and each Subsidiary owns, or possesses adequate rights to use, all patents, patent rights, inventions, trade secrets, know-how, technology, service marks, trade names, copyrights, trademarks and proprietary rights or information which are necessary for the conduct of its present or intended business as described in the Registration Statement or -6- Prospectus; the expiration of any patents, patent rights, trade secrets, trademarks, service marks, trade names or copyrights would not have a material adverse effect on the condition (financial or otherwise), earnings, operations or business of the Company or any of its Subsidiaries, taken as a whole; and the Company has not received any notice of, and has no knowledge of, any infringement of or conflict with the asserted rights of others with respect to any patent, patent rights, inventions, trade secrets, know-how, technology, trademarks, service marks, trade names or copyrights which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, might have a material adverse effect on the condition (financial or otherwise), earnings, operations, business or business prospects of the Company or any Subsidiary. Except as disclosed in the Registration Statement or Prospectus, the Company is not obligated or under any liability whatsoever to make any payments by way of royalties, fees or otherwise to any owner of, licensor of, or other claimant to, any patent, patent rights, inventions, trade secrets, know-how, technology, service marks, trade names, trademark, copyright or other intangible asset, with respect to the use thereof or in connection with the conduct of its business or otherwise. (xvii) The Common Stock and the Redeemable Warrants have been approved for quotation on The Nasdaq SmallCap Market. (xviii) The Company has no defined benefit pension plan or other pension benefit plan which is intended to comply with the provisions of the Employee Retirement Income Security Act of 1974 as amended from time to time, except as disclosed in the Registration Statement. (xix) The Company has not taken and will not take, directly or indirectly, any action (and does not know of any action by its directors, officers, shareholders or others) which has constituted or is designed to, or which might reasonably be expected to, cause or result in stabilization or manipulation, as defined in the Exchange Act or otherwise, of the price of any security of the Company to facilitate the sale or resale of the Units. The Company has not distributed and will not distribute prior to the later of (A) the First Closing Date or the Second Closing Date, as the case may be, and (B) completion of the distribution of the Units, any offering material in connection with the offering and sale of the Units other than any Preliminary Prospectus, the Prospectus, the Registration Statement and other materials, if any, permitted by the Securities Act. Except as is otherwise disclosed in the Registration Statement or Prospectus, and to the best of the Company's knowledge, no person is entitled, directly or indirectly, to compensation from the Company or the Underwriter for services as a "finder" or otherwise in connection with the transactions contemplated by this Agreement. (xx) The Company and each Subsidiary maintains insurance, which is in full force and effect, with insurers of recognized financial responsibility of the types and in the amounts generally deemed adequate for their respective businesses; and neither the Company nor any Subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would not materially and adversely affect the condition (financial or otherwise), earnings, operations, business or business prospects of the Company. (xxi) Each executive officer and director of the Company and each beneficial owner of five percent (5%) or more of the Common Stock to be outstanding after the sale of the Firm Units (calculated in accordance with Rule 13d-3 under the Exchange Act) has agreed pursuant to the form of Two-Year Lock-up Agreement attached hereto as APPENDIX A-1 (the "Two-Year Lock-up Agreement") that such person will not, for a period of two years from the date (the "Effective Date") that the Registration Statement is declared effective by the SEC (the "Two-Year Lock-up Period"), without the prior written consent of the Underwriter, offer to sell, contract to sell, sell, pledge, hypothecate, transfer or otherwise dispose of, or grant any rights with respect to (collectively, a "Disposition"), any shares of Common Stock and any options, warrants and other rights to purchase any shares of Common Stock or any securities convertible into or exchangeable or exercisable for shares of Common Stock now owned or hereafter acquired by -7- such person (collectively, "Securities"), or with respect to which such person has or hereafter acquires the power of Disposition, other than as permitted by the Two-Year Lock-up Agreement. In addition, each other beneficial owner of Common Stock of the Company has agreed pursuant to the Lock-up Agreement attached hereto as APPENDIX A-2 (the "Six-Month Lock-up Agreement") that such person shall not, for a period of six (6) months from the Effective Date ("Six-Month Lock-up Period"), Dispose of any Securities now owned or hereafter acquired by such person or with respect to which such person has or hereafter acquires the power of Disposition, other than as permitted by the Six-Month Lock-up Agreement. (The Two-Year Lock-up Agreement and the Six-Month Lock-up Agreement shall hereinafter be collectively referred to as the "Lock-up Agreements.") The Company has provided to counsel for the Underwriter ("Underwriter's Counsel") true, accurate and complete copies of all of the Lock-up Agreements. The Company has provided to Underwriter's Counsel a complete and accurate list of all holders of Securities of the Company and the number and type of Securities held by each holder of Securities. (xxii) Neither the Company nor any Subsidiary has at any time during the last five (5) years (or, if formed during the last five years, since its inception) made any unlawful contribution to any candidate for an office or failed to disclose fully any contribution in violation of law, or made any payment to any federal or state governmental officer or official, domestic or foreign, or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. The Company maintains a system of internal accounting controls sufficient to provide reasonable assurances that transactions are executed in accordance with management's general or specific authorizations, transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, access to assets is permitted only in accordance with management's general or specific authorization, and the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (xxiii) Neither the Company nor any of its affiliates is presently doing business with the government of Cuba or with any person or affiliate located in Cuba. (b) Any certificate signed by any officer of the Company and delivered to you or to Underwriter's Counsel shall be deemed a representation and warranty by the Company to the Underwriter as to the matters covered thereby. 2. PURCHASE, SALE, DELIVERY AND PAYMENT. (a) On the basis of the representations, warranties and agreements herein contained, and subject to the terms and conditions herein set forth, the Company agrees to sell to the Underwriter, and the Underwriter agrees to purchase from the Company, the Firm Units at a purchase price of $__________ per Unit. The Underwriter will purchase all of the Firm Units if any are purchased. The Firm Units will be delivered by the Company to the Underwriter for the account of the Underwriter against payment of the purchase price therefor by wire transfer or other same-day funds payable to the order of the Company at the offices of Equity Securities Investments, Inc., 2820 IDS Center, 80 South Eighth Street, Minneapolis, Minnesota 55402 (or at such other place as may be agreed upon by the Underwriter and the Company), at 9:00 a.m., Minneapolis, Minnesota time, on (i) the third (3rd) full business day following the date hereof if the Registration Statement is declared effective before 3:30 p.m., Minneapolis, Minnesota time on the date hereof, (ii) the fourth (4th) full business day following the date hereof if the Registration Statement is declared effective after 3:30 p.m., Minneapolis, Minnesota time on the date hereof, or (iii) such other time and date as the Underwriter and the Company may determine, such time and date of payment and delivery being herein called the "First Closing Date." Delivery of the Firm Units will be made by credit to "full fast" transfer to the account or accounts at The Depository Trust Company designated by the Underwriter. -8- (b) On the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company hereby grants an option to the Underwriter to purchase an aggregate of up to 120,000 Option Units at the same purchase price as the Firm Units, for use solely in covering any over-allotments made by the Underwriter in the sale and distribution of the Firm Units. The option granted hereunder may be exercised by the Underwriter at any time (but not more than once), in whole or in part, during the period of forty-five (45) days after the date of this Agreement by giving written notice to the Company and the Company's counsel, which notice shall set forth the aggregate number of Option Units as to which the Underwriter is exercising the option, the names and denominations in which the Option Units are to be registered, and the date and time, as determined by the Underwriter, when the Option Units are to be delivered, such time and date being herein referred to as the "Second Closing Date;" provided, however, that the Second Closing Date shall not be earlier than the First Closing Date nor earlier than the second business day after the date on which the option shall have been exercised. No Option Units shall be sold and delivered unless the Firm Units previously have been, or simultaneously are, sold and delivered. The Option Units will be delivered by the Company to the Underwriter for the account of the Underwriter against payment of the purchase price therefor by wire transfer or other same-day funds payable to the order of the Company at the offices of Equity Securities Investments, Inc. 2820 IDS Center, 80 South Eighth Street, Minneapolis, Minnesota 55402 (or at such other place as may be agreed upon by the Underwriter and the Company) at 9:00 a.m., Minneapolis, Minnesota time, on the Second Closing Date. Delivery of the Option Units will be made by credit to "full fast" transfer to the account or accounts at The Depository Trust Company designated by the Underwriter. 3. COVENANTS OF THE COMPANY. The Company hereby covenants and agrees with the Underwriter as follows: (a) If the Registration Statement has not already been declared effective by the SEC, the Company will use its best efforts to cause the Registration Statement and any post-effective amendments thereto to become effective as promptly as possible; the Company will notify the Underwriter promptly of the time when the Registration Statement or any post-effective amendment to the Registration Statement has become effective or any supplement to the Prospectus has been filed and of any request by the SEC for any amendment or supplement to the Registration Statement or Prospectus or additional information; if the Company has elected to rely on Rule 430A of the Rules and Regulations, the Company will file a Prospectus containing the information omitted therefrom pursuant to such Rule 430A with the SEC within the time period required by, and otherwise in accordance with the provisions of, Rules 424(b) and 430A of the Rules and Regulations; the Company will prepare and file with the SEC, promptly upon your request, any amendments or supplements to the Registration Statement or Prospectus that, in your opinion, may be necessary or advisable in connection with the distribution of the Units by the Underwriter; and the Company will not file any amendment or supplement to the Registration Statement or Prospectus to which the Underwriter shall reasonably object by notice to the Company after having been furnished a copy a reasonable time prior to the filing. (b) The Company will advise the Underwriter, promptly after it shall receive notice or obtain knowledge thereof, of the issuance by the SEC of any stop order suspending the effectiveness of the Registration Statement, of the suspension of the qualification of the Units for offering or sale in any jurisdiction, or of the initiation or threatening of any proceeding for any such purpose; and the Company will promptly use its best efforts to prevent the issuance of any stop order or to obtain its withdrawal if such a stop order should be issued. (c) Within the time during which a prospectus relating to the Units is required to be delivered under the Securities Act, the Company will comply as far as it is able with all requirements imposed upon it by the Securities Act, as now and hereafter amended, and by the Rules and Regulations, as from time to time in force, so far as necessary to permit the continuance of sales of or dealings in the Units as contemplated by the provisions hereof and the Prospectus. If, during such period, any event occurs as a result of which the Prospectus would include an untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances then existing, not misleading, or if, during such period, it is necessary to amend the Registration Statement or -9- supplement the Prospectus to comply with the Securities Act, the Company will promptly notify the Underwriter and will amend the Registration Statement or supplement the Prospectus (at the expense of the Company) so as to correct such statement or omission or effect such compliance. (d) The Company will use its best efforts to arrange for the qualification of the Units for offering and sale under the securities laws of such jurisdictions as the Underwriter may designate and to continue such qualifications in effect for so long as may be required for purposes of the distribution of the Units; provided, however, that in no event shall the Company be obligated to qualify to do business in any jurisdiction where it is not now so qualified or to take any action which would subject it to the service of process in suits, other than those arising out of the offering or sale of the Units, in any jurisdiction where it is not now so subject. In each jurisdiction in which the Units shall have been qualified as herein provided, the Company will make and file such statements and reports in each year as are or may be reasonably required by the laws of such jurisdiction. (e) The Company will furnish to the Underwriter copies of the Registration Statement (two of which will be signed and will include all exhibits), each Preliminary Prospectus, the Prospectus, and all amendments and supplements to such documents, in each case as soon as available and in such quantities as the Underwriter may from time to time reasonably request. (f) For a period of five years from the Effective Date, the Company will furnish directly to the Underwriter as soon as the same shall be sent to its shareholders generally copies of all annual or interim shareholder reports of the Company and will, for the same period, also furnish the Underwriter with the following: (i) One copy of any report, application or document (other than exhibits, which, however, will be furnished on your request) filed by the Company with the SEC, Nasdaq, the NASD or any securities exchange; (ii) As soon as the same shall be sent to shareholders generally, copies of each communication sent to shareholders; and (iii) From time to time, such other information concerning the Company as the Underwriter may reasonably and specifically request, provided that the Company shall not be required to furnish any information pursuant hereto that is not furnished to its shareholders or not otherwise made publicly available. (g) The Company will, for a period of two (2) years from the Effective Date, furnish directly to the Underwriter quarterly profit and loss statements, reports of the Company's cash flow and statements of application of the proceeds of the offering of the Units by the Company in such reasonable detail as the Underwriter may request. (h) The Company will make generally available to its security holders as soon as practicable, but in any event not later than the fifteen (15) months after the end of the Company's current fiscal quarter, an earnings statement (which will be in reasonable detail but need not be audited) complying with the provisions of Section 11(a) of the Securities Act and Rule 158 of the Rules and Regulations and covering a twelve (12)-month period beginning after the Effective Date of the Registration Statement. (i) The Company will prepare and file with the SEC any required reports on Form SR in accordance with the Securities Act and the Rules and Regulations. (j) After completion of the offering of the Units, the Company will make all filings required to maintain the quotation of the Common Stock and the Redeemable Warrants on The Nasdaq SmallCap Market, The Nasdaq National Market, or any national stock exchange. -10- (k) The Company will apply the net proceeds from the sale of the Units substantially in the manner set forth under the caption "Use of Proceeds" in the Prospectus. (l) For a period of six months after the Second Closing Date, the Company will not, without the prior written consent of the Underwriter, directly or indirectly, effect the Disposition of any Securities including, without limitation, any Securities that are convertible into or exchangeable or exercisable for Common Stock, and shall not accelerate the exercisability of any Securities that are convertible into or exchangeable or exercisable for Common Stock, except for the sale of Units by the Company pursuant to this Agreement, the exercise of options granted under the Company's Stock Plan and other options outstanding on the date of this Agreement, and the grant of options under the Plan in the ordinary course. (m) For a period of six months from the Effective Date, the Company will not, without the prior written consent of the Underwriter, file a registration statement with the SEC or any state securities or "Blue Sky" law authority relating to any of the Company's Securities, whether such shares are to be offered and sold by the Company or by its shareholders, except for a Registration Statement on Form S-8 (or any successor or replacement form of registration statement) relating only to shares of Common Stock subject to options granted under the Stock Plan. (n) The Company will not take, and will use its best efforts to cause each of its officers and directors not to take, directly or indirectly, any action designed to or which might reasonably be expected to cause or result in the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Units. (o) The Company will inform the Florida Department of Banking and Finance at any time prior to the consummation of the distribution of the Units by the Underwriter if it commences engaging in business with the government of Cuba or with any person or affiliate located in Cuba. Such information shall be provided within ninety (90) days after the commencement thereof or after a change occurs with respect to previously reported information. (p) For a period of three (3) years from the Effective Date, the Underwriter shall have the right, but not the obligation, to act as (i) managing underwriter or sole or lead selling agent in any public or private offering of equity or debt securities by the Company, and (ii) the Company's investment banker or financial advisor in connection with any strategic partnership, sale of the Company or its assets, merger, acquisition of stock or assets of another entity, or any similar transaction. If the Company intends to consider or enter into any of the transactions described in this Section 3(p), it will notify the Underwriter in writing, which notification shall contain a description of such transaction in reasonable detail. (q) For a period of three years from the Effective Date, and if the Underwriter so requests, the Company will use its best efforts to secure the election to the Company's Board of Directors of a representative selected by the Underwriter. (r) The Company will cause the Common Stock, the Redeemable Warrants and the Units to be registered under the Exchange Act, which registrations shall be effective concurrently with the effectiveness of the Registration Statement. (s) Unless the Company's Common Stock and Redeemable Warrants are listed on The Nasdaq National Market or other suitable secondary trading exemptions are available, or if for any reason state Blue Sky or securities laws do not apply to secondary trading of the Common Stock and Redeemable Warrants, the Company will seek to become listed in Standard & Poors or another recognized securities manual as soon as practicable after the effective date of the Registration Statement and shall pay all filing fees in connection therewith, for the purpose of facilitating secondary trading in the Common Stock and Redeemable Warrants; and the Company shall also agree to make appropriate filings to qualify the Common Stock and Redeemable Warrants for secondary trading in states in which such filings are necessary to cause the Common Stock and Redeemable Warrants to be qualified, provided that such qualification may be obtained without causing the Company extraordinary cost or hardship. -11- 4. EXPENSES. (a) The Company agrees with the Underwriter that: (i) Whether or not this Agreement becomes effective or is terminated or cancelled or the sale of the Units hereunder is consummated, and regardless of the reason for or cause of any such termination, cancellation, or failure to consummate, the Company will pay or cause to be paid (A) all expenses (including any transfer taxes) incurred in connection with the delivery to the Underwriter of the Units, (B) all expenses and fees (including, without limitation, fees and expenses of the Company's accountants and of counsel to the Company, excluding, however, fees of Underwriter's Counsel) in connection with the preparation, printing, filing, delivery, and shipping of the Registration Statement (including the financial statements therein and all amendments, schedules, and exhibits thereto), each Preliminary Prospectus, the Prospectus, and any amendment thereof or supplement thereto, (C) all fees and reasonable expenses, including all reasonable counsel fees of Underwriter's Counsel, incurred in connection with the qualification of the Units for offering and sale by the Underwriter or by dealers under the securities or Blue Sky laws of the states and other jurisdictions which the Underwriter may designate in accordance with Section 3(d) hereof, (D) all costs and expenses incident to qualification with The Nasdaq SmallCap Market, (E) postage and express charges and other expenses in connection with delivery to the Underwriter of the Preliminary Prospectus and Prospectus, and (F) all other costs and expenses incident to the performance of the Company's obligations hereunder that are not otherwise specifically described herein. In addition to and not in lieu of the foregoing, the Company shall pay to the Underwriter on each Closing Date for out-of-pocket expenses (including fees of Underwriter's Counsel other than fees and expenses incurred in connection with Blue Sky or state securities qualifications) a nonaccountable expense allowance equal to two percent (2.0%) of the aggregate Price to Public for all the Units sold to the Underwriter on each Closing Date, including Units sold pursuant to orders received through the Company. If the Underwriter withdraws from the sale of the Units as herein proposed (A) for any reason within the control of the Company such as, for example, the sale of the Units as herein proposed is abandoned by the Company; (B) based upon the fact that there has been a material adverse change in the financial or other affairs of the Company since the date of the last financial statements of the Company provided to the Underwriter; (C) because any of the Company's representations or warranties in this Agreement prove to be untrue; (D) because there shall have occurred any general suspension of trading in securities on the New York Stock Exchange or any limitation on prices for such trading or because any new restrictions on the distribution of securities shall have been established by the New York Stock Exchange or by the SEC or by any federal or state agency, all to such a degree as, in the Underwriter's judgment, would restrict materially a free market for the Units, shares of Common Stock included in the Units, or the Redeemable Warrants; (E) because there shall have occurred such a materiel change in general economic, political or financial conditions, or because the effect of international conditions on the financial markets in the United States become such as, in the Underwriter's judgment, makes it inadvisable to proceed with the sale of the Units; (F) because the Company's financial condition or its business prospects do not fulfill the Underwriter's expectations based on representations made by the Company prior to March 3, 1997; (G) because the offering of the Units lacks public interest prior to the Effective Date; or (H) because adverse market or other conditions make the offering of the Units not feasible in the Underwriter's judgment, the Company will pay to the Underwriter the amount of all actual accountable, out-of-pocket expenses (including fees and disbursements of Underwriter's Counsel) incurred by the Underwriter in connection with the contemplated purchase, offer and sale of the Units, including, without limitation, expenses incurred in its investigation, preparation to market, and marketing of the Units, and in contemplation of performing and in performance of its obligations hereunder, up to a maximum of $35,000.00. All reimbursements pursuant to this Section 4(a)(i) shall occur within ten (10) days after the Underwriter delivers to the Company a written itemization of such expenses. The provisions of this Section 4(a)(i) are intended to relieve the Underwriter from the -12- payment of the expenses and costs which the Company hereby agrees to pay and shall not impair the obligations of the Company hereunder to the Underwriter. (ii) In addition to its other obligations under Sections 7(a) and 8 hereof, the Company agrees that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding described in Section 7(a), it will reimburse the Underwriter on a monthly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's obligation to reimburse the Underwriter for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, the Underwriter shall promptly return such payment to the Company together with interest, compounded daily, determined on the basis of the prime rate (or other commercial lending rate for borrowers of the highest credit standing) listed from time to time in The Wall Street Journal which represents the base rate on corporate loans posted by a substantial majority of the nation's thirty (30) largest banks (the "Prime Rate"). Any such interim reimbursement payments which are not made to the Underwriter within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. (b) It is agreed that any controversy rising out of the operation of the interim reimbursement arrangements set forth in Section 4(a)(ii) hereof, including the amounts of any requested reimbursement payments and the method of determining such amounts, shall be settled by arbitration conducted pursuant to the Code of Arbitration Procedure of the National Association of Securities Dealers, Inc. ("NASD"). Any such arbitration must be commenced by service of a written demand for arbitration or a written notice of intention to arbitrate, therein electing the arbitration tribunal. If the party demanding arbitration does not make such designation of an arbitration tribunal in such demand or notice, then the party responding to said demand or notice is authorized to do so. Any such arbitration will be limited to the operation of the interim reimbursement provisions contained in Section 4(a)(ii) hereof and will not resolve the ultimate propriety or enforceability of the obligation to indemnify for expenses which is created by the provisions of Sections 7(a) and 7(b) hereof or the obligation to contribute to expenses which is created by the provisions of Section 8(a) hereof. 5. CONDITIONS OF THE UNDERWRITER'S OBLIGATIONS. The obligation of the Underwriter to purchase and pay for the Units as provided herein shall be subject to the accuracy of the representations and warranties of the Company, in the case of the Firm Units, as of the date hereof and the First Closing Date (as if made on and as of the First Closing Date), and in the case of the Option Units, as of the date hereof and the Second Closing Date (as if made on and as of the Second Closing Date); to the performance by the Company of its obligations hereunder; and to the satisfaction of the following additional conditions on or before the First Closing Date in the case of the Firm Units and on or before the Second Closing Date in the case of the Option Units: (a) The Registration Statement shall have become effective not later than 4:00 p.m. Minneapolis, Minnesota time on the date of this Agreement, or such later date or time as shall be consented to in writing by you (the "Effective Date"); and no stop order suspending the effectiveness thereof shall have been issued and no proceedings for that purpose shall have been initiated or, to the knowledge of the Company, or the Underwriter, threatened by the SEC or any state securities commission or similar regulatory body; and any request of the SEC for additional information (to be included in the Registration Statement or the Prospectus or otherwise) shall have been complied with to the satisfaction of the Underwriter and Underwriter's Counsel. (b) The Underwriter shall not have advised the Company that the Registration Statement or Prospectus, or any amendment thereof or supplement thereto, contains any untrue statement of a fact which is material or omits to state a fact which is material and is required to be stated therein or is necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading; provided, however, that this Section 5(b) shall not apply to statements in, or omissions from, the Registration Statement or Prospectus, or any amendment thereof or supplement -13- thereto, which are based upon and conform to written information furnished to the Company by the Underwriter specifically for use in the preparation of the Registration Statement or the Prospectus, or any such amendment or supplement. (c) Subsequent to the Effective Date and prior to each Closing Date, there shall not have occurred any change, or any development involving a prospective change, which materially and adversely affects the Company's condition (financial or otherwise), earnings, operations, properties, business or business prospects from that set forth in the Registration Statement or Prospectus, and which, in the Underwriter's sole judgment, is material and adverse and that makes it, in the Underwriter's sole judgment, impracticable or inadvisable to proceed with the public offering of the Units as contemplated by the Prospectus and this Agreement. (d) All corporate proceedings and other legal matters in connection with this Agreement, the form of Registration Statement and the Prospectus, and the registration, authorization, issue, sale and delivery of the Units shall have been reasonably satisfactory to Underwriter's Counsel, and Underwriter's Counsel shall have been furnished with such papers and information as it may reasonably have requested to enable it to pass upon the matters referred to in this Section. (e) On each Closing Date, the Underwriter shall have received the opinion of Robins, Kaplan, Miller & Ciresi L.L.P., counsel for the Company, dated as of such Closing Date, satisfactory in form and substance to the Underwriter and Underwriter's Counsel, to the effect that: (i) Each of the Company and the Subsidiaries has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation and has the corporate power and authority to own, lease and operate its properties and to conduct its business as currently being carried on and as described in the Registration Statement and Prospectus. (ii) Each of the Company and the Subsidiaries is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction, if any, in which the ownership or leasing of its properties or the conduct of its business requires such qualification, except where the failure to be so qualified or be in good standing would not have a material adverse effect on the condition (financial or otherwise), earnings, operations or business of the Company and the Subsidiaries considered as one enterprise. To the best of such counsel's knowledge, the Company does not own or control, directly or indirectly, any corporation, association or other entity other than the Subsidiaries. (iii) The capital stock of the Company conforms as to legal matters to the description thereof contained in the Prospectus under the caption "Description of Securities." The issued and outstanding Units of the Company have been duly and validly issued and are fully paid and non-assessable, and the holders thereof are not subject to any personal liability solely by reason of being such holders. (iv) The Units to be issued by the Company pursuant to the terms of this Agreement have been duly authorized and, upon issuance and delivery against payment therefor in accordance with the terms hereof, will be duly and validly issued and fully paid and non-assessable, and the holders thereof will not be subject to personal liability solely by reason of being such holders. The shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Units have been duly authorized and, when issued and delivered upon such exercise, will be duly and validly issued and fully paid and non-assessable, and the holders thereof will not be subject to personal liability solely by reason of being such holders. Except as otherwise stated in the Registration Statement and Prospectus, there are no preemptive rights or other rights to subscribe for or to purchase, or any restriction upon the voting or transfer of, any shares of capital stock pursuant to the Company's articles of incorporation, bylaws or any agreement or other instrument known to such counsel to which the Company is a party or by which the Company is bound. To the best of such counsel's knowledge, except as set forth in the -14- Prospectus, neither the filing of the Registration Statement nor the offering or sale of the Units as contemplated by this Agreement gives rise to any rights for or relating to the registration of any shares of capital stock or other securities of the Company and no such rights exist, other than those rights described in Section 3(m) hereof. To the best of such counsel's knowledge, except as described in the Registration Statement and Prospectus, there are no options, warrants, agreements, contracts or rights in existence to purchase or acquire from the Company any shares of capital stock of the Company. (v) The Redeemable Warrants included in the Units to be sold by the Company have been duly and validly authorized and, when authenticated by the Warrant Agent and issued, delivered and sold in accordance with this Agreement and the Warrant Agreement dated as of the date hereof between the Company and the Warrant Agent, will have been duly and validly executed, authenticated, issued and delivered and will constitute valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance. A sufficient number of shares of Common Stock of the Company has been reserved for issuance by the Company upon exercise of the Redeemable Warrants. (vi) The Underwriter's Warrants and the Common Stock and Redeemable Warrants included in the Warrant Units have been duly authorized. The Underwriter's Warrants, when issued and delivered to the Underwriter, will constitute valid and binding obligations of the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium, or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance. The Common Stock included in the Warrant Units, when issued in accordance with the terms of this Agreement and pursuant to the Underwriter's Warrants, will be fully paid and non-assessable and subject to no preemptive rights or similar rights on the part of any person or entity. The Redeemable Warrants included in the Warrant Units, when authenticated by the Warrant Agent and issued, delivered and sold in accordance with this Agreement, the Warrant Agreement between the Company and the Warrant Agent, and the Underwriter's Warrants, will have been duly and validly executed, authenticated, issued and delivered and will constitute valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance. The Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units has been duly authorized and, when issued and delivered upon such exercise, will be validly issued, fully paid and non-assessable and, to such counsel's knowledge, subject to no preemptive rights or similar rights on the part of any person or entity. A sufficient number of shares of Common Stock of the Company has been reserved for issuance by the Company upon exercise of the Underwriter's Warrants and upon the exercise of the Redeemable Warrants included in the Warrant Units. (vii) The Company has the requisite corporate power and authority to enter into this Agreement and to issue, sell and deliver to the Underwriter the Units to be issued and sold by it hereunder. This Agreement has been duly authorized by all necessary corporate action on the part of the Company and has been duly executed and delivered by the Company and, assuming due authorization, execution and delivery by the Underwriter, is a valid, legal and binding agreement of the Company, enforceable in accordance with its terms, except insofar as indemnification and contribution provisions may be limited by applicable law or the public policies underlying such law and except as enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or similar laws relating to or affecting creditors' rights generally or by general equitable principles. -15- (viii) The Registration Statement has become effective under the Securities Act and, to the best of such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceeding for that purpose has been instituted or is pending or threatened under the Securities Act. (ix) The Registration Statement and the Prospectus, and each amendment thereof or supplement thereto (other than the financial statements, including the notes thereto and the supporting schedules, and other financial, numerical, statistical and accounting data derived therefrom, as to which such counsel need express no opinion), comply as to form in all material respects with the requirements of the Securities Act and the Rules and Regulations. (x) The forms of certificates evidencing the Common Stock and the Redeemable Warrants and filed as exhibits to the Registration Statement comply with Minnesota law. (xi) The description in the Registration Statement and the Prospectus of the Company's articles of incorporation and bylaws and of statutes, legal and governmental proceedings, contracts and other documents are accurate in all material respects and fairly present the information required to be presented by the Securities Act and the applicable Rules and Regulations; and such counsel does not know of any statutes or legal or governmental proceedings required to be described in the Prospectus that are not described as required, or of any agreements, contracts, leases or documents of a character required to be described or referred to in the Registration Statement or Prospectus or to be filed as an exhibit to the Registration Statement which are not described or referred to therein or filed as required. (xii) The execution, delivery and performance of this Agreement and the consummation of the transactions herein contemplated (other than performance of the Company's indemnification and contribution obligations hereunder, concerning which no opinion need be expressed) do not result in any violation of the Company's articles of incorporation or bylaws or result in a breach or violation of any of the terms and provisions of, or constitute a default under, any bond, debenture, note or other evidence of indebtedness, or any material lease, contract, indenture, mortgage, deed of trust, loan agreement, joint venture or other material agreement or instrument known to such counsel to which the Company is a party or by which its properties are bound, or any applicable statute, rule or regulation known to such counsel or, to the best of such counsel's knowledge, any order, writ or decree of any court, government or governmental agency or body having jurisdiction over the Company or the Subsidiaries or other any of their material properties or operations. (xiii) No consent, approval, authorization or order of, or filing with, or qualification with, any court, government or governmental agency or body is necessary in connection with the execution, delivery and performance of this Agreement or for the execution, delivery and performance of this Agreement or for the consummation of the transactions herein contemplated, except such as have been obtained under the Securities Act or such as may be required under state or other securities or Blue Sky laws in connection with the purchase and the distribution of the Units by the Underwriter. (xiv) To the best of such counsel's knowledge, there are no legal or governmental proceedings pending or threatened against the Company or any of the Subsidiaries of a character required to be disclosed in the Registration Statement or the Prospectus by the Securities Act or the Rules and Regulations, other than those described therein. (xv) To the best of such counsel's knowledge, neither the Company nor any of the Subsidiaries is presently (A) in violation of its respective articles of incorporation or bylaws, (B) in material breach or violation of any applicable statute, rule or regulation known to such counsel or any order, writ or decree of any court or governmental agency or body, or (C) in breach of or otherwise in default in the performance of any material obligation, agreement or condition contained in any bond, debenture, note, loan agreement or any other material contract, -16- lease or other instrument to which the Company is subject or by which it may be bound, or to which any of the material assets or property of the Company is subject. (xvi) To the best of such counsel's knowledge, the Company holds, and is operating in compliance in all material respects with, all franchises, grants, authorizations, licenses, permits, easements, consents, certificates and orders of any government or self-regulatory body required for the conduct of its business, and all such franchises, grants, authorizations, licenses, permits, easements, consents, certifications and orders are valid and in full force and effect. (xvii) To the best of such counsel's knowledge, after due inquiry, the Company has not received any notice of, and has no knowledge of, any infringement of or conflict with the asserted rights of others with respect to any patent, patent rights, inventions, trade secrets, know-how, technology, trade marks, service marks, trade names, or copyrights which, singularly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would have a material adverse effect on the condition (financial or otherwise), earnings, operations, business or business prospects of the Company. (xviii) To the best of such counsel's knowledge, after due inquiry, the Company owns, or possesses adequate rights to use, all patents, patent rights, inventions, trade secrets, know-how, technology, service marks, trade names, copyrights, trade marks and proprietary rights or information which are necessary for the conduct of its present or intended business as described in the Registration Statement or Prospectus. (xix) On the basis of information obtained as a result of discussions and meetings with officers and other Underwriter of the Company, discussions with Underwriter of the independent public accountants for the Company in connection with the preparation of the Registration Statement and the Prospectus, and the examination of other information and documents requested by such counsel, nothing has come to such counsel's attention that has caused them to believe that the Registration Statement and any amendment thereof, at the time it became effective and at all times subsequent thereto up to and on that Closing Date, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein not misleading, or that the Prospectus, and any amendment or supplement thereto, at the first date of its issuance and up to and at all times subsequent thereto up to and on that Closing Date, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Such counsel may further state that in making the foregoing comments, such counsel does not intend them to include or cover the financial statements and notes thereto and related schedules and other financial, numerical, statistical and accounting data contained or omitted from the Registration Statement and any amendment or supplement thereto and the Prospectus. Counsel rendering the foregoing opinion may rely as to questions of law not involving the laws of the United States or the State of Minnesota upon opinions of local counsel, and, as to questions of fact, upon representations or certificates of officers of the Company or its Subsidiaries and of government officials, in which case their opinion is to state the extent of such reliance. Copies of any opinion, representation or certificate so relied upon shall be delivered to the Underwriter and to Underwriter's Counsel. (f) The Underwriter shall have received from Winthrop & Weinstine, P.A., Underwriter's Counsel, such opinion or opinions as the Underwriter may reasonably require, dated as of the First Closing Date and the Second Closing Date, which are satisfactory in form and substance to the Underwriter, with respect to the sufficiency of corporate proceedings and other legal matters relating to this Agreement and the transactions contemplated hereby, and the Company shall have furnished to Underwriter's Counsel such documents as it may have requested for the purpose of enabling it to pass upon such matters. In connection with such opinion, as to matters of fact relevant to conclusions of law, -17- Underwriter's Counsel may rely, to the extent that it deems proper, upon representations or certificates of public officials and of responsible officers of the Company. (g) At the time of execution of this Agreement, the Underwriter shall have received from Schechter Dokken Kanter Andrews & Selcer, Ltd. a letter dated the date of such execution, in form and substance satisfactory to the Underwriter, to the effect that they are independent accountants with respect to the Company within the meaning of the Securities Act and the applicable published instructions, and the Rules and Regulations thereunder, and further stating in effect that: (i) In their opinion, the audited financial statements included in the Registration Statement and Prospectus covered by their report included therein comply as to form in all material respects with the applicable requirements of the Securities Act, the published instructions and the Rule and Regulations. (ii) On the basis of (A) a reading of the minutes of the shareholders' and directors' meetings of the Company since January 1, 1994, (B) inquiries of certain officials of the Company responsible for financial and accounting matters, (C) a reading of the Company's monthly operating statements for the months beginning on January 1, 1994, and (D) other specified procedures and inquiries (but not an audit in accordance with generally accepted accounting principles), nothing came to their attention causing them to believe that: (1) the unaudited consolidated financial statements of the Company and its Subsidiaries contained in the Prospectus and any amendment thereof or supplement thereto do not comply as to form, in all material respects, with the applicable accounting requirements of the Securities Act and the published Rules and Regulations or were not prepared in conformity with generally accepted accounting principles and practices applied on a basis consistent in all material respects with those followed in the preparation of the audited consolidated financial statements of the Company and its Subsidiaries included therein; or (2) the unaudited consolidated amounts of revenues, income before provision for income taxes, net income and ratio of earnings to fixed charges of the Company and its Subsidiaries, if any, contained in the Prospectus, or any amendment thereof or supplement thereto, were not derived from consolidated financial statements prepared in conformity with generally accepted accounting principles and practices applied on a basis consistent in all material respects with those followed in the preparation of the audited consolidated financial statements of the Company and its Subsidiaries included therein; or (3) the unaudited pro forma consolidated financial statements of the Company and its Subsidiaries and recently-acquired companies, if any, contained in the Prospectus or any amendment thereof or supplement thereto, were not properly compiled in accordance with generally accepted accounting principles or did not provide for all adjustments necessary for a fair presentation of the information purported to be shown thereby; or (4) with respect to the period subsequent to March 31, 1997, there were, at a specified date, not more than five (5) business days prior to the date of the letter, any changes or any material increases or decreases in capital stock, long-term or short-term debt or shareholders' equity, decreases in net assets, net current assets, or net worth or any material decrease, as compared with the corresponding period of the prior year, in revenues or net income of the Company as compared with the amounts shown in the consolidated balance sheet included in the Registration Statement, except as disclosed or referred to in the Prospectus and Registration Statement. -18- (iii) Certain information set forth on the cover of the Prospectus and in the Prospectus under the headings "Prospectus Summary" (including the subheading "Summary Combined Financial Data"), "Risk Factors," "Use of Proceeds," "Dividend Policy," "Capitalization," "Dilution," "Selected Combined Financial Data," "Recent Acquisitions," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business," "Management," "Certain Transactions," "Principal Shareholders," "Shares Eligible for Future Sale," and "Description of Securities" and that are expressed in dollars (or percentages derived from dollar amounts) or numbers have been compared to accounting records of the Company which were subject to the internal accounting controls of the Company and are in agreement with such records or computations made therefrom, excluding any questions of legal interpretation. (h) The Underwriter shall have received from Schechter Dokken Kanter Andrews & Selcer, Ltd. a letter dated as of each Closing Date to the effect that such accountants reaffirm, as of such Closing Date, and as though made on such Closing Date, the statements made in the letter furnished by such accountants pursuant to Section 5(g), except that the specified date referred to in such letter will be a date not more than five (5) business days prior to such Closing Date. (i) The Underwriter shall have received from the Company a certificate, dated as of the First Closing Date and the Second Closing Date, of the principal executive officer and the principal financial or accounting officer of the Company, to the effect that: (i) The representations and warranties of the Company in this Agreement are true and correct as if made on and as of such Closing Date, and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at, or prior to, such Closing Date; (ii) No stop order or other order suspending the effectiveness of the Registration Statement or any amendment thereof or the qualification of the Units for offering or sale have been issued, and no proceedings for that purpose have been instituted or, to the best of their knowledge, are contemplated by the SEC or any state or regulatory body; and (iii) The signers of said certificate have carefully examined the Registration Statement and the Prospectus and any amendments thereof or supplements thereto, and (A) such documents contain all statements and information required to be included therein; the Registration Statement, or any amendment thereof, does not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading; and the Prospectus, as amended or supplemented, does not include any untrue statement of material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; (B) since the Effective Date of the Registration Statement, there has occurred no event required to be set forth in an amended or supplemented Prospectus which has not been so set forth; (C) subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, the Company has not incurred any material liabilities or material obligations, direct or contingent, or entered into any material transactions, not in the ordinary course of business consistent with past practice, or declared or paid any dividends or made any distribution of any kind with respect to its capital stock, and except as disclosed in the Prospectus, there has not been any change in the capital stock (other than a change in the number of outstanding shares of Common Stock due to the offering of the Units or the issuance of shares upon the exercise of options outstanding as of the Effective Date or options granted pursuant to the Stock Plan described to in the Registration Statement), or any material increase in the short-term debt or long-term debt, or in the issuance of options, warrants, convertible securities or other rights to purchase the capital stock, of the Company, or any material adverse change or any development involving a prospective material adverse change (whether or not arising in the ordinary course of business) in the general affairs, condition (financial or otherwise), business, key personnel, property, prospects, net worth or results of operations of the Company, and (D) -19- except as stated in the Registration Statement and Prospectus, there is not pending or, to their knowledge, threatened or contemplated, any action, suit or proceeding to which the Company is a party before or by any court or governmental agency, authority or body, or any arbitrator, which might result in any material adverse change of the condition, (financial or otherwise), business, prospects, or results of operations of the Company. (j) On each Closing Date, there shall have been furnished to you a certificate of Secretary of the Company, dated as of such Closing Date, with the documents listed herein attached, and to the effect and certifying as follows: (i) Attached thereto are true and correct copies of the articles of incorporation of the Company, as amended to the date of the certificate, and stating that there have been no changes or amendments to the attached articles of incorporation of the Company, and no resolutions have been adopted by the Board of Directors or shareholders of the Company relating to (A) the amendment of said articles of incorporation, (B) the merger, consolidation or dissolution of the Company, or (C) the sale of all or substantially all of the assets or business of the Company, and that the Company is in good standing in the State of Minnesota and has paid all of its corporate franchise taxes due as of the date of such certificate. (ii) Attached thereto is a true and correct copy of the bylaws of the Company as in effect as of the date of such certificate and no resolutions have been adopted by the Board of Directors or shareholders of the Company relating to changes or amendments to the attached Bylaws. (iii) Attached thereto are true and correct copies of the resolutions of the Board of Directors of the Company relating to the preparation and signing of the Registration Statement and this Agreement, the issuance and sale of the Units and other related matters, and such resolutions have not been amended, modified or rescinded and are in full force and effect as of the date of such certificate and are the only resolutions adopted by the Board of Directors of the Company with respect to the offering contemplated by the Registration Statement. (iv) Attached thereto are true and correct copies of all material correspondence with respect to the Registration Statement and Prospectus and related matters between the Company, its counsel, and/or Schechter Dokken Kanter Andrews & Selcer, Ltd., on the one hand, and the SEC, on the other. (v) This Agreement, as executed and delivered by the Company, is in the form presented to and approved by officers authorized to do so by the Board of Directors of the Company. (vi) Attached thereto are specimens of the certificates for the Common Stock and the Redeemable Warrants in the forms authorized and approved for use by the Board of Directors of the Company. (vii) The persons who have signed the Registration Statement and all amendments thereto were duly elected at the respective times of such signing and duly acting as officers and directors of the Company or as an attorney-in-fact therefor, as set forth in the Registration Statement. (k) The Underwriter shall have received from each of the executive officers and directors of the Company and each beneficial owner of five percent (5%) or more of the Common Stock to be outstanding after the sale of the Firm Units (calculated in accordance with Rule 13d-3 under the Exchange Act) the Two-Year Lock-up Agreement in the form of APPENDIX A-1 hereto whereby each such person agrees that during the Two-Year Lock-up Period such person will not, without the Underwriter's prior written consent, effect the Disposition of any Securities except as permitted by the Two-Year Lock-up Agreement, and the Underwriter shall have received from each other shareholder of the Company the Six- -20- Month Lock-up Agreement in the form of APPENDIX A-2 hereto whereby each such person agrees that during the Six-Month Lock-up Period such person will not, without the Underwriter's prior written consent, effect the Disposition of any Securities other than as permitted by the Six-Month Lock-up Agreement. (l) The Common Stock of the Company shall be included and quoted on The Nasdaq SmallCap Market. (m) Winthrop & Weinstine, P.A. shall deliver to the Underwriter a Blue Sky Memorandum reasonably satisfactory to the Underwriter confirming that all requisite actions for the offer and sale of the Units in all jurisdictions requested by the Underwriter have been taken. (n) The Company shall have furnished to the Underwriter and to Underwriter's Counsel such additional certificates, documents and evidence as the Underwriter shall reasonably request. All such opinions, certificates, letters and documents will be in compliance with the provisions hereof only if they are reasonably satisfactory to the Underwriter and Underwriter's Counsel. All statements contained in any certificate, letter or other document delivered pursuant hereto by, or on behalf of, the Company shall be deemed to constitute representations and warranties of the Company. The Underwriter may waive in writing the performance of any one or more of the conditions specified in this Section 5 or extend the time for their performance. If any of the conditions specified in this Section 5 shall not have been fulfilled when and as required by this Agreement to be fulfilled and if the fulfillment of said condition has not been waived by the Underwriter, this Agreement and all obligations of the Underwriter hereunder may be canceled at, or at any time prior to, each Closing Date by the Underwriter. Any such cancellation shall be without liability of the Underwriter to the Company and shall not relieve the Company of its obligations under Section 4(a) hereof. Notice of such cancellation shall be given to the Company at the address specified in Section 12 hereof in writing, or by telegraph or telephone confirmed in writing. 6. UNDERWRITER'S WARRANTS. In consideration of the agreement of the Underwriter to act as Underwriter, and upon payment of a purchase price of $100.00, on the First Closing Date the Company will issue and deliver to the Underwriter, for its account, the Underwriter's Warrants to purchase the Warrant Units in an amount equal to ten percent (10%) of the number of Firm Units purchased by the Underwriter in the offering. The Underwriter's Warrants shall be issued on the First Closing Date and shall be dated as of the Effective Date. The Underwriter's Warrants shall be exercisable commencing one year after the Effective Date and for a period ending five years after the Effective Date at a price equal to 120% of the Per Unit Price to Public set forth on the cover page of the Prospectus. As to other terms, the Underwriter's Warrants shall be in form and substance substantially the same as APPENDIX B hereto. 7. INDEMNIFICATION. (a) The Company hereby agrees to indemnify and hold harmless the Underwriter, and each person, if any, who controls the Underwriter within the meaning of Section 15 of the Securities Act, against any losses, claims, damages or liabilities, joint or several, to which the Underwriter or each such controlling person may become subject under the Securities Act, the Exchange Act, the common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of, or are based upon, (i) any breach of any representation, warranty, agreement or covenant of the Company contained in this Agreement, (ii) any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement or any amendment thereof or supplement thereto, or the omission or alleged omission to state in the Registration Statement or any amendment thereof or supplement thereto a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; (iii) any untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, if used prior to the Effective Date of the Registration Statement, or in the Prospectus (as amended or as supplemented, if the Company shall have filed with the SEC any -21- amendment thereof or supplement thereto), or the omission or alleged omission to state therein a material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; or (iv) any untrue statement or alleged untrue statement of a material fact contained in any application or other statement executed by the Company or based upon written information furnished by the Company filed in any jurisdiction in order to qualify the Units under, or exempt the Units or the sale thereof from qualification under, the securities laws of such jurisdiction, or the omission or alleged omission to state in such application or statement a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. The Company will reimburse each Underwriter and each such controlling person for any legal or other expenses reasonably incurred by such Underwriter or controlling person in connection with investigating or defending against any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with written information relating to the Underwriter furnished to the Company by the Underwriter specifically for use in the preparation of the Registration Statement or any such post-effective amendment thereof, any such Preliminary Prospectus, or the Prospectus, or any such amendment thereof or supplement thereto, or in any application or other statement executed by the Company or the Underwriter filed in any jurisdiction in order to qualify the Units under, or exempt the Units or the sale thereof from qualification under, the securities laws of such jurisdiction; and provided further that the foregoing indemnity agreement is subject to the condition that, insofar as it relates to any untrue statement, alleged untrue statement, omission or alleged omission made in any Preliminary Prospectus but eliminated or remedied in the Prospectus, such indemnity agreement shall not inure to the benefit of the Underwriter (or to the benefit of any person who controls the Underwriter) if the person asserting any loss, claim, damage or liability purchased the Units from the Underwriter if a copy of the Prospectus was not sent or given to such person with, or prior to, the written confirmation of the sale of such Units to such person. This indemnity agreement is in addition to any liability which the Company may otherwise have. (b) The Underwriter agrees to indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the Registration Statement, and each person who controls the Company within the meaning of Section 15 of the Securities Act against any losses, claims, damages or liabilities to which the Company or any such director, officer or controlling person may become subject under the Securities Act, the Exchange Act, the common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of, or are based upon, (i) any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement or any amendment thereof or supplement thereto, or the omission or alleged omission to state in the Registration Statement or any amendment thereof or supplement thereto, a material fact required to be stated therein or necessary to make the statements therein not misleading; (ii) any untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, if used prior to the Effective Date of the Registration Statement, or in the Prospectus (as amended or as supplemented, if the Company shall have filed with the SEC any amendment thereof or supplement thereto), or the omission or alleged omission to state therein a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; or (iii) any untrue statement or alleged untrue statement of a material fact contained in any application or other statement executed by the Company or by the Underwriter and filed in any jurisdiction in order to qualify the Units under, or exempt the Units or the sale thereof from qualification under, the securities laws of such jurisdiction, or the omission or alleged omission to state in such application or statement a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by, or on behalf of, the Underwriter specifically for use in the preparation of the Registration Statement or any such post-effective amendment thereof, any such Preliminary Prospectus, or the Prospectus or any such amendment thereof or supplement thereto, or in any application or other statement executed by the Company or by the Underwriter and filed in any jurisdiction; and the Underwriter will reimburse any legal or other expenses reasonably incurred by the Company or any such director, officer, or controlling person in connection with investigating or -22- defending against any such loss, claim, damage, liability or action. This indemnity agreement is in addition to any liability which the Underwriter may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 7 of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against any indemnifying party under this Section 7, notify in writing the indemnifying party of the commencement thereof. The omission so to notify the indemnifying party will relieve it from any liability under this Section 7 as to the particular item for which indemnification is then being sought, but not from any other liability which it may have to any indemnified party. In case any such action is brought against any indemnified party, and the indemnified party notifies an indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel who shall be reasonably satisfactory to such indemnified party; and after notice from the indemnifying party to such indemnified party of the indemnifying party's election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section 7 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party, and the indemnified party shall have reasonably concluded that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to assume such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties, in which event the fees and expenses of one such separate counsel shall be borne by the indemnifying party. Any such indemnifying party shall not be liable to any such indemnified party on account of any settlement of any claim or action effected without the consent of such indemnifying party. 8. CONTRIBUTION. (a) In order to provide for just and equitable contribution in any action in which the Underwriter or the Company (or any person who controls the Underwriter or the Company within the meaning of Section 15 of the Securities Act) makes claim for indemnification pursuant to Section 7 hereof, but such indemnification is unavailable or insufficient to hold harmless and indemnify a party under Section 7, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages or liabilities referred to in Section 7 above (i) in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Underwriter on the other from the offering of the Units hereunder or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in such clause (i) but also the relative fault of the Company on the one hand and the Underwriter on the other in connection with the statements or omissions that resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriter on the other shall be deemed to be in the same proportion as the total net proceeds from the offering of the Units (before deducting expenses) received by the Company bear to the total underwriting discounts received by the Underwriter, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Underwriter and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The Company and the Underwriter agree that it would not be just and equitable if contributions pursuant to this Section 8 were to be determined by pro rata allocation or by any other method of allocation which does not take into account the equitable considerations referred to in the first sentence of this Section 8. The amount paid by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the first sentence of this Section 8 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending against any action or claim which is the subject of this Section 8. Notwithstanding the provisions of this Section 8, the Underwriter shall not be required to contribute any amount in excess of the amount by which the total -23- price at which the Units underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages that the Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who is not guilty of such fraudulent misrepresentation. (b) Promptly after receipt by a party to this Agreement of notice of the commencement of any action, suit or proceeding, such person will, if a claim for contribution in respect thereof is to be made against another party (the "Contributing Party"), notify the Contributing Party of the commencement thereof; but the omission so to notify the Contributing Party will not relieve the Contributing Party from any liability which it may have to any party other than under this Section 8. Any notice given pursuant to Section 7 hereof shall be deemed to be like notice hereunder. In case any such action, suit or proceeding is brought against any party, and such person notifies a Contributing Party of the commencement thereof, the Contributing Party will be entitled to participate therein with the notifying party and any other Contributing Party similarly notified. 9. EFFECTIVE DATE OF THIS AGREEMENT AND TERMINATION. (a) This Agreement shall become effective at immediately after the time at which the Registration Statement shall become effective under the Securities Act upon the Effective Date of the Registration Statement. (b) Until the First Closing Date, this Agreement may be terminated by the Underwriter, at its option, by giving notice to the Company, and the option referred to in Section 2(b), if exercised, may be cancelled at any time prior to the Second Closing Date, if (i) the Company shall have failed, refused, or been unable, at or prior to such Closing Date, to perform any agreement on its part to be performed hereunder, (ii) any other condition of the Underwriter's obligations hereunder is not fulfilled or waived by the Underwriter, (iii) trading in securities generally on the New York Stock Exchange, the American Stock Exchange or in the over-the-counter market shall have been suspended, (iv) minimum or maximum prices for trading shall have been fixed, or maximum ranges for prices for securities shall be required, on the New York Stock Exchange, the American Stock Exchange, or in the over-the-counter market, by such Exchange or by Nasdaq or by order of the SEC or any other governmental authority having jurisdiction, (v) a banking moratorium shall have been declared by federal, New York, or Minnesota authorities, (vi) there shall have been such a serious, unusual and material change in general economic, monetary, political or financial conditions, or the effect of international conditions on the financial markets in the United States shall be such as, in the judgment of the Underwriter, makes it inadvisable to proceed with the delivery of the Units, (vii) the enactment, publication, decree or other promulgation of any federal or state statute, regulation, rule or order of any court or other governmental authority which, in the judgment of the Underwriter, materially and adversely affects or will materially and adversely affect the business or operations of the Company, or (viii) there shall be a material outbreak of hostilities or material escalation and deterioration in the political and military situation between the United States and any foreign power, or a formal declaration of war by the United States of America shall have occurred. Any such termination shall be without liability of any party to any other party, except as provided in Sections 7 and 8 hereof; provided, however, that the Company shall remain obligated to pay costs and expenses to the extent provided in Section 4 hereof. (c) If the Underwriter elects to prevent this Agreement from becoming effective or to terminate this Agreement as provided in this Section 9, it shall notify the Company and the Company's counsel promptly by telegram or telephone, confirmed by letter sent to the address specified in Section 11 hereof. If the Company shall elect to prevent this Agreement from becoming effective, it shall notify the Underwriter promptly by telegram or telephone, confirmed by letter sent to the addresses specified in Section 11 hereof. 10. SURVIVAL OF INDEMNITIES, CONTRIBUTION AGREEMENTS, WARRANTIES AND REPRESENTATIONS. The respective indemnity and contribution agreements of the Company and the Underwriter contained in Sections 7 and 8, the representations and warranties of the Company set forth in Section 1 hereof, and the covenants and agreements of -24- the Company set forth in Section 3 hereof, shall remain operative and in full force and effect, regardless of any investigation made by, or on behalf of, the Underwriter, the Company, any of its officers and directors, or any controlling person referred to in Sections 7 and 8, and shall survive the delivery of and payment for the Units. The aforesaid indemnity and contribution agreements shall also survive any termination or cancellation of this Agreement. Any successor of any party or of any such controlling person, or any legal representative of such controlling person, as the case may be, shall be entitled to the benefit of the respective indemnity and contribution agreements. 11. NOTICES. All notices or communications hereunder, except as herein otherwise specifically provided, shall be in writing and shall be mailed, delivered or telegraphed, and confirmed, as follows: If to the Underwriter, to: Equity Securities Investments, Inc. 2820 IDS Center 80 South Eighth Street Minneapolis, Minnesota 55402 Attention: Mr. Nathan Newman with a copy to: Winthrop & Weinstine, P.A. 3000 Dain Bosworth Plaza 60 South Sixth Street Minneapolis, Minnesota 55402 Attention: Michele D. Vaillancourt, Esq. If to the Company, to: ChoiceTel Communications, Inc. 9724 10th Avenue North Plymouth, MN 55441 Attention: Mr. Jack S. Kohler with a copy to: Robins, Kaplan, Miller & Ciresi L.L.P. 2800 LaSalle Plaza 800 LaSalle Avenue Minneapolis, Minnesota 55402 Attention: Robert T. Montague, Esq. 12. INFORMATION FURNISHED BY THE UNDERWRITER. The statements relating to the stabilization activities of the Underwriter and the statements under the caption "Underwriting" in any Preliminary Prospectus and in the Prospectus constitute the written information furnished by, or on behalf of, the Underwriter specifically for use with reference to the Underwriter referred to in Section 1(a)(ii) and Sections 7(a) and 7(b) hereof. 13. SUCCESSORS AND ASSIGNS. This Agreement shall inure to the benefit of and be binding upon the Underwriter and the Company and their respective successors and assigns, and the officers, directors and controlling persons referred to in Sections 7 and 8. Nothing expressed in this Agreement is intended or shall be construed to give any person or corporation, other than the parties hereto, their respective successors and assigns, and the controlling persons, officers and directors referred to in Sections 7 and 8 any legal or equitable right, remedy or claim under, or in respect of, this Agreement or any provision herein contained, this Agreement and all conditions and provisions hereof being intended to be and being for the sole and exclusive benefit of the parties hereto and their respective executors, administrators, successors, assigns and such controlling persons, officers and directors, and for the benefit of no other person or corporation. No purchaser of any Units from the Underwriter shall be construed a successor or assign merely by reason of such purchase. -25- 14. GOVERNING LAW. This Agreement shall be construed and enforced in accordance with the laws of the State of Minnesota. If the foregoing is in accordance with your understanding of our agreement, please sign and return to us the enclosed counterpart of this Agreement, whereupon it will become a binding agreement between the Company and the Underwriter in accordance with its terms. Very truly yours, CHOICETEL COMMUNICATIONS, INC. By -------------------------------------- Signature -------------------------------------- Name Typed or Printed Its ----------------------------------- Title Typed or Printed ACCEPTANCE The foregoing Underwriting Agreement is hereby confirmed and accepted by us as of the date first above written. Equity Securities Investments, Inc. By ------------------------------------- Signature ------------------------------------- Name Type or Printed Its ---------------------------------- Title Typed or Printed -26- APPENDIX A-1 TWO-YEAR LOCK-UP AGREEMENT Equity Securities Investments, Inc. 2800 IDS Center 80 South 8th Street Minneapolis, MN 55402 Re: ChoiceTel Communications, Inc. Ladies and Gentlemen: The undersigned, a beneficial owner of common stock, $.01 par value per share (the "Common Stock"), of ChoiceTel Communications, Inc. (the "Company"), understands and acknowledges that the Company is intending to file or has filed with the Securities and Exchange Commission a Registration Statement on Form SB-2 (the "Registration Statement") for the registration of the offer and sale of units (the "Units"), each Unit consisting of one share of Common Stock of the Company and a redeemable warrant to purchase one share of Common Stock, including units subject to the over-allotment option described in the Registration Statement (collectively, the "Units"). The undersigned further understands that the Company, as issuer, and Equity Securities Investments, Inc., as the underwriter (the "Underwriter") to be named in that certain proposed underwriting agreement expected to be entered into in connection with the public offering of the Units by the Underwriter (the "Underwriting Agreement"), contemplate entering into such Underwriting Agreement. In order to induce the Underwriter to proceed with the public offering, the undersigned agrees, for the benefit of the Company and the Underwriter, that should such public offering be effectuated, the undersigned will not, without the prior written consent of the Underwriter, during the two years commencing on the effective date of the Registration Statement ("Effective Date"): (i) offer to sell, contract to sell, pledge, hypothecate, transfer or otherwise dispose of, grant any rights with respect to (collectively, a "Disposition"), any shares of Common Stock of the Company, and options, warrants or other rights to purchase any shares of Common Stock or any securities convertible into or exchangeable or exercisable for shares of Common Stock (collectively, "Securities") now owned or hereafter acquired by the undersigned or with respect to which the undersigned has or hereafter acquires the power of Disposition; or (ii) effect any Disposition of any Securities other than by gifts to donees who agree in writing to be bound by the same restrictions, or by will or the laws of descent and distribution; in which case the Securities also will be subject to the same restriction. Notwithstanding the foregoing, the Underwriter hereby agrees to release from this Lock-up Agreement ten percent (10%) of the Securities beneficially owned by the undersigned one (1) year following the Effective Date. The undersigned hereby agrees to the entry of stop transfer instructions with the Company's transfer agent against the transfer of the Securities except in compliance with this Agreement. The undersigned hereby further agrees that during the two years commencing on the Effective Date, the undersigned will effect all sales of Securities only through the Underwriter. Dated: ________________, 1997 Very truly yours, ___________________________________ Signature ___________________________________ Name Typed or Printed A-1 APPENDIX A-2 SIX-MONTH LOCK-UP AGREEMENT Equity Securities Investments, Inc. 2800 IDS Center 80 South 8th Street Minneapolis, MN 55402 Re: ChoiceTel Communications, Inc. Ladies and Gentlemen: The undersigned, a beneficial owner of common stock, $.01 par value per share (the "Common Stock"), of ChoiceTel Communications, Inc. (the "Company"), understands and acknowledges that the Company is intending to file or has filed with the Securities and Exchange Commission a Registration Statement on Form SB-2 (the "Registration Statement") for the registration of the offer and sale of units (the "Units"), each Unit consisting of one share of Common Stock of the Company and a redeemable warrant to purchase one share of Common Stock, including Units subject to the over-allotment option described in the Registration Statement (collectively, the "Units"). The undersigned further understands that the Company, as issuer, and Equity Securities Investments, Inc., as the underwriter (the "Underwriter") to be named in that certain proposed underwriting agreement expected to be entered into in connection with the public offering of the Units by the Underwriter (the "Underwriting Agreement"), contemplate entering into such Underwriting Agreement. In order to induce the Underwriter to proceed with the public offering, the undersigned agrees, for the benefit of the Company and the Underwriter, that should such public offering be effectuated, the undersigned will not, without the prior written consent of the Underwriter, for six months commencing on the effective date of the Registration Statement ("Effective Date"): (i) offer to sell, contract to sell, pledge, hypothecate, transfer or otherwise dispose of, grant any rights with respect to (collectively, a "Disposition"), any shares of Common Stock of the Company, and options, warrants or other rights to purchase any shares of Common Stock or any securities convertible into or exchangeable or exercisable for shares of Common Stock (collectively, "Securities") now owned or hereafter acquired by the undersigned or with respect to which the undersigned has or hereafter acquires the power of Disposition; or (ii) effect any Disposition of any Securities other than by gifts to donees who agree in writing to be bound by the same restrictions, or by will or the laws of descent and distribution; in which case the Securities also will be subject to the same restriction. The undersigned hereby agrees to the entry of stop transfer instructions with the Company's transfer agent against the transfer of the Securities except in compliance with this Agreement. The undersigned hereby further agrees that during the two years commencing on the Effective Date, the undersigned will effect all sales of Securities only through the Underwriter. Dated: ________________, 1997 Very truly yours, _________________________________ Signature _________________________________ Name Typed or Printed A-2 APPENDIX B FORM OF WARRANT TO PURCHASE 80,000 UNITS (EACH UNIT CONSISTING OF ONE SHARE OF COMMON STOCK AND ONE REDEEMABLE COMMON STOCK PURCHASE WARRANT) CHOICETEL COMMUNICATIONS, INC. NO. ______ 80,000 UNITS FOR GOOD AND VALUABLE CONSIDERATION, ChoiceTel Communications, Inc., a Minnesota corporation (the "Company"), hereby certifies that Equity Securities Investments, Inc., Minneapolis, Minnesota (the "Underwriter"), or its registered assigns, is entitled to subscribe for and purchase from the Company at any time or from time to time after ONE YEAR FROM EFFECTIVE DATE, to and including [FIVE YEARS FROM EFFECTIVE DATE] Eighty Thousand (80,000) Units (the "Units"), each Unit consisting of one share of the Company's Common Stock and one redeemable Common Stock purchase warrant of the Company. The per Unit exercise price of this Warrant is $___ (the "Warrant Exercise Price"), subject to adjustment as provided herein. This Warrant is one of the Underwriter's Warrants referred to in the Underwriting Agreement dated_____________, 1997 by and between the Company and the Underwriter (the "Offering") entered into in connection with the offering by the Company of 800,000 Units (the "Units"), plus an additional 120,000 Units solely to cover over-allotments. As used herein, (i) this Warrant and all warrants hereafter issued in exchange or substitution for this Warrant are referred to as the "Warrants;" (ii) the Units which may be acquired upon exercise of the Warrants are referred to herein as the "Warrant Units;" (iii) the term "Holder" means the Underwriter, any party who acquires all or a part of this Warrant as a registered transferee of the Underwriter, or any record holder or holders of the Warrant Units issued upon exercise, whether in whole or in part, of the Warrant; (iv) the term "Common Stock" means and includes the Company's presently authorized common stock, par value $.01 per share, together with any other equity securities which may be issued by the Company with respect thereto or in substitution therefor; (v) the term "Redeemable Warrants" means the redeemable common stock purchase warrants subject to the Warrant Agreement dated __________, 1997 between the Company and Norwest Bank Minnesota, National Association, as warrant agent (the "Warrant Agent"), each Redeemable Warrant representing the right to purchase at any time on or before _______, 2002 one share of Common Stock at a price of $9.50 per share, subject to adjustment as provided in said Warrant Agreement; and (vi) the term "Convertible Securities" means any stock or other securities convertible into, or exchangeable for, Common Stock. This Warrant is subject to the following provisions, terms and conditions, to which each Holder hereof consents and agrees: 1. EXERCISE; TRANSFERABILITY. (a) The rights represented by this Warrant may be exercised by the Holder hereof, in whole or in part (but not as to a fractional Unit) by written notice of exercise (in the form attached hereto) delivered to the Company at the principal office of the Company prior to the expiration of this Warrant and accompanied or preceded by the surrender of this Warrant along with a check in payment of the Warrant Exercise Price for such Units. B-1 (b) If the Company has redeemed the Redeemable Warrants prior to the date upon which this Warrant first becomes exercisable, the Holder may, for a period of thirty (30) days beginning on the date on which this Warrant first becomes exercisable, exercise the Redeemable Warrants included in the Warrant Units. (c) This Warrant may not be sold, assigned, hypothecated, or otherwise transferred for a period of one year from the effective date of the Offering (other than by will, pursuant to the operation of law, or where directed by a court of competent jurisdiction upon the dissolution or liquidation of a corporate Holder hereof), except to (i) a person who is both an officer and a shareholder of the Underwriter, (ii) a successor in interest to the business of the Underwriter, (iii) a person who is an officer and a shareholder of a successor, or (iv) a person who is an employee of the Underwriter or a successor, but only if such employee is also an officer of the Underwriter or successor; such transfer to be by endorsement (by the Holder hereof executing the form of assignment attached hereto) and delivery in the same manner as in the case of a negotiable instrument transferable by endorsement and delivery. Further, this Warrant may not be sold, transferred, assigned, hypothecated or divided into two or more Warrants of smaller denominations, nor may any shares of Common Stock or Redeemable Warrants issued pursuant to exercise of this Warrant or shares of Common Stock issued pursuant to exercise of the Redeemable Warrants be transferred, except as provided in Section 7 hereof. 2. EXCHANGE AND REPLACEMENT. Subject to Sections 1 and 7 hereof, this Warrant is exchangeable upon the surrender hereof by the Holder to the Company at its office for new Warrants of like tenor and date representing in the aggregate the right to purchase the number of Warrant Units purchasable hereunder, each of such new Warrants to represent the right to purchase such number of Warrant Units (not to exceed the aggregate total number purchasable hereunder) as shall be designated by the Holder at the time of such surrender. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction, or mutilation of this Warrant, and, in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it, and upon surrender and cancellation of this Warrant, if mutilated, the Company will make and deliver a new Warrant of like tenor, in lieu of this Warrant; provided, however, that if the Underwriter shall be such Holder, an agreement of indemnity by such Holder shall be sufficient for all purposes of this Section 2. This Warrant shall be promptly canceled by the Company upon the surrender hereof in connection with any exchange or replacement. The Company shall pay all expenses, taxes (other than stock transfer taxes), and other charges payable in connection with the preparation, execution, and delivery of Warrants pursuant to this Section 2. 3. ISSUANCE OF THE WARRANT UNITS. (a) The Company agrees that the shares of Common Stock and the Redeemable Warrants comprising the Warrant Units purchased upon exercise of this Warrant shall be and are deemed to be issued to the Holder as of the close of business on the date on which this Warrant shall have been surrendered and the payment made for such Warrant Units as aforesaid. Subject to the provisions of Section 3(b), certificates for the shares of Common Stock and the Redeemable Warrants comprising the Warrant Units so purchased shall be delivered to the Holder within a reasonable time, not exceeding fifteen (15) days after the rights represented by this Warrant shall have been so exercised, and, unless this Warrant has expired, a new Warrant representing the right to purchase the number of Warrant Units, if any, with respect to which this Warrant shall not then have been exercised shall also be delivered to the Holder within such time. (b) Notwithstanding the foregoing, the Company shall not be required to deliver any shares of Common Stock or the Redeemable Warrants comprising the Warrant Units upon exercise of this Warrant except in accordance with exemptions from the applicable securities registration requirements or registrations under applicable securities laws. Nothing herein, however, shall obligate the Company to effect registrations under federal or state securities laws, except as provided in Section 9. If registrations are not in effect and if exemptions are not available when the Holder seeks to exercise the Warrant, the Warrant exercise period will be extended, if need be, to prevent the Warrant from expiring, until such time as either registrations become effective or exemptions are available, and the Warrant shall then remain exercisable for a period of at least thirty (30) calendar days from the date the Company delivers to the Holder written notice of the availability of such registrations or exemptions. The Holder agrees to execute such documents and make such representations, warranties, and agreements as may be reasonably required solely to comply with the exemptions relied upon by the Company, or B-2 the registrations made, for the issuance of the shares of Common Stock and the Redeemable Warrants comprising the Warrant Units. 4. COVENANTS OF THE COMPANY. The Company covenants and agrees that (a) all shares of Common Stock included in the Warrant Units will, upon issuance, be duly authorized and issued, fully paid, non-assessable and free from all taxes, liens and charges with respect to the issue thereof; (b) all Redeemable Warrants included in the Warrant Units, when authenticated by the Warrant Agent and issued, delivered and sold in accordance with this Warrant and the Warrant Agreement between the Company and the Warrant Agent, will be duly and validly executed, authenticated, issued and delivered and will constitute valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited by the application of bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the rights of creditors generally and by judicial limitations on the right of specific performance; and (c) all shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units will, upon issuance, be duly authorized and issued, fully paid, non-assessable and free from all taxes, liens and charges with respect to the issue thereof. The Company further covenants and agrees that during the period within which the rights represented by this Warrant may be exercised, the Company will at all times have authorized and reserved for the purpose of issue or transfer upon exercise of the subscription rights evidenced by this Warrant a sufficient number of shares of Common Stock and Redeemable Warrants to provide for the exercise of the rights represented by this Warrant. 5. ANTI-DILUTION ADJUSTMENTS. The provisions of this Warrant are subject to adjustment as provided in this Section 5. (a) The Warrant Exercise Price shall be adjusted from time to time such that in case the Company shall hereafter: (i) pay any dividends on any class of stock of the Company payable in Common Stock or securities convertible into Common Stock; (ii) subdivide its then outstanding shares of Common Stock into a greater number of shares; or (iii) combine outstanding shares of Common Stock, by reclassification or otherwise; then, in any such event, the Warrant Exercise Price in effect immediately prior to such event shall (until adjusted again pursuant hereto) be adjusted immediately after such event to a price (calculated to the nearest full cent) determined by dividing (A) the number of shares of Common Stock outstanding immediately prior to such event, multiplied by the then existing Warrant Exercise Price, by (B) the total number of shares of Common Stock outstanding immediately after such event (including in each case the maximum number of shares of Common Stock issuable in respect of any securities convertible into Common Stock), and the resulting quotient shall be the adjusted Warrant Exercise Price per share. An adjustment made pursuant to this subsection shall become effective immediately after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination, reclassification or other event. If, as a result of an adjustment made pursuant to this subsection, the Holder of any Warrant thereafter surrendered for exercise shall become entitled to receive shares of two or more classes of capital stock or shares of Common Stock and other capital stock of the Company, the Board of Directors (whose determination shall be conclusive) shall determine the allocation of the adjusted Warrant Exercise Price between or among shares of such classes of capital stock or shares of Common Stock and other capital stock. All calculations under this subsection shall be made to the nearest cent or to the nearest 1/100 of a share, as the case may be. In the event that at any time, as a result of an adjustment made pursuant to this subsection, the holder of any Warrant thereafter surrendered for exercise shall become entitled to receive any shares of the Company other than shares of Common Stock, thereafter the Warrant Exercise Price of such other shares so receivable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to Common Stock contained in this subsection. B-3 (b) If the Company shall distribute to all holders of Common Stock (including any such distribution made to the shareholders of the Company in connection with a consolidation or merger in which the Company is the continuing corporation) evidences of its indebtedness, cash (other than any cash dividend which, together with any cash dividends paid within the 12 months prior to the record date for such distribution, does not exceed 5% of the "Current Market Price" (as hereinafter defined) at the record date for such distribution) or assets (other than dividends payable in shares of its capital stock), or rights, options, or warrants to subscribe for or purchase Common Stock or securities convertible into or exchangeable for shares of Common Stock, then, in each such case, the Warrant Exercise Price shall be adjusted by multiplying the Warrant Exercise Price in effect immediately prior to the record date for the determination of shareholders entitled to receive such distribution by a fraction, the numerator of which shall be the Current Market Price per share of Common Stock on such record date, less the fair market value (as determined in good faith by the Company's Board of Directors, whose determination shall be conclusive, absent manifest error) of the portion of the evidences of indebtedness or assets so to be distributed, or of such rights, options, or warrants or convertible or exchangeable securities, or the amount of such cash, applicable to one share, and the denominator of which shall be such Current Market Price per share of Common Stock. Such adjustment shall be made whenever any such distribution is made, and shall become effective on the record date for the determination of shareholders entitled to receive such distribution. (c) For the purpose of any computation under this Warrant, the "Current Market Price" per share of Common Stock on any date shall be the average of the daily closing prices for the 30 consecutive trading days immediately preceding the date in question. The closing price for each day shall be the last reported sales price regular way or, in case no such reported sale takes place on such day, the closing bid price regular way, in either case on the principal national securities exchange (including, for purposes hereof, The Nasdaq National Market and The Nasdaq SmallCap Market) on which the Common Stock is listed or admitted to trading or, if the Common Stock is not listed or admitted to trading on any national securities exchange, the highest reported bid price for the Common Stock as furnished by the National Association of Securities Dealers, Inc. through Nasdaq or a similar organization if Nasdaq is no longer reporting such information. If, on any such date, the Common Stock is not listed or admitted to trading on any national securities exchange and is not quoted by Nasdaq or any similar organization, the fair value of a share of Common Stock on such date, as determined in good faith by the Company's Board of Directors, whose determination shall be conclusive, absent manifest error, shall be used. (d) No adjustment in the Warrant Exercise Price shall be required if such adjustment is less than $.05; provided, however, that any adjustments which by reason of this Section 5 are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 5 shall be made to the nearest cent or to the nearest whole share, as the case may be. (e) In any case in which this Section 5 shall require that an adjustment in the Warrant Exercise Price may be made effective as of a record date for a specified event, the Company may elect to defer, until the occurrence of such event, issuing to the Holder, if the Holder exercised or converted this Warrant after such record date, the shares of Common Stock, if any, issuable upon such exercise or conversion over and above the shares of Common Stock, if any, issuable upon such exercise or conversion on the basis of the Warrant Exercise Price in effect prior to such adjustment; provided, however, that the Company shall deliver to the Holder a due bill or other appropriate instrument evidencing the Holder's right to receive such additional shares upon the occurrence of the event requiring such adjustment. (f) Upon each adjustment of the Warrant Exercise Price pursuant to Section 5(a) above, the Holder of each Warrant shall thereafter (until another such adjustment) be entitled to purchase at the adjusted Warrant Exercise Price the number of Warrant Units, calculated to the nearest full Unit, obtained by multiplying the number of Units specified in such Warrant (as adjusted as a result of all adjustments in the Warrant Exercise Price in effect prior to such adjustment) by the Warrant Exercise Price in effect prior to such adjustment and dividing the product so obtained by the adjusted Warrant Exercise Price. (g) In case of any consolidation or merger to which the Company is a party other than a merger or consolidation in which the Company is the continuing corporation, or in case of any sale or conveyance B-4 to another corporation of the property of the Company as an entirety or substantially as an entirety, or in the case of any statutory exchange of securities with another corporation (including any exchange effected in connection with a merger of a third corporation into the Company), there shall be no adjustment under Subsection (a) of this Section above but the Holder of each Warrant then outstanding shall have the right thereafter to convert such Warrant into the kind and amount of shares of stock and other securities and property which he would have owned or have been entitled to receive immediately after such consolidation, merger, statutory exchange, sale, or conveyance had such Warrant been converted immediately prior to the effective date of such consolidation, merger, statutory exchange, sale, or conveyance and in any such case, if necessary, appropriate adjustment shall be made in the application of the provisions set forth in this subsection with respect to the rights and interests thereafter of any Holders of the Warrant, to the end that the provisions set forth in this subsection shall thereafter correspondingly be made applicable, as nearly as may reasonably be, in relation to any shares of stock and other securities and property thereafter deliverable on the exercise of the Warrant. The provisions of this subsection shall similarly apply to successive consolidations, mergers, statutory exchanges, sales or conveyances. (h) Upon any adjustment of the Warrant Exercise Price, then and in each such case, the Company shall (i) give written notice thereof, by first-class mail, postage prepaid, within ten (10) calendar days after the date when the circumstances giving rise to the adjustment occurred, addressed to the Holder as shown on the books of the Company, which notice shall state the Warrant Exercise Price resulting from such adjustment and the increase or decrease, if any, in the number of Units purchasable at such price upon the exercise of this Warrant, setting forth in reasonable detail the method of calculation and the facts upon which such calculation is based; and (ii) prepare and retain on file a statement describing in reasonable detail the method used in arriving at the new Warrant Exercise Price. 6. NO VOTING RIGHTS. This Warrant shall not entitle the Holder to any voting rights or other rights as a shareholder of the Company. 7. NOTICE OF TRANSFER OF WARRANT OR RESALE OF THE SHARES OF COMMON STOCK OR REDEEMABLE WARRANTS. (a) Subject to the sale, assignment, hypothecation, or other transfer restrictions set forth in Section 1 hereof, the Holder, by acceptance hereof, agrees to give written notice to the Company before transferring this Warrant, or any shares of Common Stock or Redeemable Warrants comprising the Warrant Units, or any shares of Common Stock issuable upon the exercise of the Redeemable Warrants included in the Warrant Units, of such Holder's intention to do so, describing briefly the manner of any proposed transfer. Promptly upon receiving such written notice, the Company shall present copies thereof to the Company's counsel and to counsel to the original purchaser of this Warrant. If, in the opinion of each such counsel, the proposed transfer may be effected without registration or qualification (under any federal or state securities laws), the Company, as promptly as practicable, shall notify the Holder of such opinion, whereupon the Holder shall be entitled to transfer this Warrant or to dispose of shares of Common Stock and Redeemable Warrants comprising the Warrant Units received upon the previous exercise of this Warrant or shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units, all in accordance with the terms of the notice delivered by the Holder to the Company; provided that an appropriate legend may be endorsed on this Warrant or the certificates for such shares of Common Stock or Redeemable Warrants comprising the Warrant Units or shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units, describing restrictions upon transfer thereof necessary or advisable in the opinion of counsel and satisfactory to the Company to prevent further transfers which would be in violation of Section 5 of the Securities Act of 1933, as amended (the "Securities Act"), and applicable state securities laws; and provided further that the prospective transferee or purchaser shall execute such documents and make such representations, warranties, and agreements as may be required solely to comply with the exemptions relied upon by the Company for the transfer or disposition of the Warrant or shares of Common Stock or Redeemable Warrants comprising the Warrant Units or shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units. (b) If, in the opinion of either of the counsel referred to in this Section 7, the proposed transfer or disposition of this Warrant or of such shares of Common Stock or Redeemable Warrants comprising the B-5 Warrant Units, or of shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units, described in the written notice given pursuant to this Section 7 may not be effected without registration or qualification of this Warrant, or such shares of Common Stock or Redeemable Warrants comprising the Warrant Units or the shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units, the Company shall promptly give written notice thereof to the Holder, and the Holder will limit its activities in respect to such transfer or disposition as, in the opinion of both such counsel, are permitted by law. (c) Until this Warrant is duly transferred on the books of the Company, the Company shall treat the registered Holder of this Warrant as absolute owner hereof for all purposes without being affected by any notice to the Company. 8. FRACTIONAL UNITS. Fractional Units shall not be issued upon the exercise of this Warrant, but in any case where the holder would, except for the provisions of this Section, be entitled under the terms hereof to receive a fractional Unit, the Company shall, upon the exercise of this Warrant for the largest number of whole Units then called for, pay a sum in cash equal to the sum of (a) the excess, if any, of the "Fair Market Value" (as defined in Section 10(d) hereof) of such fractional Unit over the proportional part of the Warrant Exercise Price represented by such fractional Unit, plus (b) the proportional part of the Warrant Exercise Price represented by such fractional Unit. 9. REGISTRATION RIGHTS. (a) The Company agrees that, if at any time (but on a one-time basis only) during the period commencing [ONE YEAR FROM EFFECTIVE DATE] and ending [FIVE YEARS FROM EFFECTIVE DATE], the Holder of this Warrant and/or the Holders of any other Warrants and/or shares of Common Stock included in the Warrant Units, Redeemable Warrants included in the Warrant Units, and shares of Common Stock issuable upon exercise of the Redeemable Warrants included in the Warrant Units (collectively ""Registrable Securities'') who collectively shall hold not less than 50% of the Warrants and/or Registrable Securities outstanding at such time and not previously sold pursuant to this Section 9 shall request that the Company file a registration statement covering all or any part of the Registrable Securities: (i) the Company will promptly notify the Holder and all other registered Holders, if any, of other Warrants and of Registrable Securities that such registration statement will be filed and that Registrable Securities which are then held and/or which may be acquired upon the exercise of the Warrants by the Holder and such other Holders will be included in such registration statement at the Holder's and such Holders' request; and (ii) the Company will cause such registration statement to include all Registrable Securities which it has been so requested to include, will take all necessary steps to register or qualify such Registrable Securities under the Securities Act and the securities laws of such states as the Holders may reasonably request, and will use its best efforts to cause such registration statement and qualifications to become effective as soon as practicable; provided, however, that the Company shall not be required to register any Registrable Securities that are eligible for resale under Rule 144(k) promulgated under the Securities Act. The Company shall keep effective and maintain any registration, qualification, notification, or approval specified in this Section 9(a) for such period as may be reasonably necessary for such Holder or Holders of such Registrable Securities to dispose thereof and from time to time shall amend or supplement the prospectus used in connection therewith to the extent necessary in order to comply with applicable law; provided, however, that the Company need not maintain the effectiveness of any such registration, qualification, notification or approval, whether or not at the request of the Holders, more than nine (9) months following the effective date thereof. With regard to and notwithstanding this Section 9(a), the Company may delay filing a registration statement for a reasonable period of time, and may withhold efforts to cause the registration statement to become effective for a reasonable period of time, if the Company determines in good faith that such registration might interfere with or B-6 affect the negotiation or completion of any transaction that is being contemplated by the Company (whether or not a final decision has been made to undertake such transaction) at the time the right to delay is exercised, or involve initial or continuing disclosure obligations that might not be in the best interest of the Company's shareholders. (b) The Company agrees that, if at any time and from time to time during the period commencing [ONE YEAR FROM EFFECTIVE DATE] and ending two (2) years after complete exercise of this Warrant (but not later than [SEVEN YEARS AFTER THE EFFECTIVE DATE]), the Company proposes to file a registration statement under the Securities Act (other than a Form S-4 or Form S-8 Registration Statement or any successor or replacement forms thereto) with respect to, or qualify for a public distribution under Section 3(b) of the Securities Act, any of its securities in connection with the proposed offer of such securities by the Company or any of its shareholders: (i) the Company will promptly notify the Holder and all other registered Holders, if any, of other Warrants, and of Registrable Securities, at least thirty (30) days prior to each such filing, that it intends to file such registration statement or effect such qualification, and that the Registrable Securities which are then held and/or which may be acquired upon the exercise of the Warrants by the Holder and such other Holders will be included in such registration statement or qualification at the Holder's and such Holders' request; and (ii) the Company will use its best efforts to cause such registration statement or qualification to include all Registrable Securities which it has been so requested to include; provided, however, that if a greater number of Registrable Securities is offered for participation in the proposed offering than in the reasonable opinion of the managing underwriter of the proposed offering can be accommodated without adversely affecting the proposed offering, then the amount of Registrable Securities proposed to be offered by such Holders for registration, as well as the number of securities of any other selling shareholders participating in the registration (other than selling shareholders participating in the registration as holders of demand registration rights granted to them by the Company), shall be excluded or proportionately reduced to a number deemed satisfactory by the managing underwriter. The Holder and such other Holders may request that their Registrable Securities be included in such registration statement or qualification by making written request to the Company specifying the number of shares of Common Stock and/or Redeemable Warrants to be so included. Such request shall be made within twenty (20) days after receipt from the Company of notice of such intended registration or qualification. (c) With respect to each inclusion of securities in a registration or qualification pursuant to this Section 9, the Company shall bear all fees, costs, and expenses thereof, including, without limitation, all filing fees, fees imposed by the National Association of Securities Dealers, Inc., printing expenses, fees and disbursements of counsel and accountants for the Company, fees and disbursements of counsel for the underwriter or Underwriter of such securities (if the Company is required to bear such fees and disbursements), all internal expenses, the premiums and other costs of policies of insurance against liability arising out of the public offering, and legal fees and disbursements and other expenses of complying with state securities laws of any jurisdictions in which the securities to be offered are to be registered or qualified. Fees and disbursements of special counsel and accountants for the selling Holders, underwriting discounts and commissions, and transfer taxes for selling Holders shall be borne by the selling Holders. (d) The Company will furnish the Holders whose Registrable Securities are included in a registration or qualification pursuant to this Section 9 with a reasonable number of copies of any prospectus and/or other offering materials included in such filings and will amend or supplement the same as required during the period of required use thereof. In connection with any registration filed or qualification made pursuant to this Section 9 in which Registrable Securities are included, and to the extent permissible under the Securities Act and controlling precedent thereunder, the Company and each Holder whose Registrable Securities are so included in such registration or qualification shall provide cross-indemnification agreements to each other in customary scope covering the accuracy and completeness of the information furnished by each in connection therewith. B-7 (e) Each Holder of Registrable Securities included in a registration or qualification pursuant to this Section 9 agrees to cooperate with the Company in the preparation and filing of any such registration statement or other offering materials and in the furnishing of information concerning the Holder for inclusion therein, or in any efforts by the Company to establish that the proposed sale is exempt under the Securities Act as to any proposed distribution. (f) If, after any registration statement filed as required under either (a) or (b) of this Section 9 becomes effective, the Company advises Holder that the Company considers it appropriate for the registration statement to be amended, the Company shall use its commercially reasonable efforts to amend such registration statement as soon as practicable and the holders of such shares shall suspend any further sales of their registered shares until the Company advises them that the registration statement has been so amended. 10. RIGHT TO CONVERT. (a) The Holder of this Warrant shall have the right (but not the obligation) to require the Company to convert this Warrant (the "Conversion Right"), at any time after one year from the date of this Warrant and prior to its expiration, into Warrant Units as provided for in this Section 10. Upon exercise of the Conversion Right by the Holder, the Company shall deliver to the Holder (without payment by the Holder of any exercise price) that number of Warrant Units equal to the quotient obtained by dividing (i) the value of the Warrant at the time the Conversion Right is exercised (determined by subtracting the aggregate Warrant Exercise Price for the Warrant Units in effect immediately prior to the exercise of the Conversion Right from the aggregate "Fair Market Value" (as determined below) for the Warrant Units immediately prior to the exercise of the Conversion Right) by (ii) the Fair Market Value of one Unit immediately prior to the exercise of the Conversion Right. (b) The Conversion Right may be exercised by the Holder, at any time or from time to time, prior to its expiration, on any business day, by delivering a written notice (the "Conversion Notice") to the Company at the offices of the Company exercising the Conversion Right and specifying (i) the total number of Units the Holder will purchase pursuant to such conversion, and (ii) a place, and a date not less than five (5) nor more than twenty (20) business days from the date of the Conversion Notice, for the closing of such purchase. (c) At any closing under Section 10(b) hereof, (i) the Holder will surrender the Warrant, (ii) the Company will deliver or cause to be delivered to the Holder a certificate or certificates for the number of shares of Common Stock and Redeemable Warrants comprising the Warrant Units issuable upon such conversion, together with cash, in lieu of any fraction of a Unit, and (iii) the Company will deliver to the Holder a new Warrant representing the number of Units, if any, with respect to which the Warrant shall not have been converted. (d) "Fair Market Value" of a Unit as of a particular date (the "Determination Date") shall mean the aggregate Fair Market Value of the share of Common Stock and the Redeemable Warrant comprising that Unit as of the Determination Date. "Fair Market Value" of a share of Common Stock or of the Redeemable Warrants as of the Determination Date shall mean: (i) If the Company's Common Stock and Redeemable Warrants are traded on an exchange or are quoted on The Nasdaq National Market or The Nasdaq SmallCap Market, then the average closing or last sale prices, respectively, reported for the ten (10) business days immediately preceding the Determination Date. (ii) If the Company's Common Stock and Redeemable Warrants are not traded on an exchange or on The Nasdaq National Market or The Nasdaq SmallCap Market but are traded in the over-the-counter market, then the average of the closing bid and asked prices as reported by Metro Data Company, Inc. (or a similar organization) from quotations by market makers in such Common Stock or Redeemable Warrants on the Minneapolis-St. Paul local over-the-counter market for the ten (10) business days immediately preceding the Determination Date. B-8 11. MISCELLANEOUS. The Company shall not, by amendment of its articles of incorporation or through reorganization, consolidation, merger, dissolution or sale of assets, or by any other voluntary act or deed, avoid or seek to avoid the observance or performance of any of the covenants, stipulations or conditions to be observed or performed hereunder by the Company, but will, at all times in good faith, assist, insofar as it is able, in the carrying out of all provisions hereof and in the taking of all other action which may be necessary in order to protect the rights of Holders against dilution. Upon written request of the Holder of this Warrant, the Company will promptly provide such Holder with a then current written list of the names and addresses of all Holders of warrants originally issued under the terms of, and concurrent with, this Warrant. The representations, warranties and agreements herein contained shall survive the exercise of this Warrant. This Warrant shall be interpreted under the laws of the State of Minnesota. IN WITNESS WHEREOF, ChoiceTel Communications, Inc. has caused this Warrant to be signed by its duly authorized officer and to be dated ______________, 1997. CHOICETEL COMMUNICATIONS, INC. By ----------------------------- Signature ----------------------------- Name Typed or Printed Its ---------------------------- Title Typed or Printed B-9 NOTICE OF EXERCISE OF WARRANT (To be signed upon the exercise of the Warrant for cash or by check) The undersigned hereby irrevocably elects to exercise the attached Warrant and to purchase thereunder, for cash, ______________ of the Units of ChoiceTel Communications, Inc. issuable upon the exercise of such Warrant, herewith makes payment of $___________ therefor in cash or by check, and requests that certificates for the shares of Common Stock and Redeemable Warrants comprising such Units (together with a new Warrant to purchase the number of Units, if any, with respect to which this Warrant is not exercised) be issued in the name set forth below and be delivered to the address set forth below. Dated: ------------------------- ------------------------------------------ (Signature) ------------------------------------------ (Name Typed or Printed) ------------------------------------------ (Address) ------------------------------------------ (Social Security or Tax Ident. No.) * The signature on the Notice of Exercise of Warrant must exactly correspond to the name as written upon the face of the Warrant in every particular without alteration or any change whatsoever. When signing on behalf of a corporation, partnership, trust or other entity, PLEASE indicate your position(s) and title(s) with such entity. NOTICE OF WARRANT CONVERSION (To be signed only upon conversion of warrant) The undersigned hereby irrevocably elects to exercise the conversion right provided in Section 10 of the attached Warrant and to purchase thereunder _______ Units of ChoiceTel Communications, Inc. to which such Warrant relates and herewith tenders the Warrant in full payment of the shares and requests that the certificates for the shares of Common Stock and Redeemable Warrants comprising such Units be issued in the name of, and be delivered to _______________________, whose address is set forth below the signature of the undersigned. Dated: ------------------------- ------------------------------------------ (Signature) ------------------------------------------ (Name Typed or Printed) ------------------------------------------ (Address) * The signature on the Notice of Warrant Conversion must exactly correspond to the name as written upon the face of the Warrant in every particular without alteration or any change whatsoever. When signing on behalf of a corporation, partnership, trust or other entity, PLEASE indicate your position(s) and title(s) with such entity. ASSIGNMENT OF WARRANT (To be signed only upon authorized transfer of the Warrant) FOR VALUE RECEIVED, the undersigned hereby sells, assigns, and transfers unto ____________________________ the right to purchase _______________ Units of ChoiceTel Communications, Inc. to which the within Warrant relates and appoints _________________________________, as attorney-in-fact, to transfer said right on the books of ChoiceTel Communications, Inc. with full power of substitution in the premises. Dated: ------------------------- ------------------------------------------ (Signature) ------------------------------------------ (Name Typed or Printed) ------------------------------------------ (Address) ------------------------------------------ (Social Security or Tax Ident. No.) * The signature on the Assignment of Warrant must exactly correspond to the name as written upon the face of the Warrant in every particular without alteration or any change whatsoever. When signing on behalf of a corporation, partnership, trust or other entity, PLEASE indicate your position(s) and title(s) with such entity. RESTRICTION ON TRANSFER THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS AND MAY NOT BE SOLD, TRANSFERRED, ASSIGNED, OFFERED, PLEDGED OR OTHERWISE DISTRIBUTED FOR VALUE UNLESS THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER SUCH ACT OR LAWS COVERING SUCH SECURITY OR THE COMPANY RECEIVES AN OPINION OF COUNSEL FOR THE COMPANY STATING THAT SUCH SALE, TRANSFER, ASSIGNMENT, PLEDGE OR DISTRIBUTION IS EXEMPT FROM THE REGISTRATION AND PROSPECTUS DELIVERY REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND ALL APPLICABLE STATE SECURITIES LAWS. EX-5 3 EXHIBIT 5 - OPINION OF ROBINS, KAPLAN [LETTERHEAD] August 22, 1997 ChoiceTel Communications, Inc. 9724 10th Avenue North Plymouth, MN 55441 Gentlemen: As counsel for ChoiceTel Communications, Inc. (the "Company"), we have participated in the preparation of the Registration Statement on Form SB-2, filed by the Company with the Securities and Exchange Commission on June 25, 1997, as amended by Amendment No. 1 dated as of the date hereof (the "Registration Statement"), Registration No. 333-29969, with respect to the issuance and sale of units (the "Units"), each Unit consisting of one share of the Company's Common Stock, par value $0.01 per share (the "Common Stock"), and one redeemable Common Stock Purchase Warrant entitling the holder thereof to purchase one share of Common Stock (the "Redeemable Warrants"), and we have examined the Company's Amended and Restated Articles of Incorporation, the form of Redeemable Warrant Agreement with Norwest Bank Minnesota, National Association, as warrant agent, included in the Registration Statement as Exhibit 4.2 thereto, pursuant to which the Redeemable Warrants will be issued (the "Warrant Agreement"), and such other documents, corporate records and matters of law as we have deemed necessary for purposes of this opinion. Based upon such examination and review, it is our opinion that: 1. The Company has been duly incorporated and is validly existing under the laws of the State of Minnesota. 2. When delivered and paid for as contemplated by the Registration Statement, the issuance of the Units in a public offering pursuant to the Registration Statement will have been duly authorized by all necessary corporate action on the part of the Company and the shares of Common Stock comprising part of the Units will be legally issued, fully paid and non-assessable. 3. When issued in accordance with the terms of Redeemable Warrants and the Warrant Agreement, the issuance of the shares of Common Stock issuable upon exercise of the Redeemable Warrants comprising part of the Units will have been duly authorized by all necessary corporate action on the part of the Company and such shares of Common Stock will be legally issued, fully paid and non-assessable. We hereby consent to being named in the Registration Statement, and in the Prospectus which constitutes a part thereof, as counsel for the Company who have passed upon legal matters in connection with the issuance of the Units, the Common Stock and the Redeemable Warrants. We further consent to the filing of this opinion as an exhibit to the Registration Statement. Yours very truly, /s/ Robins, Kaplan, Miller & Ciresi L.L.P. EX-10.21 4 EXHIBIT 10-21 DUSTIN ELDER EMPLOYMENT AGREEMENT EMPLOYMENT AND NON-COMPETITION AGREEMENT THIS EMPLOYMENT AND NON-COMPETITION AGREEMENT (the "Agreement") is made effective as of the 14th day of August, 1997, by and between CHOICETEL COMMUNICATIONS, INC., a Minnesota corporation with offices at 9724 10th Avenue North, Plymouth, MN 55441 (the "Company"), and DUSTIN ELDER, a resident of Minnesota whose mailing address is 2745 Colfax Avenue South, Minneapolis, Minnesota ("Employee"). RECITALS: WHEREAS, the Company has entered into an Agreement for Sale and Purchase of Assets by which it has agreed to purchase certain assets of Computer Assisted Technologies, Inc., a Wisconsin corporation ("CAT"); WHEREAS, Employee has gained valuable experience and knowledge with respect to CAT's business as an officer, director, shareholder and/or employee of CAT; WHEREAS, Employee desires to commence his employment with the Company, and the Company desires to employ Employee, on the terms and conditions set forth below; WHEREAS, Employee and the Company acknowledge that it is in their best interests to establish formal severance arrangements for the benefit of Employee, in partial consideration for which Employee has agreed to observe certain nondisclosure and non-competition restrictions with respect to the Company, as set forth herein. NOW, THEREFORE, in consideration of the foregoing recital and the mutual promises and agreements contained in this Agreement, the parties agree as follows: 1. EMPLOYMENT. The Company hereby employs Employee and appoints him a Vice President and Employee hereby accepts such employment with the Company, on the terms and conditions set forth in this Agreement. Employee hereby acknowledges and agrees that the Company has no obligation to retain Employee in such position during the term of this Agreement, and that it may place Employee in another position and/or reassign him different duties as the Board of Directors may determine in its sole discretion. 2. TERM AND RENEWAL. Employee's employment by the Company shall commence under the terms hereof as of August 14, 1997, and shall continue until April 15, 1999, unless such employment is terminated earlier as provided herein. The term of this Agreement shall renew automatically for successive one (1) year terms unless a party gives notice to the other not less than thirty (30) days prior to the end of a term that this Agreement is not to be renewed, or unless this Agreement is otherwise terminated as provided herein. 3. DUTIES. Employee agrees to perform faithfully and to the best of his abilities such duties as are reasonably assigned to him from time to time by the Company's Board of Directors. Employee agrees to devote his entire business time, and to apply his best efforts, energy and skills, to properly discharge the duties of such employment, to promote the Company's interests, and to participate in the active management of the Company while employed hereunder. Employee shall report directly to the Company's Board of Directors or to such other officer of the Company as the Board of Directors may determine in its sole discretion. 4. COMPENSATION. (a) Employee's compensation for the services performed under this Agreement and for Employee's covenants and agreements hereinafter set forth shall be a salary of Sixty-Five Thousand Dollars ($65,000) per year or Five Thousand Four Hundred Sixteen Dollars and Sixty-Six Cents ($5,416.66) per month. Employee's salary may be adjusted at the sole discretion of the Company's Board of Directors. In the event of Employee's termination of employment without cause as defined in Section 11 below, Employee shall be entitled to receive such salary through the term of this Agreement then in effect. (b) As additional compensation, Employee shall be entitled to the fringe benefits described in Paragraph 5 below and may, in the sole discretion of the Company's Board of Directors, receive such additional compensation, salary, bonus or other benefits as the Company's Board of Directors shall determine from time to time. (c) As additional compensation, Employee shall be entitled to an initial stock option to acquire up to 20,000 shares of the Company's common stock at an exercise price of $6.75 per share. In addition, so long as he remains employed hereunder or is terminated without cause, Employee shall be entitled to exercise successive stock options for 10,000 each during the three (3) years following the completion of the first year of employment hereunder all as set forth in the Incentive Stock Option Agreement attached hereto as Exhibit A. In the event of termination of employment without cause as defined in Section 11 below, Employee shall be entitled to exercise the balance of any unexercised options held by him at termination and to receive and exercise the stock options otherwise due to him on February 1, 1998, February 1, 1999 and February 1, 2000 even if he is no longer employed hereunder. Employee hereby acknowledges that the foregoing share amounts assume that the Company will have effected a two-for-one split of its common stock prior to the exercise of any such option. In the event such split does not occur, all share amounts will be reduced to reflect the Company's then existing capital structure. 5. FRINGE BENEFITS. Employee shall have the right to participate in the fringe benefit plans generally provided by the Company to its officers, subject, however, to Employee's qualification for participation in such benefit plans pursuant to the terms and conditions under which such benefit plans are offered. 6. VACATION. Employee shall be entitled during each calendar year in which this Agreement remains in effect such paid vacation time as the Company's Board of Directors shall -2- determine in its sole discretion. Any vacation time not used during any such calendar year may not be carried forward to any succeeding calendar year and shall be forfeited. No vacation may be taken in advance. Employee shall not be entitled to receive any payment in cash for vacation time remaining unused at the end of any year or upon termination of this Agreement. 7. NON-COMPETITION. The parties also acknowledge and agree that the Company's customer contacts and relations are established and maintained at great expense and that Employee, by virtue of his employment under this Agreement, will have unique and extensive exposure to, and personal contact with, the Company's customers and that Employee will be able to establish a unique relationship with those individuals that will enable him, both during and after employment, to unfairly compete with the Company. In consideration of the continued employment by the Company of Employee, and in consideration of the compensation and newly established severance arrangement provided to Employee by the Company under this Agreement, Employee agrees that he shall not do any of the following at any time during the term of this Agreement, nor, after he ceases to be employed by the Company, for a period of two (2) years with respect to subparagraphs (a) and (b), and for a period of five (5) years with respect to subparagraph (c): (a) directly or indirectly, become a stockholder, partner, member or other owner in any business or entity that is a business competitor of the Company, provided, however, that Employee shall not be prohibited from, and the foregoing restriction shall not apply to, Employee's ownership of less than a ten percent (10%) interest in any company whose shares of stock are traded in a recognized stock exchange or traded in the over-the-counter market; and/or (b) in any manner induce, attempt to induce or assist others to induce any customer, client, employee or other person or entity having a business or employment relationship with the Company to terminate such relationship, or do anything to interfere with the relationship of the Company with such person or entity. (c) communicate with any party with which the Company has a Site Agreement until six (6) months after the expiration of any such Agreement. Employee expressly agrees that in the event of a breach of the subparagraph (c), in addition to any other remedies provided hereunder or by law, the Company will be entitled to recover from Employee as liquidated damages, an amount equal to Five Thousand Dollars ($5,000) for each phone located on any site where a communication has been made in violation of this subparagraph (c). 8. CONFIDENTIAL INFORMATION. The parties agree that the Company's customers, business connections, agreements, customer lists, procedures, operations, business software and computer programs and printouts, techniques, financial information and other aspects of the business are established at great expense and protected as confidential information and provide the Company with a substantial competitive advantage in conducting its business. The parties further agree that by virtue of Employee's employment with the Company, Employee will have access to, and be entrusted with, secret, confidential and proprietary information, and that the Company would suffer great loss and injury if Employee would disclose this information or use it to -3- compete with the Company. Therefore, in consideration of the compensation and other benefits to be provided to Employee under this Agreement, including the severance arrangement established herein, Employee agrees that during the term of his employment, and for a period of one (1) year after the termination of Employee's employment with the Company, Employee shall not, directly or indirectly, either individually or as an employee, agent, partner, shareholder, consultant or in any other capacity, use or disclose, or cause to be used or disclosed, any secret, confidential or proprietary information acquired by Employee during his employment with the Company, whether owned by the Company prior to or discovered and developed by the Company subsequent to Employee's employment, even though Employee may have participated in the discovery or development of such information. 9. RELIEF FOR VIOLATIONS. Employee covenants and agrees that if he shall violate any of the covenants and agreements under Paragraph 7 and/or Paragraph 8 or both, the Company shall be entitled to an accounting and repayment of all profits, compensation, commissions, remuneration or benefits which Employee directly or indirectly has realized and/or may realize as the result of, arising out of, or in connection with, any such violation. Employee acknowledges that an irreparable injury may result to the Company and its business in the event of a breach of Employee's covenants contained in Paragraph 7 and/or Paragraph 8 of this Agreement. Employee also acknowledges and agrees that the damages or injuries which the Company may sustain as a result of Employee's breach of Paragraphs 7 and/or Paragraph 8 of this Agreement are difficult to ascertain and money damages alone may not be an adequate remedy to the Company. Employee, therefore, agrees that if a controversy arises concerning the rights or obligations of a party under this Agreement, such rights or obligations shall be enforceable in a court of equity by a decree of specific performance and the Company shall also be entitled to any injunctive relief necessary to prevent or restrain any violation by Employee or any persons directly or indirectly acting for or with Employee of the provisions of Paragraphs 7 and/or Paragraph 8 of this Agreement. Such remedies, however, shall be cumulative and non-exclusive and shall be in addition to any other remedy to which the parties may be entitled. 10. REASONABLE RESTRICTIONS. Employee agrees that the terms and conditions of Paragraphs 7, 8 and 9 of this Agreement are reasonable and necessary for the protection of the Company's business, trade secrets and confidential information and to prevent damage or loss to the Company as the result of action taken by Employee. Employee acknowledges that the consideration provided for herein is sufficient to fully and adequately compensate Employee for agreeing to the restrictions set forth in Paragraphs 7, 8 and 9 of this Agreement. Employee acknowledges that he could continue to actively pursue his career and earn sufficient compensation in business without breaching any of the restrictions contained in this Agreement. 11. TERMINATION; SEVERANCE ARRANGEMENT. (a) Except as otherwise set forth herein, if either party desires to terminate Employee's employment with the Company, such party shall give written notice of termination to the other party not less than thirty (30) days prior to the effective date of termination. -4- (b) In the event of any termination of Employee's employment with the Company except that "for cause" (as defined in Section 11(c) below), Employee shall be entitled to continue receiving the full compensation and benefits set forth in Section 4 above for a period of six (6) months following such termination. If such termination is occasioned by Employee's death or "disability," the continued compensation to which Employee is entitled shall be paid to Employee's estate or personal representative, as the case may be. For purposes of this Agreement, "disability" shall mean that Employee is unable to perform substantially all of his duties for a period of one (1) year or for a total of twelve (12) months in any two (2) year period. (c) The Company shall have the right to terminate the employment of Employee immediately "for cause" without notice upon the happening of any of the following events: (i) The breach by Employee of any provisions of Paragraph 7 or Paragraph 8 of this Agreement; (ii) The commission by Employee of any act of gross misconduct or malfeasance with respect to the Company or its business; or (iii) The conviction of Employee of a felony or misdemeanor which, in the reasonable judgment of the Company's Board of Directors, is likely to have a material adverse effect upon the business or reputation of Employee or the Company or which substantially impairs Employee's ability to perform his duties for the Company. (d) Upon notice of termination of employment or at any time thereafter as directed by the Company, Employee shall return to the Company any and all property of the Company in Employee's possession or control. The agreements of Employee pursuant to Paragraphs 7, 8, 9 and 10 shall survive the termination of employment under this Agreement. 12. REIMBURSEMENT OF BUSINESS EXPENSES. The Company shall reimburse Employee for the amount of expenses reasonably and necessarily incurred by Employee in connection with the Company's business; provided, however, that no single expenditure in excess of $100 shall be made without the Company's prior approval. Employee shall submit an itemized accounting for all expenses for which reimbursement is sought at such time and in such detail as the Company shall reasonably require. The Company shall not be obligated to pay or reimburse expenses for which adequate documentation is not furnished in the manner directed by the Company. 13. WAIVER. The failure of either party to insist, in any one or more instances, upon performance of the terms or conditions of this Agreement shall not be construed as a waiver or a relinquishment of any right granted hereunder or of the future performance of any such term, covenant or condition. 14. SEVERABILITY. In the event any provision of this Agreement is held to be invalid or unenforceable for any reason whatsoever, such invalidity or unenforceability shall not affect any other provision of this Agreement and the remaining covenants, restrictions and provisions -5- hereof shall remain in full force and effect and any court of competent jurisdiction may so modify the objectionable provision as to make it valid, reasonable and enforceable. FURTHERMORE, THE PARTIES SPECIFICALLY ACKNOWLEDGE THE ABOVE COVENANT NOT TO COMPETE AND COVENANT NOT TO DISCLOSE CONFIDENTIAL INFORMATION ARE SEPARATE AND INDEPENDENT AGREEMENTS. 15. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Minnesota. 16. BENEFIT. This Agreement shall be binding upon and inure to the benefit of and shall be enforceable by and against the Company, its successors and assigns, and Employee, his heirs, beneficiaries and legal representatives. Employee's rights and obligations under this Agreement may not be delegated or assigned except as specifically set forth herein. 17. NOTICES. Any notice to be given hereunder shall be deemed sufficient if addressed in writing, and delivered by registered or certified mail or delivered personally, in the case of the Company to its principal business office, and in the case of Employee, to his address appearing on the Company's records, or to such other address as he may designate in writing to the Company. 18. ENTIRE AGREEMENT; AMENDMENT. This Agreement contains the entire agreement and understanding between the parties hereto in reference to all of the matters herein agreed upon, and no representations, promises, agreements or understandings, whether written or oral, not herein contained shall be of any force or effect. This Agreement may only be amended by an agreement in writing signed by all of the parties hereto. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day, month and year first above written. EMPLOYEE COMPANY: /S/ DUSTIN ELDER CHOICETEL COMMUNICATIONS, INC. - ---------------------------- a Minnesota corporation Dustin Elder BY: /S/ JACK KOHLER -------------------------------- Name: JACK KOHLER -------------------------------- Title: VICE PRESIDENT AND -------------------------------- CHIEF FINANCIAL OFFICER -------------------------------- -6- EXHIBIT A STOCK OPTION AGREEMENT THIS STOCK OPTION AGREEMENT ("Agreement") is made as of the 14th day of August, 1997, between Choicetel Communications, Inc. ("Corporation"), a Minnesota corporation, and Dustin Elder ("Participant"), an employee of the Corporation. WHEREAS, the Corporation and Participant have entered into an Employment and Non-Competition Agreement dated as of August 14, 1997 (the "Employment Agreement"); and WHEREAS, the Board of Directors of the Corporation has determined that the Participant is to receive certain stock options to purchase shares of the Corporation's common stock. NOW, THEREFORE, in consideration of the foregoing, of the mutual promises set forth later in this Agreement, and of other good and valuable consideration, the receipt and sufficiency of which are acknowledged, the parties to this Agreement, intending to be legally bound, agree as follows: SECTION 1. GRANT OF INITIAL OPTION. Subject to the terms and conditions set forth below in this Agreement, the Corporation hereby grants to Participant an option (the "Option"), exercisable from and after this date, to purchase Twenty Thousand (20,000) shares of the Corporation's common stock ("Shares") at a price of Six Dollars and Seventy-Five Cents ($6.75) per share ("Exercise Price"). SECTION 2. GRANT OF FUTURE OPTIONS. Subject to Participant's continued employment or termination without cause in accordance with the terms and conditions of the Employment Agreement, Participant shall have the right to purchase Ten Thousand (10,000) additional Shares on each of the dates set forth below: February 1, 1998 February 1, 1999 February 1, 2000 The Exercise Price for the Shares shall in each instance be the fair market value of the Shares as determined by the Board of Directors of the Corporation. SECTION 3. EFFECT OF STOCK SPLIT; DURATION OF OPTIONS. Participant hereby acknowledges that the number of Shares which he may purchase under the options granted herein reflects the Corporation's effectuation of a two-for-one split of its common stock prior to the exercise of any such option. In the event such split does not occur, all Share amounts will be reduced to reflect the Corporation's then existing capital structure. The Initial Option shall be effective during the period commencing as of the date of this Agreement and the Future Options will be effective as of the date of grant set forth in the preceding table. The Options will end on the earliest of (i) the date all the Shares are purchased pursuant to the terms of this Agreement or (ii) the date of the termination of employment of the Participant "for cause" (as defined in Section 11 of the Employment Agreement) or (iii) three (3) years after the date of grant. In the event of a merger or consolidation to which the Corporation is a party (other than as the surviving entity), or any other sale or transfer of a majority of the outstanding shares of the Common Stock of the Corporation, or any transfer of all or substantially all of the assets of the Corporation, or of the Corporation's liquidation or dissolution, the Corporation shall give the Participant at least ten (10) days' prior written notice of any event of this type and the Option, to the extent that it is still in force and has not been exercised, shall be accelerated, and the Participant may purchase any or all of the Shares before the occurrence of any event of this type, and, to the extent that the Option shall not be exercised, it shall expire upon any event of this type becoming effective. Upon the expiration of that period of the Option, the Option shall have no further effect, and the Participant shall have no further rights in or under the Option or to the Shares that shall not have been purchased at that time pursuant to the Option. SECTION 4. EXERCISE OF OPTION. a. Notwithstanding anything contained in this Agreement to the contrary, the Option may be exercised only in amounts of one hundred (100) Shares or multiples of one hundred (100); provided, however, that this restriction shall not apply to the purchase by the Participant of all Shares that are the subject of the Option that have not previously been purchased by the Participant and as to which the Participant shall be otherwise entitled to purchase. The Option may be exercised only if compliance with all applicable federal and state securities laws can be effected and only by (i) the Participant's completion, execution, and delivery to the Corporation of a notice of exercise and "investment letter" in the forms supplied by the Corporation, and (ii) the payment to the Corporation, as provided in Section 3(b) of this Agreement, of an amount equal to the amount obtained by multiplying the Exercise Price by the number of Shares being purchased pursuant to that exercise, as shall be specified by the Participant in that notice of exercise. Notwithstanding any other provision of this Agreement, the Option shall not be exercisable, in whole or in part, while there is outstanding, within the meaning of Section 422A(c)(7) of the Internal Revenue Code of 1986, as amended ("Code"), any other stock option, as defined in Section 422A(b) of the Code, that was granted, before the granting of that Option, to the Participant to purchase stock in the Corporation. The Option or any of the rights under the Option may be exercised by the Participant only and may not be transferred or assigned, voluntarily, involuntarily, or by operation of law including, without limitation, the laws of bankruptcy, intestacy, descent and distribution, and succession. b. Payment of the amount determined pursuant to Section 3(a) of this Agreement shall be made by check. 2 c. Upon the exercise of the Option by the Participant, or as soon thereafter as is practicable, the Corporation shall issue and deliver to the Participant a certificate or certificates evidencing the number of Shares the Participant has elected to purchase. The certificate or certificates shall be registered in the name of the Participant and shall bear an appropriate investment legend, any legend required by federal or state securities laws, rules, or regulations, and (if applicable) a legend referring to the restrictions provided under this Agreement and under the Plan. Upon the exercise of the Option and the issue of the certificate or certificates, the Participant shall have all the rights of a stockholder with respect to those Shares and to receive all dividends or other distributions paid or made with respect to those Shares; provided, however, that those Shares shall be subject to the restrictions under this Agreement and in the Plan. In the event of a merger or consolidation to which the Corporation is a party (other than as the surviving entity), any other sale or transfer of a majority of the outstanding shares of Common Stock of the Corporation, or any transfer of all or substantially all of the assets of the Corporation, the acquiring corporation alone shall determine whether the stock of the acquiring corporation so received, if any, shall be subject to the restrictions set forth in this Agreement. d. A Participant may elect to pay all or a part of the Exercise Price of the Shares by having the Corporation withhold from the Shares, the number of shares having a fair market value equal to the aggregate Option Exercise Price for the Shares with respect to which such election is made. SECTION 5. RESTRICTIONS ON TRANSFER OF SHARES. a. The Participant hereby covenants and agrees that any Shares acquired pursuant to the exercise of the Option shall be acquired solely for investment and not for resale or other distribution. b. Except as otherwise provided in this Agreement or in the Plan, neither the Option nor any Shares shall or may be sold, exchanged, delivered, assigned, bequeathed or given, pledged, mortgaged, hypothecated or otherwise encumbered, transferred or permitted to be transferred, or otherwise disposed of, whether voluntarily, involuntarily, or by operation of law (including, without limitation, the laws of bankruptcy, intestacy, descent and distribution, and succession). SECTION 6. CHANGES IN CAPITAL STRUCTURE. The number of Shares held by the Participant shall be adjusted in any manner for (i) a division or combination of any of the outstanding shares of common stock of the Corporation, (ii) a dividend payable in shares of common stock of the Corporation, (iii) a reclassification of any outstanding shares of common stock of the Corporation, or (iv) any other change of a similar nature in the capital structure of the Corporation. SECTION 7. RIGHTS BEFORE EXERCISE. The Participant shall not have an equity interest in the Corporation or any voting, dividend, liquidation, or dissolution rights with respect to 3 any capital stock of the Corporation solely by reason of having an Option or having executed this Agreement. Furthermore, prior to the exercise of the Option, as set forth in Section 3(a) of this Agreement, the Participant shall not have an interest in, or any voting, dividend, liquidation, or dissolution rights with respect to, the Shares. SECTION 8. TERMS AND CONDITIONS OF PLAN. The terms and conditions included in the Plan are incorporated by reference in this Agreement, and, to the extent that any conflict may exist between any term or provision of this Agreement and any term or provision of the Plan, the term or provision of the Plan shall control. SECTION 9. HEADINGS. The headings and other captions contained in this Agreement are for convenience and reference only and shall not be used in interpreting, construing, or enforcing any of the provisions of this Agreement. SECTION 10. ENTIRE AGREEMENT. This Agreement sets forth all of the promises, agreements, conditions, understandings, warranties, and representations between the parties to this Agreement with respect to the Option and the Shares, and there are no promises, agreements, conditions, understandings, warranties, or representations, oral or written, express or implied, between them with respect to the Option or the Shares other than as set forth in this Agreement. Any and all prior agreements between the parties to this Agreement with respect to any stock purchase rights or stock option rights regarding the shares of capital stock of the Corporation are hereby revoked. This Agreement is, and is intended by the parties to be, an integration of any and all prior agreements or understandings, oral or written, with respect to the Option and the Shares. SECTION 11. NOTICES. Any and all notices provided for in this Agreement shall be addressed: (i) if to the Corporation, to the principal executive office of the Corporation; and (ii) if to the Participant, to the address of the Participant as reflected on the records of the Corporation. SECTION 12. INVALID OR UNENFORCEABLE PROVISIONS. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions of this Agreement, and this Agreement shall be construed in all respects as if those invalid or unenforceable provisions were omitted. SECTION 13. GOVERNING LAW. This Agreement shall be construed and enforced in accordance with the laws of Minnesota. SECTION 14. MODIFICATIONS Any modification of this Agreement must be written and signed by the parties to this Agreement to be valid; provided, however, that the Participant covenants and agrees to execute any amendment to this Agreement that shall be required or desirable (in the opinion of the Corporation or its counsel) to comply with any rule or regulation promulgated or proposed under the Code by the Internal Revenue Service. 4 THE SECURITIES REPRESENTED HEREBY ARE ISSUED WITHOUT REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT") AND UPON REPRESENTATION OF THE HOLDER HEREOF THAT SAID SECURITIES ARE BEING HELD FOR INVESTMENT AND NOT WITH A VIEW TO DISTRIBUTION THEREOF, AND NO SALE, TRANSFER, OR OTHER DISPOSITION MAY BE MADE EXCEPT IN COMPLIANCE WITH THE PROVISIONS OF THE ACT. IN WITNESS WHEREOF, the Corporation and the Participant have executed this Agreement as of the day and year first above written. CHOICETEL COMMUNICATIONS, INC., a Minnesota corporation By ---------------------------------------------- Jack Kohler, Vice President and Chief Financial Officer PARTICIPANT: ---------------------------------------------- Dustin Elder 2745 Colfax Avenue South ------------------------------------------------- (Address) ###-##-#### ------------------------------------------------- (Social Security Number) 5 EX-10.22 5 EXHIBIT 10.22 LEASE AGREEMENT LEASE DATED: JULY 11, 1997 BETWEEN: PACIFIC REALTY ASSOCIATES, L.P., A DELAWARE LIMITED PARTNERSHIP LANDLORD AND: INTELLIPHONE, INC., A MINNESOTA CORPORATION dba TELCO NORTHWEST, INC. TENANT Tenant wishes to lease from Landlord the following described property, hereinafter referred to as "the Premises": Approximately 2,250 square feet of warehouse and office space located in Building C, Oregon Business Park II, 15838 S.W. Upper Boones Ferry Road, Lake Oswego, Oregon 97035 and as further described on the attached Exhibits A and B. If the Premises consist of a portion but not all of a building, the building housing the Premises is hereinafter referred to as "the Building." Landlord leases the Premises to Tenant for a term of 12 months commencing August 1, 1997 and continuing through July 31, 1998 at a base rent of One Thousand Two Hundred and No/100 Dollars ($1,200.00) per month. Rent for the first month of the Lease term shall be paid upon execution of this Lease. All rent, including base rent together with the charges, taxes and expenses to be paid to Landlord specified in Paragraphs 3 and 4 of this Lease, is payable in advance on the first day of each calendar month. If Landlord consents, Tenant may occupy the Premises prior to such commencement date upon payment of rent on a prorated basis and compliance with all terms of this Lease. Delivery of possession shall occur when the Premises are occupied by Tenant or are ready to be occupied by Tenant with all work to be performed by Landlord substantially completed. No notice shall be required from Landlord if the Premises are ready on the date set for commencement of the term or on the first business day thereafter. If Landlord is unable to deliver possession of the Premises to Tenant because of strikes, acts of God, or any other cause beyond Landlord's control, then Tenant may take possession when Landlord notifies Tenant that the Premises are ready for possession, and the term of this Lease shall commence on the first day of the first month following such date and continue for the specified number of months thereafter, notwithstanding the commencement and termination dates stated above. Tenant shall owe no rent until the Premises are ready for possession. Landlord shall have no liability for such delays in delivery of possession, and neither party shall have the right to terminate except that Landlord may cancel this Lease without liability if permission to construct, use, or furnish necessary utilities to the Premises is denied or revoked by any governmental agency or public utility with such authority. This Lease is subject to the following additional terms to which the parties agree: 1. USE OF THE PREMISES. 1.1. Tenant shall use the Premises only for the purpose of conducting the following business: Sales, warehouse, and administration of pay telephone and related items. If such use is prevented by any law or governmental regulation, Tenant may use the Premises for other reasonable uses. 1.2. In connection with its use, Tenant shall at its expense comply with all applicable laws, ordinances, and regulations of any public authority, including those requiring alteration of the Premises because of Tenant's specific use; shall create no nuisance nor allow any objectionable liquid, odor, or noise to be emitted from the Premises; shall store no gasoline or other highly combustible materials on the Premises which would violate any applicable fire code or regulation nor conduct any operation that will increase Landlord's fire insurance rates for the Premises; and shall not overload the floors or electrical circuits of the Premises. Landlord shall have the right to approve the installation of any power-driven machinery by Tenant and may select a qualified electrician whose opinion will control regarding electrical circuits and a qualified engineer or architect whose opinion will control regarding floor loads. Allowable ground floor load shall be 500 pounds per square foot. 1.3. Tenant may erect a sign stating its name, business, and product after first securing Landlord's written approval of the size, color, design, wording, and location, and all necessary governmental approvals. No signs shall be painted on the Building or exceed the height of the Building. All signs installed by Tenant shall be removed upon termination of this Lease with the sign location restored to its former state. 1.4. Tenant shall make no alterations, additions, or improvements to the Premises or change the color of the exterior without Landlord's prior written consent and without a valid building permit issued by the appropriate governmental agency. Upon termination of this Lease, any such alterations, additions, or improvements (including without limitation all electrical, lighting, plumbing, heating and air-conditioning equipment, doors, windows, partitions, drapery, carpeting, shelving, counters, and physically attached fixtures) shall at once become part of the realty and belong to Landlord unless the terms of the applicable consent provide otherwise, or Landlord requests that part of all of the additions, alterations, or improvements be removed. In such case, Tenant shall at its sole cost and expense promptly remove the specified additions, alterations, or improvements and repair and restore the Premises to its original condition. 2. SECURITY DEPOSIT. Upon execution of this Lease, Tenant shall deposit with Landlord the sum of $1,200.00, hereinafter referred to as "the Security Deposit," to secure the faithful performance by Tenant of each term, covenant, and condition of this Lease. If Tenant shall at any time fail to make any payment or fail to keep or perform any term, covenant, and condition on its part to be made or performed or kept under this Lease, Landlord may, but shall not be obligated to and without waiving or releasing Tenant from any obligation under this Lease, use, apply or retain the whole or any part of the Security Deposit (i) to the extent of any sum due to Landlord; or (ii) to make any required payment on Tenant's behalf; or (iii) to compensate Landlord for any loss, damage, attorneys' fees, or expense sustained by Landlord due to Tenant's default. In such event, Tenant shall, within five (5) days of written demand by Landlord, remit to Landlord sufficient funds to restore the Security Deposit to its original sum; Tenant's failure to do so shall be a material breach of this Lease. Landlord shall not be required to keep the Security Deposit separate from its general funds, and Tenant shall not be entitled to interest on such deposit. Should Tenant comply with all of the terms, covenants, and conditions of this Lease and at the end of the term of this Lease leave the Premises in the condition required by this Lease, then the Security Deposit, less any sums owing to Landlord, shall be returned to Tenant (or, at Landlord's option, to the last assignee of Tenant's interest hereunder) within thirty (30) days after the termination of this Lease and vacancy of the Premises by Tenant. 3. UTILITY CHARGES; MAINTENANCE. 3.1 Tenant shall pay when due all charges for electricity, natural gas, water, garbage collection, janitorial service, sewer, and all other utilities of any kind furnished to the Premises during the lease term. If charges are not separately metered or stated, Landlord shall apportion the utility charges on an equitable basis. Landlord shall have no liability resulting from any interruption of utility services caused by fire or other casualty, strike, riot, vandalism, the making of necessary repairs or improvements, or any other cause beyond Landlord's reasonable control. Tenant shall control the temperature in the Premises to prevent freezing of any sprinkler system. 3.2. Landlord shall repair and maintain the roof, gutters, downspouts, exterior walls, building structure, foundation, exterior paved areas, and curbs of the Premises in good condition. Except for such obligations of Landlord and except for any repairs or maintenance necessitated by the neglect or will misconduct of Landlord, Tenant shall keep the Premises neatly maintained and in good order and repair. Tenant's responsibility shall include any routine maintenance and repair of the electrical system, plumbing, drainpipes to sewers, air-conditioning and heating systems, overhead and personnel doors, and the replacement of all broken or cracked glass with glass of the same quality. Tenant shall refrain from any discharge that will damage the septic tank or sewers serving the Premises. 3.3. If the Premises have a separate entrance, Tenant shall keep the sidewalks abutting the Premises or the separate entrance free and clear of snow, ice, debris, and obstructions of every kind. 4. TAXES, ASSESSMENTS, AND OPERATING EXPENSES. 4.1. In conjunction with monthly rent payments, Tenant shall each month pay a sum representing Tenant's proportionate share of real property taxes and operating expenses for the Premises. Such amount shall annually be estimated by Landlord in good faith to reflect actual or anticipated costs. Upon termination of this Lease or at periodic intervals during the term hereof, Landlord shall compute its actual costs for such expenses during such period. Any overpayment by Tenant shall be credited to Tenant, and any deficiency shall be paid by Tenant within fifteen (15) days after receipt of Landlord's statement. Landlord's records of expenses for taxes and operating expenses may be inspected by Tenant at reasonable times and intervals. 4.2. Tenant's proportionate share of real property taxes shall mean that percentage of the total assessment affecting the Premises which is the same as the percentage which the rentable area of the Premises bears to the total rentable area of all buildings covered by the tax statement. Tenant's proportionate share of operating expenses for the Building shall be computed by dividing the rentable area of the Premises by the total rentable area of the Building. If in Landlord's reasonable judgment either of these methods of allocation results in an inappropriate allocation to Tenant, Landlord shall select some other reasonable method of determining Tenant's proportionate share. 4.3. Real property taxes charged to Tenant hereunder shall include all general real property taxes assessed against the Premises or payable during the lease term, installment payments on Bancrofted special assessments, and any rent tax, tax on Landlord's interest under this Lease, or any tax in lieu of the foregoing, whether or not any such tax is now in effect. Tenant shall not, however, be obligated to pay any tax based upon Landlord's net income. Operating expenses charged to Tenant hereunder shall include all usual and necessary costs of operating and maintaining the Premises, Building, and any surrounding common areas including, but not limited to, the cost of all utilities or services not paid directly by Tenant, property insurance, property management, maintenance and repair of landscaping, parking areas, and any other common facilities. Operating expenses shall not include roof replacement or correction of structural deficiencies of the Building. Notwithstanding the above, the increase in Tenant's proportionate share of operating expenses shall not exceed five percent (5%) annually, on a cumulative basis, for the term of this Lease, exclusive of real estate taxes. 4.4. 5. PARKING AND STORAGE AREAS. 5.1. Tenant, its employees, and customers shall have the exclusive right to use any private parking spaces immediately adjacent to the Premises. Tenant shall control the use of such parking spaces so that there will be no unreasonable interference with the normal traffic flow, and shall permit no parking on any landscaped or unpaved surface. Under no circumstances shall trucks serving the Premises be permitted to block streets. 5.2. Tenant shall not store any materials, supplies, or equipment outside in any unapproved or unscreened area. If Tenant erects any visual barriers for storage areas, Landlord shall have the right to approve the design and location. Trash and garbage receptacles shall be kept covered at all times. 6. TENANT'S INDEMNIFICATION; LIABILITY INSURANCE. 6.1. Tenant shall not allow any liens to attach to the Premises as a result of its activities. Tenant shall indemnify and defend Landlord from any claim, liability, damage, or loss arising out of any activity on the Premises by Tenant, its agents, or invitees or resulting from Tenant's failure to comply with any term of this Lease. 6.2. Tenant shall carry general liability insurance on an occurrence basis with combined single limits of not less than $1,000,000. Such insurance shall be provided by an insurance carrier reasonably acceptable to Landlord and shall be evidenced by a certificate delivered to Landlord stating that the coverage will not be cancelled or materially altered without ten (10) days' advance written notice to Landlord. Landlord shall be named as an additional insured on such policy. 7. PROPERTY DAMAGE; SUBROGATION WAIVER. 7.1. If fire or other casualty causes damage to the Building or the Premises in an amount exceeding thirty percent (30%) of the full construction-replacement cost of the Building or Premises, respectively, Landlord may elect to terminate this Lease as of the date of the damage by notice in writing to Tenant within thirty (30) days after such date. Otherwise, Landlord shall promptly repair the damage and restore the Premises to their former condition as soon as practicable. Rent shall be reduced during the period to the extent the Premises are not reasonably usable for the use permitted by this Lease because of such damage and required repairs. 7.2. Landlord shall be responsible for insuring the Building, and Tenant shall be responsible for insuring its personal property and trade fixtures located on the Premises. 7.3. Landlord and Tenant each hereby releases the other, and the other's partners, officers, directors, agents and employees, from any and all liability and responsibility to the releasing party and to anyone claiming by or through it or under it, by way of subrogation or otherwise, for all claims, or demands whatsoever which arise out of damage or destruction of property occasioned by perils which can be insured by an All Risk Property Insurance Coverage Form. Landlord and Tenant grant this release on behalf of themselves and their respective insurance companies and each represents and warrants to the other that it is authorized by its respective insurance company to grant the waiver of subrogation contained in this Paragraph 7.3. This release and waiver shall be binding upon the parties whether or not insurance coverage is in force at the time of the loss or destruction of property referred to in this Paragraph 7.3. 8. CONDEMNATION. If a condemning authority takes the entire Premises or a portion sufficient to render the remainder unsuitable for Tenant's use, then either party may elect to terminate this Lease effective on the date that title passes to the condemning authority. Otherwise, Landlord shall proceed as soon as practicable to restore the remaining Premises to a condition comparable to that existing at the time of the taking. Rent shall be abated during the period of restoration to the extent the Premises are not reasonably usable by Tenant, and rent shall be reduced for the remainder of the term in an amount equal to the reduction in rental value of the Premises caused by the taking. All condemnation proceeds shall belong to Landlord. 9. ASSIGNMENT AND SUBLETTING. 9.1. Tenant shall not assign its interest under this Lease nor sublet the Premises without first obtaining Landlord's consent in writing, which consent shall not be unreasonably withheld or delayed. This provision shall apply to all transfers by operation of law or through waivers and changes in control of Tenant. No assignment shall relieve Tenant of its obligation to pay rent or perform other obligations required by this Lease and no one assignment or subletting shall be a consent to any further assignment or subletting. If Tenant assigns this Lease or sublets the Premises for an amount in excess of the rent called for by this Lease, such excess shall be paid to Landlord promptly as it is received by Tenant. 9.2. Subject to the above limitations on transfer of Tenant's interest, this Lease shall bind and inure to the benefit of the parties, their respective heirs, successors, and assigns. 10. DEFAULT. Any of the following shall constitute a default by Tenant under this Lease: 10.1. Tenant's failure to pay rent or any other charge under this Lease within ten (10) days after it is due, or failure to comply with any other term or condition within twenty (20) days following written notice from Landlord specifying the noncompliance. If such noncompliance cannot be cured within the twenty (20) day period, this provision shall be satisfied if Tenant commences correction within such period and thereafter proceeds in good faith and with reasonable diligence to effect compliance as soon as possible. 10.2. Tenant's insolvency; assignment for the benefit of its creditors; Tenant's voluntary petition in bankruptcy or adjudication as bankrupt, or the appointment of a receiver for Tenant's properties. 11. REMEDIES FOR DEFAULT. In case of default as described in Paragraph 10 above, Landlord shall have the right to the following remedies which are intended to be cumulative and in addition to any other remedies provided under applicable law: 11.1. Terminate this Lease without relieving Tenant from its obligation to pay damages. 11.2. Retake possession of the Premises by summary proceedings or otherwise, in which case Tenant's liability to Landlord for damages shall survive the tenancy. Landlord may, after such retaking of possession, relet the Premises upon any reasonable terms. No such reletting shall be construed as an acceptance of a surrender of Tenant's leasehold interest. 11.3. Recover damages caused by Tenant's default which shall include reasonable attorneys' fees at trial and on any appeal therefrom. Landlord may sue periodically to recover damages as they occur throughout the lease term, and no action for accrued damages shall bar a later action for damages subsequently accruing. Landlord may elect in any one action to recover accrued damages plus damages attributable to the remaining term of the Lease equal to the difference between the rent under this Lease and the reasonable rental value of the Premises for the remainder of the term, discounted to the time of judgment at the rate of six (6%) percent per annum. 11.4. Make any payment or perform any obligation required of Tenant so as to cure Tenant's default, in which case Landlord shall be entitled to recover all amounts so expended from Tenant, plus interest at the rate of ten percent (10%) per annum from the date of the expenditure. 12. SURRENDER ON TERMINATION. 12.1. On expiration or early termination of this Lease, Tenant shall deliver all keys to Landlord, have final utility readings made on the date of move out, and surrender the Premises clean and free of debris inside and out, with all mechanical, electrical, and plumbing systems in good operating condition, all signing removed and defacement corrected, and all repairs called for under commencement of the term, subject only to depreciation and wear from ordinary use. Tenant shall remove all of its furnishings and trade fixtures that remain its property and restore all damage resulting from such removal. Failure to remove said property shall be an abandonment of same, and Landlord may dispose of its in any manner without liability. 12.2 If Tenant fails to vacate the Premises when required, Landlord may elect either to treat Tenant as a tenant from month to month, subject to all provisions of this Lease except the provision for term, or to eject Tenant from the Premises and recover damages caused by wrongful holdover. 13. LANDLORD'S LIABILITY. 13.1. Landlord warrants that so long as Tenant complies with all terms of this Lease it shall be entitled to peaceable and undisturbed possession of the Premises free from any eviction or disturbance by Landlord or persons claiming through Landlord. 13.2. All persons dealing with Pacific Realty Associates, L.P. ("Partnership") must look solely to the property and assets of Partnership for the payment of any claim against Partnership or for the performance or any obligation of Partnership as neither the general partner, limited partners, employees, nor agents of Partnership assume any personal liability for obligations entered into on behalf of Partnership (or its predecessors in interest) and their respective properties shall not be subject to the claims of any person in respect of any such liability or obligation. As used herein, the words "property and assets of partnership" exclude any rights of Partnership for the payment of capital contributions or other obligations to it by the general partner or any limited partner in such capacity. 14. MORTGAGE OR SALE BY LANDLORD; ESTOPPEL CERTIFICATES. 14.1. This Lease is and shall be prior to any mortgage or deed of trust ("Encumbrance") recorded after the date of this Lease and affecting the Building and the land upon which the Building is located. However, if any lender holding an Encumbrance secured by the Building and the land underlying the Building requires that this Lease be subordinate to the Encumbrance, then Tenant agrees that this Lease shall be subordinate to the Encumbrance if the holder thereof agrees in writing with Tenant that so long as Tenant performs its obligations under this Lease no foreclosure, deed given in lieu of the foreclosure, or sale pursuant to the terms of the Encumbrance, or other steps or procedures taken under the Encumbrance shall affect Tenant's rights under this Lease. If the foregoing condition is met, Tenant shall execute the written agreement and any other documents required by the holder of the Encumbrance to accomplish the purposes of this paragraph. 14.2. If the Building is sold as a result of foreclosure of any Encumbrance thereon or otherwise transferred by Landlord or any successor, Tenant shall attorn to the purchaser or transferee, and the transferor shall have no further liability hereunder. 14.3. Either party shall within twenty (20) days after notice from the other execute and deliver to the other party a certificate stating whether or not this Lease has been modified and is in full force and effect and specifying any modifications or alleged breaches by the other party. The certificate shall also state the amount of monthly base rent, the dates to which rent has been paid in advance, and the amount of any security deposit or prepaid rent. Failure to deliver the certificate within the specified time shall be conclusive upon the party of whom the certificate was requested that the Lease is in full force and effect and has not been modified except as may be represented by the party requesting the certificate. 15. DISPUTES - ATTORNEYS' FEES. In the event of any litigation arising out of this lease, the prevailing party shall be entitled to recover from the other party, in addition to all other relief provided by law or judgement, its reasonable costs and attorneys' fees incurred both at and in preparation for trial and any appeal or review, such amount to be as determined by the court(s) before which the matter is hears. Disputes between the parties which are to be litigated shall be tried before a judge without a jury. 16. SEVERABILITY. If any provision of this Lease is held to be invalid, unenforceable or illegal the remaining provisions shall not be affected and shall be enforced to the fullest extent permitted by law. 17. INTEREST AND LATE CHARGES. Rent not paid within ten (10) days of when due shall bear interest from the date due until paid at the rate of ten percent (10%) per annum. Landlord may at its option impose a late charge of $.05 for each $1.00 of rent for rent payments made more than ten (10) days late in addition to interest and other remedies available for default. 18. GENERAL PROVISIONS. 18.1 Waiver by either party of strict performance of any provision of this Lease shall not be a waiver of nor prejudice the party's right otherwise to require performance of the same provision or any other provision. 18.2 Subject to the limitations on transfer of Tenant's interest, this Lease shall bind and inure to the benefit of the parties, their respective heirs, successors, and assigns. 18.3 Landlord shall have the right to enter upon the Premises at any time to determine Tenant's compliance with this Lease, to make necessary repairs to the Building or the Premises, or to show the Premises to any prospective tenant or purchasers, provided that in doing so Landlord shall exercise reasonable efforts to minimize disruptions to Tenant's business. During the last two months of the term, Landlord may place and maintain upon the Premises notices for leasing or sale of the Premises. 18.4 If this Lease commences or terminates at a time other than the beginning or end of one of the specified rental periods, then the rent (including Tenant's share of real property taxes, if any) shall be prorated as of such date, and in the event of termination for reasons other than default all prepaid rent shall be refunded to Tenant or paid on its account. 18.5 Tenant shall within ten (10) days following Landlord's written request deliver to Landlord a written statement specifying the dates to which the rent and other charges have been paid, whether the Lease is unmodified and in full force and effect, and any other matters that may reasonably be requested by Landlord. 18.6 Notices between the parties relating to this Lease shall be in writing, effective when delivered, or if mailed, effective on the second day following mailing, postage prepaid, to the address for the party stated in this Lease or to such other address as either party may specify by notice to the other. Rent shall be payable to Landlord at the same address and in the same manner. 19. ENVIRONMENTAL. 19.1 DEFINITIONS. The term "Environmental Law" shall mean any federal, state or local statute, regulation or ordinance or any judicial or other governmental order pertaining to the protection of health, safety or the environment. The term "Hazardous Substance" shall mean any hazardous, toxic, infectious or radioactive substance, waste and material as defined or listed by any Environmental Law and shall include, without limitation, petroleum oil and its fractions. 19.2 USE OF HAZARDOUS SUBSTANCES. Tenant shall not cause or permit any Hazardous Substance to be spilled, leaked, disposed of or otherwise released on or under the Premises. Tenant may use and sell on the Premises only those Hazardous Substances typically used and sold in the prudent and safe operation of the business permitted by Paragraph 1 of this Lease. Tenant may store such Hazardous Substances on the Premises, but only in quantities necessary to satisfy Tenant's reasonably anticipated needs. Tenant shall comply with all Environmental Laws and exercise the highest degree of care in the use, handling and storage of Hazardous Substances and shall take all practicable measures to minimize the quantity and toxicity of Hazardous Substances used, handled or stored on the Premises. 19.3 NOTICES. Tenant shall immediately notify Landlord upon becoming aware of the following: (a) any spill, leak, disposal or other release of a Hazardous Substance on, under or adjacent to the Premises; (b) any notice or communication from a governmental agency or any other person relating to any Hazardous Substance on, under or adjacent to the Premises; or (c) any violation of any Environmental Law with respect to the Premises or Tenant's activities on or in connection with the Premises. 19.4 SPILLS AND RELEASES. In the event of a spill, leak, disposal or other release of a Hazardous Substance on or under the Premises caused by Tenant or any of its contractors, agents or employees or invitees, or the suspicion or threat of the same, Tenant shall (i) immediately undertake all emergency response necessary to contain, cleanup and remove the released Hazardous Substance, (ii) promptly undertake all investigatory, remedial, removal and other response action necessary or appropriate to ensure that any Hazardous Substances contamination is eliminated to Landlord's reasonable satisfaction, and (iii) provide Landlord copies of all correspondence with any governmental agency regarding the release (or threatened or suspected release) or the response action, a detailed report documenting all such response action, and a certification that any contamination has been eliminated. All such response action shall be performed, all such reports shall be prepared and all such certifications shall be made by an environmental consultant reasonably acceptable to Landlord. 19.5 CONDITION UPON TERMINATION. Upon expiration of this Lease or sooner termination of this Lease for any reason, Tenant shall remove all Hazardous Substances and facilities used for the storage or handling of Hazardous Substances from the Premises and restore the affected areas by repairing any damage caused by the installation or removal of the facilities. Following such removal, Tenant shall certify in writing to Landlord that all such removal is complete. 19.6 ASSIGNMENT AND SUBLETTING. Notwithstanding the provisions of Paragraph 9 of this Lease, it shall not be unreasonable for Landlord to withhold its consent to any assignment, sublease or other transfer of the Tenant's interest in this Lease if a proposed transferee's anticipated use of the Premises involves the generation, storage, use, sale, treatment, release or disposal of any Hazardous Substance. 19.7 Indemnity. 19.7.1 BY TENANT. Tenant shall indemnify, defend and hold harmless Landlord, its employees and agents, any persons holding a security interest in the Premises, and the respective successors and assigns of each of them from and against any and all claims, demands, liabilities, damages, fines, losses, costs (including without limitation the cost of any investigation, remedial, removal or other response action required by Environmental Law) and expenses (including without limitation attorneys' fees and expert fees in connection with any trial, appeal, petition for review or administrative proceeding) arising out of or in any way relating to the use, treatment, storage, generation, transport, release, leak, spill, disposal or other handling of Hazardous Substances on the Premises by Tenant or any of its contractors, agents or employees or invitees. Tenant's obligations under this paragraph shall survive the expiration or termination of this Lease for any reason. Landlord's rights under this paragraph are in addition to and not in lieu of any other rights or remedies to which Landlord may be entitled under this agreement or otherwise. 19.7.2. BY LANDLORD. Landlord shall indemnify, defend and hold harmless Tenant and its employees and agents and the respective successors and assigns of each of them from and against any and all claims, demands, liabilities, damages, fines, losses, costs (including without limitation the cost of any investigation, remedial, removal or other response action required by Environmental Law) and expenses (including without limitation) attorneys' fees and expert fees in connection with any trial, appeal, petition for review or administrative proceeding) arising out of or in any way relating to the actual or alleged use, treatment, storage, generation, transport, release, leak, spill, disposal or other handling of Hazardous Substances on the Premises by Landlord, or any of its contractors, agents or employees or by Landlord's previous tenants of the Premises. Landlord's obligations under this paragraph shall survive the expiration or termination of this Lease for any reason. Tenant's rights under this paragraph are in addition to and not in lieu of any other rights or remedies to which Tenant may be entitled under this Agreement or otherwise. 20. OPTION TO REVIEW. If not then in default, Tenant shall have the option to renew this Lease for two additional 1-year terms by giving Landlord written notice of intent to extend at least 120 days prior to expiration of the proceeding term. All provisions of this Lease shall apply during the extended term, except that rent for the renewal periods shall be as follows: BASE RENT PERIOD PER MONTH --------------------------------------------------------- August 1, 1998 through July 31, 1999 $1,200.00 --------------------------------------------------------- August 1, 1999 through July 31, 2000 $1,250.00 --------------------------------------------------------- If Tenant elects not to exercise the first 1-year renewal period, then the second 1-year renewal period shall be null and void. 21. TENANT IMPROVEMENTS. The Premises shall be taken by Tenant in "as-is" condition with existing improvements configured generally as shown on the attached Exhibit B. IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the respective dates set opposite their signatures below, but this Agreement on behalf of such party shall be deemed to have been dated as of the date first above written. LANDLORD: PACIFIC REALTY ASSOCIATES, L.P., a Delaware limited partnership By: PacTrust Realty, Inc., a Delaware corporation, its General Partner Date: Aug 2 , 1997 By: /s/ David G. Hicks ----------------- ---------------------------- David G. Hicks Vice President Address for Notices/Rent Payments to Landlord: 15350 S.W. Sequoia Parkway, #300-WMPC Portland, OR 97224 TENANT: INTELLIPHONE, INC., A MINNESOTA CORPORATION dba TELCO NORTHWEST, INC. Date: 7/25 , 1997 By: /s/ Melvin Graf ----------------- -------------------------- Name: Melvin Graf ------------------------ Title: Exec V.P. ----------------------- Date: , 1997 By: /s/ Jack Kohler ----------------- -------------------------- Name: Jack Kohler ------------------------ Title: CFO ----------------------- Address for Legal Notices to Tenant: ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- Address for Invoices to Tenant: ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- Tenant Employer Identification Number: ---------------------------------------------- EX-23.2 6 EXHIBIT 23.2 CONSENT OF CERT ACCOUNTANT CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT We hereby consent to the use in this Amendment No. 1 to Registration Statement on Form SB-2, Reg. No. 333-29969, of (i) our report dated March 20, 1997 except for Note 7 for which the date is July 31, 1997 relating to the combined financial statements of Intelliphone, Inc. and Choicetel, Inc., (ii) our report dated April 30, 1997 relating to the statements of revenue and direct expenses for the Telco West, Inc. pay telephone division and the statement of assets acquired by Intelliphone, Inc. on January 2, 1997, (iii) our report dated May 16, 1997 relating to the statements of operations for Computer Assisted Technologies, Inc. and the statement of assets to be acquired and liabilities to be assumed by ChoiceTel Communications, Inc., (iv) the reference to our Firm under the caption "Selected Combined Financial Data" in the Prospectus included therein and (v) the reference to our Firm under the caption "Experts" in such Prospectus. /s/ Schechter Dokken Kanter Andrews & Selcer, Ltd. ---------------------------------------- SCHECHTER DOKKEN KANTER ANDREWS & SELCER, LTD. Minneapolis, Minnesota August 22, 1997 -----END PRIVACY-ENHANCED MESSAGE-----