**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10–KSB**

**(MarkOne)**
| ý | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|--------|-------------------------------------------------------------------------------------------|

** **

**For the Fiscal Year Ended December31, 2001**

 
| o | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|---|-----------------------------------------------------------------------------------------------|

 

**CommissionFile No. 0-230 17**

 

**CHOICETELCOMMUNICATIONS, INC.**

(Name of smallbusiness issuer in its charter)

 
| **Minnesota**                                                   |               | **41-1649949**                        |
|-----------------------------------------------------------------|--------------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |               | (I.R.S. Employer  Identification No.) |
|                                                            |               |                                  |
| **15500 Wayzata Blvd. #1029 Wayzata,  MN 55391**                |
| (Address of  principal executive offices)                       |
|                                                            |               |                                  |
| Issuer’s telephone  number:                                | **(952) 249-1801** |
|                                                                 |                    |                                       |  |

 

Securities registeredpursuant to Section 12(b) of the Act: **None**

 

Securities registered pursuant to Section 12(g) of theAct:

 
| **Title of each class:**     |   | **Name of each exchange on which registered:** |
|------------------------------|--------|------------------------------------------------|
| Common Stock, $.01 par value |   | The NASDAQ SmallCap Market                     |
| Redeemable Warrant           |   | The NASDAQ SmallCap Market                     |

 

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the past 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes ý  No o

 

Check if there isno disclosure of delinquent filers in response to Item 405 of Regulation S-B isnot contained in this form, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB. o

 

The revenues forChoiceTel Communications, Inc. for the fiscal year ended December 31, 2001 were$3,807,325.

 

Theaggregate market value of the voting and non-voting common equity held by non–affiliatesas of March 15, 2002, based on the closing sale price of the Common Stock onsuch date as reported on the NASDAQ SmallCap Market, was $2,233,543.

 

On March 15, 2002, theCompany had outstanding 3,036,735****shares of Common Stock, par value $.01 pershare.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of theRegistrant’s Form SB-2, Registration Number 333-29969, are incorporated byreference into Part II of this Form 10-KSB.

 

Transitional SmallBusiness Disclosure Format (Check one):  Yes o;   No ý

 

 

**TABLE OF CONTENTS**

 
|      |   | PART I                                                                                                            |   |
|-----------|--------|-------------------------------------------------------------------------------------------------------------------|--------|
|      |   |                                                                                                              |   |
| ITEM 1    |   | DESCRIPTION OF  BUSINESS                                                                                          |
| ITEM 2.   |   | DESCRIPTION OF PROPERTY                                                                                           |
| ITEM  3.  |   | LEGAL  PROCEEDINGS                                                                                                |
| ITEM  4.  |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                              |
|      |   |                                                                                                              |
|      |   | PART II                                                                                                           |   |
|      |   |                                                                                                              |   |
| ITEM  5.  |   | MARKET  FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                                                         |
| ITEM  6.  |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF OPERATION                                                   |
| ITEM 7.   |   | FINANCIAL STATEMENTS                                                                                              |
| ITEM  8.  |   | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                             |
|      |   |                                                                                                              |   |
|      |   | PART III                                                                                                          |   |
|      |   |                                                                                                              |   |
| ITEM 9.   |   | DIRECTORS,  EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION  16(a) OF THE EXCHANGE ACT |
| ITEM 10.  |   | EXECUTIVE COMPENSATION                                                                                            |
| ITEM  11. |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                                                   |
| ITEM  12. |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                                   |
| ITEM 13.  |   | EXHIBITS AND  REPORTS ON FORM 8-K                                                                                 |
|      |   |                                                                                                              |
|      |   | SIGNATURES                                                                                                        |
|      |   |                                                                                                              |
|      |   | FINANCIAL STATEMENTS                                                                                              |

 

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Any statementscontained in this Form 10KSB that are not historical facts are forward-lookingstatements.  In particular, statementsusing the words “will,” “plans,” “expects,” “believes,” “anticipates,” or liketerms are by their nature predictions based upon current plans, expectations,estimates, and that could significantly affect outcomes, which may differmaterially from the forward-looking statements.  Specific risks applicable to such forward-looking statementsinclude risks associated with the failure to conclude any proposed agreementand/or changing conditions in the marketplace. Other risks and uncertainties associated with the business of ChoiceTelmay be reviewed in ChoiceTel’s public filings on Form 10-Q and Form 10-K.  Those documents are publicly on file withthe U.S. Securities and Exchange Commission.

 

**PART I**

 

**ITEM 1.****     DESCRIPTIONOF BUSINESS**

 

**General**

 

ChoiceTelCommunications, Inc. (the “Company”) was formed as a Minnesota corporation in****1989.The Company installed its first payphones in early 1990 and as of December 31,2001, had an installed phone base of approximately 1,450 payphones in PuertoRico.

 

In 1999 the Choicetel Board of directors concluded that the pay telephoneindustry was no longer a growth industry and in order to successfully competein the business, a provider must be significantly larger than the Company inorder to take advantage of economies of scale. Management determined that the Company lacked the resources to achievethe size necessary to improve its economies of scale and obtained Shareholderapproval to sell its payphone assets. Accordingly, by December 31, 2001 the Company completed sales ofapproximately 4,000 payphones leaving 1,500 phones located in Puerto Rico.  The Company intends to divest the PuertoRico phones during 2002, although there can be no assurances that an acceptabletransaction will be completed.

 

During 2000 the Company invested $3,331,000 in a majority ownedsubsidiary, Advants, Inc. Advants attempted to develop a profitable model foremploying internet access terminals. Additionally, during November and Decemberof 2001, the Company loaned approximately $175,000 to Advants.  In May 2001, the Company sold its investmentin Advants.  The Company’s financialstatements included the consolidated results of operations of Advants, Inc. upto the date of sale.

** **

On February 28,2002, the Company announced that it had entered into an Agreement and Plan ofReorganization (the “Merger Agreement”), dated as of February 27, 2002, withSontra Medical, Inc., a Delaware corporation. Pursuant to the Merger Agreement, the Company’s recently incorporated,wholly-owned subsidiary, CC Merger Corp. (“Merger Sub”), a Delawarecorporation, will merge with and into Sontra Medical.  Sontra Medical will be the surviving corporation and become awholly-owned subsidiary of ChoiceTel. On the closing date of the Merger, the outstanding shares of SontraMedical’s stock will be converted into the right to receive newly-issued sharesof ChoiceTel common stock based on an exchange ratio of 0.2347 shares ofChoiceTel common stock for each share of Sontra Medical stock.  The exchange ratio is subject to adjustmentin certain circumstances as set forth in the Merger Agreement.  After completion of the transaction, theshareholders of Sontra Medical will own approximately 71% of ChoiceTel and ChoiceTelshareholders will own approximately 29% of ChoiceTel.  Outstanding rights to purchase stock of Sontra 

 

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Medical will also beconverted into the right to purchase ChoiceTel common stock at the sameexchange ratio.The transaction, which is anticipated to be tax-free to theshareholders of both companies, is expected to close late in the second fiscalquarter, subject to regulatory approvals, approval by the shareholders of bothcompanies, and customary closing conditions. The holders of approximately 60%of ChoiceTel’s outstanding shares of common stock have agreed to vote theirshares in favor of the Merger, and the holders of approximately 85% of SontraMedical’s outstanding shares of capital stock have agreed to vote their sharesin favor of the Merger.

 

**Industry Overview**

 

In 1996, callsmade from pay telephones were estimated at $7 billion in annual revenues to theUnited States telecommunications industry. Pay telephones may be “public,”meaning they are owned by local exchange carriers (“LECs”), or “independent,”meaning they are owned and operated by companies independent of the LECs, suchas the Company. Of the approximately 2 million pay telephones operating in theUnited States in 1996, it was estimated that approximately 350,000 wereindependent.

 

Today’stelecommunications marketplace was principally shaped by the 1985 AT&Tdivestiture of the 22 regional Bell operating companies (“RBOCs”), whichprovided local telephone services within their areas of operation. The AT&Tdivestiture and the many regulatory changes adopted by the FCC and stateregulatory authorities in response to the AT&T divestiture resulted in thecreation of new business segments in the telecommunications industry.

 

As part of theAT&T divestiture, the United States was divided into geographic areas knownas local access transport areas or “LATAs.” Telephone service that bothoriginates and terminates within the same LATA (“intraLATA”) is priced based ontariffs filed with and approved by state regulatory authorities. LECs provideintraLATA telephone service to, among others, independent pay telephonecompanies. LECs are generally prohibited from offering or deriving revenues orincome from services between LATAs (“interLATA”). In addition, most stateregulatory authorities require LECs to provide local access line service toindependent pay telephone companies. See “Business – GovernmentRegulation.”

 

Long-distancecarriers provide interLATA service and, in some circumstances, may also providelong-distance service within LATAs. An interLATA long-distance pay telephonecall begins with an originating LEC transmitting the call from the paytelephone that originates the call to a point of connection with along-distance carrier. The long-distance carrier, through its owned or leasedswitching and transmission facilities, transmits the call across itslong-distance network to the LEC serving the local area in which the recipientof the call is located. This terminating LEC then delivers the call to therecipient. Independent PSPs contract with one or more long-distance carriers toprovide long-distance service to their pay telephones.

 

**Business Strategy**

 

The Company hasfocused on identifying payphone sites that have the potential to achieve a highreturn on investment (“ROI”) after depreciating the equipment over the life ofthe phone lease. Although others in the industry have used shorter leases, theCompany’s analysis indicated that a long-term lease was necessary in order toachieve the Company’s ROI objective and to offer a competitive commission tolocation owners (“Site Providers”). Therefore, most of the Company’s paytelephones are placed with Site Providers under leases having terms of tenyears or more.

 

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During 1998, theCompany researched the Puerto Rican payphone market and determined that if andwhen the full benefits of the Telecommunications Act of 1996 are reflected inthe Puerto Rican payphone market, Puerto Rico would be an attractive market forChoiceTel to operate payphones.

 

**Operations**

 

During 2001 theCompany operated, serviced and maintained a system of approximately 1,500 paytelephones, located in Puerto Rico.  Allof the Company’s pay telephones accept coins as payment for local or long–distancecalls and can also be used to place local or long–distance cashlesscalls.

 

*Coin calls*

 

The Company’s paytelephones generate coin revenue primarily from local calls.  Until October 1997, the state publicutilities commissions regulated the cost of local coin calls.  At that time, those rates werederegulated.  Management believes it canmaximize payphone coin revenues by matching the cost of a local call to themarket conditions at the phone.  Theamount charged for a local call is $0.25 for 3 minutes.

 

Long–distancecoin calls are carried by long–distance carriers that have agreed toprovide long–distance service to the Company’s telephones. The majorityof the Company’s phones sell coin long–distance for a rate of $0.25 perminute, with a two-minute minimum. Management believes that its $0.25 perminute long–distance rate results in considerable goodwill and is a pointof differentiation between its phones and its local exchange carrier (“LEC”)competitors.

 

*Non–coin calls*

 

The Company alsoreceives revenue from non–coin, or cashless, calls made from its paytelephones, including credit card calls, calling card calls, collect calls andthird party billed calls. These calls are processed by the Company’s designatedoperator service provider (“OSP”).

 

*Dial–around calls*

 

A Dial–Aroundcall originates from a payphone when the user dials a non–billable accessnumber such as, for example, 1–800–Collect, 1–800–CallATTor 10-10-333, and thereby dials around the Company’s operator serviceprovider.  The user deposits no moneyfor the call; however, the operator service provider is obligated to compensatethe payphone owner for each Dial–Around call.  See “Government Regulation – Dial–AroundCompensation.”

 

**Computer Network and Equipment.**The Company focused its early efforts on building a computer processing networkthat automated many of the operations of managing a pay telephone enterprise.Specialized software was designed and written when it was not available fromindustry suppliers. The Company’s smart phones are part of a centralizednetwork that links all of the Company’s phones in the field with centralprocessors. The system allows the Company to monitor phone call volume,identify malfunctioning equipment, dispatch repair service, schedule efficientcoin collections, calculate commissions, print checks to Site Providers, andgenerate necessary reports that analyze and monitor profitability of thephones.

 

The Companyinstalls pay telephones which it believes incorporate the latest technology.The equipment makes use of microprocessors to provide voice synthesized callinginstructions in English or Spanish, detect and count coins deposited duringeach call, inform the caller at certain intervals of the time remaining on eachcall, and identify the need for and the amount of an additional deposit. Thepay telephones 

 

3

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can be programmed andreprogrammed from the Company’s central computer facilities to update rateinformation or to direct different kinds of calls to particular carriers. TheCompany’s pay telephones can distinguish coins by size and weight, report to aremote location the total coinage in the coin box, perform self–diagnosisand automatically report problems to a pre–programmed service number, andimmediately report attempts of vandalism. The telephones also operate on poweravailable from the telephone lines, thereby avoiding the need for and relianceupon an additional power source at the installation location. The telephonesare designed to have a user–friendly appearance and manner of operationsimilar to LEC–owned pay telephones.

 

**Placement of Pay Telephones.**As of December 31, 2001, the Company’s pay telephone system consisted ofapproximately 1,500 telephones located in Puerto Rico. The following table setsforth certain information as of the dates indicated concerning the number andlocation of pay telephones operated by the Company:

 
| **Number of Pay Telephones** |   |                  |       |                  |       |
|------------------------------|--------|-----------------------|------------|-----------------------|------------|
| **State**                    |   | **December 31, 2001** | ** ** | **December 31, 2000** | ** ** |
| Puerto Rico                  |   | 1,450                 |       | 1,500                 |       |

 

The Company’s ROIfocus has enabled it to profile locations based on the likely profitability ofa location. While this methodology is proprietary, as are the specificlocations under contract, the Company’s locations include a wide variety ofestablishments, such as restaurants, shopping malls, convenience stores,grocery stores, and gas stations. The Company’s pay telephone lease mixincludes indoor phones, walk–up outdoor phones and drive–uppayphones.

 

Agreements withSite Providers to install the Company’s pay telephones (the “Site Agreements”)provide for revenue sharing with Site Providers, typically a commission basedon a negotiated percentage of revenue from the pay telephone. The SiteAgreements give the Company the exclusive right to install pay telephones atthat location and are generally of a ten–year term with automatic renewalprovisions. Further, the Company can typically terminate a Site Agreement on 30days notice to the Site Provider. Site Providers do not generally have theright to terminate a Site Agreement.

 

**Phone Line Rates**.The Company pays local line charges for each of its installed payphones. Theseline charges cover basic service to the telephone as well as the transport oflocal calls.  Line charges are regulatedby state public utilities commissions (“PUCs”).

 

**Marketing.**  The Company engages independent contractorsto locate new sites for payphone installations in Puerto Rico.  Management believes a successful contractingprogram requires identifying good locations, selling Site Providers on thebenefits of the Company’s payphones, and negotiating favorable Site Agreementterms.  Identifying good locations forpayphones is the most important aspect of the Company’s marketing program,which includes an evaluation of population density, calling patterns andneighborhood socio–economic factors. The Company concentrates its effortstowards high traffic locations, lower income neighborhoods, and venues wherepeople expect to find payphones.

 

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The Company promotes its payphone program to SiteProviders by emphasizing service and maintenance. Site Providers generally viewthe payphone as a customer service rather than a profit center. Providingprompt repair and collection services and providing live call placementassistance sometimes is more important in securing the Site Agreement than theamount of commission paid to the Site Provider.

 

**Service and Maintenance.**The Companybelieves it offers many of its Site Providers a higher level of service than isprovided by the LEC competitors, who typically offer low or no commissions anddo not monitor payphone performance. The Company monitors its payphoneselectronically.  The Company uses fulland part–time field service technicians who collect money, clean phonesand respond to trouble calls made by either a consumer or by the telephoneitself as part of its internal diagnostic procedures. Some technicians are alsoresponsible for the installation of new telephones. Due to the ability of the fieldservice technicians to perform multiple service and maintenance functions, theCompany is able to limit the frequency of trips to each pay telephone as wellas the number of employees needed to service the pay telephones.

 

**Competition**

 

The Company competes for pay telephone locations withLECs and other independent pay telephone operators. Most LECs against which theCompany competes and some independent pay telephone companies havesubstantially greater financial, marketing and other resources than theCompany.  In addition, many LECs, facedwith competition from the Company and other independent pay telephonecompanies, have increased their compensation arrangements with Site Providersto offer more favorable commission schedules.

 

The Company believes the principal competitive factorsin the pay telephone business are (i) responsiveness to customer service needs,(ii) the amount of commission payments to a Site Provider, and (iii) thequality of service and the availability of specialized services provided to aSite Provider and telephone users.

 

Commencing in the 1998 fourth quarter, the Companybegan to experience a negative impact on its revenues, which managementbelieves results from increased usage of wireless devices, which appear to bereducing consumers’ reliance on payphones. This trend has continued since then and throughout the payphoneindustry.  This negative impact onrevenue is the primary determinant of the Company’s decision to divest itspayphone assets.

 

**GovernmentRegulation**

 

In January 1996, Congress passed the Telecom Act, acomprehensive telecommunications bill that, in part, dealt with severalconcerns of the independent pay telephone industry. Congress stated that itsintent was to create a “pro–competitive, de–regulatory nationalpolicy framework designed to accelerate rapidly private sector deployment ofadvanced telecommunications and information technologies and services to allAmericans by opening all telecommunications markets to competition.” TheTelecom Act, among other things, requires local telephone companies toeliminate subsidies of their pay telephone services and to treat their own andindependent payphones in a nondiscriminatory manner. Of particular importanceto the Company, the Telecom Act addressed the inherently unfair disadvantageindependent pay telephone companies have in competing with regulatedmonopolies, the compensation of independent pay telephone companies for callsmade from their equipment that previously offered no compensation, and theissue of price regulation of local calls by the various state PUCs.

 

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**Dial–Around Compensation.** Paytelephones are required by the FCC to provide equal Dial–Around access toall long–distance carriers, either by access code (such as “10-10-333”)or by 800 service. Prior to November 1996, the Company received $6 per payphoneper month from long–distance carriers for providing this Dial–Aroundservice. The Telecom Act recognized that it is a burden to payphone companiesto provide such access and that the compensation paid to payphone companies forthis access should be greater. Because the infrastructure to track andcompensate for these calls did not exist at that time, the FCC’s 1996 orderraised the flat rate of compensation for the Dial–Around service toapproximately $45 per payphone per month, based on $0.35 per call times thenational average of 131 monthly Dial–Around calls placed per payphone.

The FCC’s 1996 order implementing the increased Dial–Aroundcompensation was appealed, with the intent of decreasing the amount of Dial–Aroundcompensation mandated by the order. In July 1997, the Court remanded the matterto the FCC for reconsideration of the rate of Dial–Around compensation.The Court found that the per call charge of $0.35 was inappropriate because theFCC did not consider evidence of the differences in the cost of coin calls andDial–Around calls. The long–distance carriers then petitioned theCourt to clarify the effect of the Court’s July decision and to vacate theportion of the FCC’s 1996 order setting the rate of Dial–Aroundcompensation pending the FCC’s re–examination of the Dial–Aroundrate. Further, in a letter to the FCC dated August 15, 1997, AT&Tchallenged the FCC’s authority to order the long–distance carriers tomake any payments during the pendency of the rate determination. The Courtagreed with the long–distance carriers. In a decision dated September 16,1997, the Court vacated the portion of the FCC’s 1996 order setting the rate ofDial–Around compensation pending a new FCC order on remand. Accordingly,the long–distance carriers were not required to make Dial–Aroundpayments to payphone service providers until the FCC issued a new order settingthe Dial– Around rate.

On October 9, 1997, the FCC issued an orderestablishing the Dial–Around rate as of October 7, 1997 at $0.284 percall ($0.35 minus an offset of $0.066 for expenses unique to coin calls) forthe two years beginning October 7, 1997. On May 15, 1998 the Court again remanded the dial-around rate back tothe FCC for further justification of the $0.35 starting point.  On February 4, 1999 the FCC issued an orderreducing the dial around rate to $0.24 retroactive to October 7, 1997 and goingforward until at least January 31, 2002. Further, the FCC indicated that it planned to address Dial-Aroundcompensation for the period from November 7, 1996 through October 6, 1997 in asubsequent order and tentatively concluded that the $0.24 per call rate adoptedon a going forward basis should also govern compensation during the period fromNovember 7, 1996 through October 6, 1997, though it has not yet issued an orderas such.  There can be no assurance thatDial–Around compensation will not be based on a rate that is less thanwhat was previously collected by the Company. Such a rate could have an adverse effect on the results of operationsand financial condition of the Company, which could be material.

 

**Operations of Advants, Inc.**

 

Advants was in the business of providing publicinternet access through internet terminals located in perceived high trafficareas such as gas stations and supermarkets. At December 31, 2000, Advants had 240 terminals in operation.  In February 2001, the Company decided tomake no additional investments or loans to Advants****and since that time,Advants’ operations have substantially decreased.  The Company sold its investment in Advants in May 2001 to a thirdparty for a nominal amount.

 

**Employees**

 

As of December 31, 2001, the Company had 18 full-timeemployees. No employees are covered by a collective bargaining agreement.  The Company believes that its relationshipswith employees are good.

 

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**ITEM 2.****     DESCRIPTIONOF PROPERTY**

 

The Company’s corporate offices are located inapproximately 500 square feet of leased space in Wayzata, Minnesota. The leasefor this property expires in April 2002. The Company also leases approximately2,000 square feet of office space in San Juan Puerto Rico.  The lease for this property expires in April2002 and the Company holds an option to extend the lease for an additionalone-year periods.  The Company believesthat its current facilities are sufficient for its needs for the foreseeablefuture.

 

**ITEM 3.****     LEGALPROCEEDINGS**

 

**Debts of Advants, Inc.**  In November 2000, a suit was commenced inHennepin County, Minnesota District Court by TKI Consulting against Advants,Inc. and Choicetel Communications, Inc. TKI was a software provider to Advants and was suing, for breach ofcontract, for approximately $750,000. While Choicetel Communications was not a party to the contract, theplaintiff was seeking to hold the Company liable for the alleged debt ofAdvants.  On August 31, 2001 the Companyreceived a summary judgement ruling in its favor on TKI’s claims to pierce thecorporate veil. Parties subsequently settled TKI’s promissory estoppelclaim.  An additional suit was filed onApril 3, 2001 in Ramsey County, Minnesota District Court by Tomato Land Displaysseeking damages in excess of $50,000 from Advants for alleged servicesprovided.  While ChoicetelCommunications is not a party to the transaction, the plaintiff is seeking tohold the Company liable for the alleged debt of Advants.

 

**ITEM 4.****     SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

There were no matters submitted to a vote of securityholders during the 4th quarter of the fiscal year ended December 31,2001.

 

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**PART II**

 

**ITEM 5.****     MARKETFOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

The Company’s Common Stock and Redeemable Warrantshave been quoted on the NASDAQ SmallCap Market under the symbol “PHON” and“PHONW”, respectively, since November 10, 1997 . The following table setsforth, for the periods indicated, the range of high and low prices for theCompany’s Common Stock and Redeemable Warrants as reported on the NASDAQSmallCap Market.

 

|           |   | **Common  Stock** |       | **Redeemable  Warrants** |       |
|----------------|--------|-------------------|------------|--------------------------|------------|
|           |   | **High**          |       | **Low**                  |       | **High** |   | **Low** |   |
| **2000:**      |   |              | ** ** |                     | ** ** |   | ** ** |   | ** ** |
| First Quarter  |   | $                 | 8.00       |                     | $          | 2.25 |   | $ | 2.00 |   | $ | 0.06 |   |
| Second Quarter |   | $                 | 5.94       |                     | $          | 2.50 |   | $ | 1.00 |   | $ | 0.25 |   |
| Third Quarter  |   | $                 | 3.75       |                     | $          | 2.13 |   | $ | 0.38 |   | $ | 0.19 |   |
| Fourth Quarter |   | $                 | 3.38       |                     | $          | 1.25 |   | $ | 0.25 |   | $ | 0.06 |   |
|           |   |              |       |                     |       |   |   |   |   |   |   |   |   |
| **2001:**      |   |              | ** ** |                     | ** ** |   | ** ** |   | ** ** |
| First Quarter  |   | $                 | 1.75       |                     | $          | 1.00 |   | $ | 0.09 |   | $ | 0.03 |   |
| Second Quarter |   | $                 | 1.45       |                     | $          | 1.00 |   | $ | 0.10 |   | $ | 0.01 |   |
| Third Quarter  |   | $                 | 1.10       |                     | $          | 0.75 |   | $ | 0.25 |   | $ | 0.01 |   |
| Fourth Quarter |   | $                 | 1.25       |                     | $          | 0.75 |   | $ | 0.09 |   | $ | 0.02 |   |

 

As of  February15, 2002 there were approximately 386 shareholders of the Company’s CommonStock.

 

**ITEM6.****     MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS**

 

*Exceptfor historical information contained in this Report, information contained inthis Form 10-KSB contains “forward–looking statements” within the meaningof the Private Securities Litigation Reform Act of 1995, which can beidentified by the use of forward-looking terminology such as “may”, “will”,“expect”, “plan”, “estimate”, or “continue” or the negative thereof or othervariations thereon or comparable terminology. There are certain important factors that could cause results to differmaterially from those anticipated by some of these forward-looking statements,including without limitation, the effects of changes in economic conditions andcertain of the “Risk Factors” entitled “Competition,” “Other RegulatoryFactors,” “Technological Change and New Services,” “Dependence Upon Third-PartyProviders,” “Service Interruptions; Equipment Failures,” “Reliance on SingleBrand of Payphones,” and “Reliance on Key Personnel” contained in the Company’sProspectus dated November 10, 1997 included in the Registration Statement onForm SB-2 filed with the Securities and Exchange Commission (Registration No.333-29969).  Such “Risk Factors” areincorporated herein by reference. Investors are cautioned that all forward-looking statements involve riskand uncertainty*

 

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**General**

 

The Company derives revenue from three principalsources: coin calls, non-coin calls and dial-around calls.  Coin calls represent calls paid for withcoins deposited in the telephone.  TheCompany recognizes coin revenue in the amount deposited.  Non-coin calls are calls charged to acustomer credit card or billed to the called party (collect calls). These callsare routed to and processed by an operator service provider (“OSP”).Compensation for Dial-Around calls is paid by long-distance carriers whenconsumers access a long-distance carrier directly by dialing an access number,or by dialing an 800 number, or by using a non-billable calling card.

 

The principal costs related to ongoing operation ofthe Company’s payphones include telephone line charges, consisting of paymentsmade by the Company to telephone companies and long-distance carriers foraccess charges and use of their networks; commission payments to SiteProviders; and service, repair and maintenance costs.

 

**Results of Operations**

 

**YearEnded December 31, 2001 compared to Year Ended December 31 2000.**

The after tax income for the year ended December 31,2001 was $1,004,000 compared to a loss of $3,021,000 in the year ended December31, 2000.  This includes the effect ofconsolidating Advants Inc.’s operations with the Company’s payphone activitiesuntil May 2001, when the Company sold its stock holdings to a third party.

 

**Revenue**

Total revenues for the year ended December 31, 2001were $3,807,000 compared to $4,409,000 in the year ended December 31, 2000.During the 2001 period, the company operated an average of 1,450 payphonescompared to an average of 1,425 payphones in the 2000 period.

Advants’ revenue in 2001 was $20,000 compared to$121,000 in 2000.

Coin revenues in 2001 were $2,034,000 compared to$2,050,000 a decrease of $16,000 or 0.1%. Non-coin revenues were $723,000 compared to $903,000 a decrease of$180,000 or 19.9%, and dial around revenues were $425,000 compared to $979,000a decrease of $555,000 or 56.6%.  TheCompany believes the decline in dial around was attributable in part to changesin the way carriers calculated their dial-around payments.  In addition, during 2001, the Companyrecognized $80,000 in dial-around revenue which was collected in 2001 andattributable to previous periods.

During 2000 the Company recognized $232,000 indial-around revenue collected in 2000, attributable to 1998 and 1999.

 

**DirectExpenses**

Total direct expenses for the year ended December 31,2001 were $728,000 compared to $1,730,000 in the year ended December 31,2000.  Direct expenses for Advants were$75,000 compared to $364,000 in 2000.

Telephone line charges were $913,000 in 2001 comparedto $936,000 in 2000 a decrease of $24,000 or 2.5%.  Commissions to site providers were $256,000 in 2001 compared to$316,000 in 2000 a decrease of $59,000 or 18.7%. During 2001 the Company paid$11,000 on direct expenses of disposed routes, and recognized a gain of$527,000 from settling its line charge disputes in Puerto Rico.

During 2000 the Company recognized $46,000 incommission expenses paid on the phones sold in 1999, recognized a $275,000 gainwhen it closed a reserve to settle a tariff dispute with the Puerto RicoTelephone Company and incurred a $250,000 expense to create a reserve to settlepast due balances on invoices for line charges in Puerto Rico.

 

**SalesGeneral and Admin Expenses**

Total sales, general and admin expenses (SG&A) forthe year ended December 31, 2001 were $2,178,000 compared to $4,005,000 in2000.  SG&A expenses for Advantswere $392,000 compared to $2,089,000 in 2000. Service and collection expenses were $551,000 in 2001 compared to $419,000 in 2000 anincrease of $131,000 or 31.4%. The increase was caused by higher removal andrelocation expenses for phones removed during 2001.

 

 

9

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The Company chose to minimize its equipment purchases by relocatingexisting phones, resulting in write-offs of unamortized installationexpenses.  Marketing expenses were$55,000 in 2001 compared to $100,000 in 2000 a decrease of $45,000 or45.1%.  Admin office and overheadexpenses were $295,000 in 2001 compared to $254,000 in 2000 an increase of$41,000 or 16.0%.

 

Corporate SG&A includes the cost of Corporateofficers, the Corporate offices, and other recurring expenses related tomaintaining the corporate entity, such as directors’ compensation, shareholderservices, and audit and reporting expenses. Corporate SG&A in 2001 was $751,000 compared to $633,000 in 2000, anincrease of $118,000 or 18.6%, primarily due to higher legal expenses.  Depreciation and amortization totaled$296,000 in 2001 compared to $287,000 in 2000.

In addition the Companycharged $305,000 to SG&A expenses in 2000 related to payphone routes soldin 1999.

 

**OtherIncome and Expense**

During 2001, other income and expense includes$251,000 earned by Choicetel on its investment in Whitebox Arbitrage TradingLLP, $15,000 interest earned by Choicetel from investing excess cash balancesin money market accounts.  Choicetelalso recognized a gain of $1,894,000 on its disposal of its investment inAdvants.

During 2000, other income and expense includes$203,000 earned by Choicetel on its investment in Whitebox Arbitrage TradingLLP, $108,000 interest earned by Choicetel from investing excess cash balancesin money market accounts.  Choicetelamortized and wrote-off $1,062,000 in goodwill, recognized on Choicetel’sinvestments in Advants, Inc. stock.  TheCompany recognized a $509,000 gain related to settling its sales tax disputewith the Minnesota Department of Revenue, took a $1,033,000 charge related tothe sale of payphone assets, and recognized a $66,000 deferred loss on the saleof payphone assets.  Advants recognizedan impairment loss of $2,744,000 principally on kiosks, computer hardware andsoftware developed to be run on internet access terminals.

 

**YearEnded December 31, 2000 compared to Year Ended December 31 1999**.

 

Net loss for the year ended December 31, 2000 was$4,915,000 compared to a loss of $17,000 in the year ended December 31,1999.  This includes the effect ofconsolidating Advants Inc.’s operations with the Company’s payphone activities.

 

**Revenue**

 

Total revenues for the year ended December 31, 2000were $4,409,000 compared to $10,381,000 in the year ended December 31,1999.  During the 2000 period, thecompany operated an average of 1,425 payphones compared to an average of 4,500payphones in the 1999 period.  Thephones in service declined primarily because of sales 3 sales transactionscovering approximately 3,900 phones. The Company sold approximately 950payphones located in Oregon, Idaho, Washington and Nevada in November of 1999,approximately 2,000 phones located in Minnesota, Wisconsin and New York inDecember 1999, and approximately 950 payphones located in Pennsylvania, NewJersey and Delaware in February 2000.

Advants had 25 terminals in service at the end of 1999and 210 in service at the end of 2000.  Total revenue in 2000 was $121,000 compared to $5,000 in 1999.

Coin revenues in 2000 were $2,226,000 compared to$7,171,000 a decrease of $4,945,000 or 69.0%, which is attributable to the saleof payphone assets.  Non-coin revenueswere $927,000 compared to $1,375,000 a decrease of $449,000 or 32.6%, and dialaround revenues were $903,000 compared to $1,830,000 a decrease of $927,000 or50.6%.  The declines are alsoattributable to the sale of payphone assets. In addition, during 2000 the Company recognized 

 

10

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$232,000 in dial-around revenue collected in 2000, attributable to 1998and 1999 activities, but not recognized in those periods.

 

**DirectExpenses**

Total direct expenses for the year ended December 31,2000 were $1,730,000 compared to $4,895,000 in the year ended December 31,1999.  Direct expenses for Advants were$364,000 compared to $10,000 in 1999.

Telephone line charges were $1,018,000 in 2000compared to $3,223,000 in 1999 a decrease of $2,204,000 or 68.4%.  Commissions to site providers were $327,000in 2000 compared to $1,663,000 in 1999 a decrease of $1,336,000 or 80.3%.  Both decreases are attributable to the saleof payphone assets.  During 2000 theCompany recognized $46,000 in commission expenses paid on the phones sold in1999, recognized a $275,000 gain when it closed a reserve to settle a tariffdispute with the Puerto Rico Telephone Company and incurred a $250,000 expenseto create a reserve to settle past due balances on invoices for line charges inPuerto Rico.

 

**SalesGeneral and Admin Expenses**

Total sales, general and admin expenses (SG&A) forthe year ended December 31, 2000 were $4,005,000 compared to $5,170,000 in1999.  SG&A expenses for Advantswere $2,089,000 compared to $292,000 in 1999.

Service and collection expenses were $465,000 in 2000compared to $1,665,000 in 1999 a decrease of $1,200,000 or 72.1%.  Marketing expenses were $100,000 in 2000compared to $469,000 in 1999 a decrease of $369,000 or 78.8%.  Admin office and overhead expenses were$285,000 in 2000 compared to $736,000 in 1999 a decrease of $451,000 or61.3%.  All decreases were attributableto closing regional offices in conjunction with sales of payphone assets.  Corporate SG&A includes the cost ofCorporate officers, the Corporate offices, and other recurring expenses relatedto maintaining the corporate entity, such as directors’ compensation,shareholder services, and audit and reporting expenses.  Corporate SG&A in 2000 was $633,000compared to $837,000 in 1999, a decrease of $204,000 or 24.4%, primarily due tohaving fewer corporate officers in 2000 compared to 1999. Depreciation andamortization totaled $287,000 in 2000 compared to $1,401,000 in 1999.

In addition the Company charged $305,000 to SG&Aexpenses in 2000 related to payphone routes sold in 1999.

 

**OtherIncome and Expense**

During 2000, other income and expense includes$203,000 earned by Choicetel on its investment in Whitebox Arbitrage TradingLLP, $113,000 interest earned by Choicetel from investing excess cash balancesin money market accounts.  Choicetelamortized and wrote-off $1,062,000 in goodwill, recognized on Choicetel’sinvestments in Advants, Inc. stock.  TheCompany recognized a $509,000 gain related to settling its sales tax disputewith the Minnesota Department of Revenue, took a $1,033,000 charge related tothe sale of payphone assets, and recognized a $66,000 deferred loss on the saleof payphone assets.

Advants recognized an impairment loss of $2,744,000principally on kiosks, computer hardware and software developed to be run oninternet access terminals.

During 1999, other income and expense included$476,000 interest expense and $66,000 in deferred operating losses.

 

**Subsidiary Activities in PublicInternet Access Terminals — Advants, Inc.**

 

During 1998, the Company began test marketing publicinternet access terminals, which allowed customers to access the internet whileaway from their home or office computer. In 1999, the Company engaged consultants to devise a strategy to developthe market more quickly by bringing into the business joint venture partnerswho might benefit in owning part of a network of public internetterminals.  Subsequently, theseactivities were transferred to a newly formed subsidiary, Advants, Inc., andseveral consultants were engaged as full-time management employees of Advants.

 

In November 1999 Advants completed a private placementof common stock raising approximately $525,000 to 

 

11

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implement the strategy.  Subsequent to the private placement, and the issuance of sharesto the initial management team at Advants, Inc., Choicetel’s equity position inAdvants, Inc. stood at 60%.  The Companyprovided additional equity funding in 2000 of approximately $3.3 million andthereby increased its equity position to approximately 80%.  Additionally the Company loanedapproximately $175,000 to Advants.  InMay 2001 the Company sold its investment in Advants to a third party for anominal amount.

 

**Sales Tax Contingency**

 

The Company, based on its analysis of the published regulations of theMinnesota Department of Revenue at the time of its inception, did not remit anysales tax payments to the State of Minnesota. In 1996, the Company learned that the opinion of the Department was thatcalls from payphones were subject to state sales tax.  Management was of the view that the payphone service it providedwas not subject to sales tax and challenged the imposition of the tax.  Nonetheless, on December 31, 1996, theCompany established a reserve of $865,000 for the years prior thereto andreserved an additional $243,000, $254,000 and $213,500 for the year endedDecember 31, 1997, 1998 and 1999 respectively.  During 2000 the Company reached a settlement with the MinnesotaDepartment of Revenue covering all sales tax liability for the period theCompany operated payphones in the State of Minnesota. As a result of thesettlement, the Company recognized a $500,000 gain.

 

**Tariff Dispute with Puerto RicoTelephone Company**

** **

During 1998, the Company began researching the Puerto Rico payphonemarket.  It was determined that althoughthe Puerto Rico Telecommunications Regulatory Board (TRB) had not required thePuerto Rico Telephone Company (PRTC) to provide “competition neutral” serviceto independent payphone providers at a “cost-based rate”, the Company wasconfident that enforcement of the Telecom Act would eventually correct thissituation.  In March 1998, the Companybegan contracting with local businesses to provide payphone service.  In April 1998 the Company received its firstpayphone lines from the PRTC and installed its first payphones. As of December31, 2001 the Company has installed approximately 1,500 payphones.

 

In March 1998, the Company received verbal assurances from the PuertoRican Telephone Company (PRTC) that pay phone lines would be made available andthe charge would be a flat rate of $50.00 per month per line.  However, when phone bills were received inthe Company’s offices, they included additional charges ranging from $0.13 to$0.26 per call.  At that time, the PRTCand the Company agreed that until a final decision was reached on a rate casebefore the TRB, the Company would not pay the per call charges.  On May 27, 1998 the TRB ruled on that ratecase and instructed the PRTC to reduce the per call charges to between $.01 and$.03 per call, depending upon the routing of the call.  The PRTC appealed the ruling to the Court ofAppeals, which upheld the ruling.  ThePRTC then appealed the ruling to the Puerto Rico Supreme Court, which uponagreeing to hear the case, issued a stay of execution until the court renderedits decision on the appeal.  In June2000 the Puerto Rico Supreme Court upheld the Court of Appeals ruling andordered the PRTC to obey the TRB rate regulation orders.

 

From April through September 1998, the Company accrued unpaid linecharges at the rate of $0.15 per call. In October 1998, the Company reduced the rate it accrued line charges to$0.06 per call based upon progress of this case.  At December 31, 1999 the Company had accrued unpaid line chargesof $356,000. In 2000 the Company reversed all accruals for unpaid line chargesrelated to this matter.

 

During the period of March 1998 to May 2000 when line rates were indispute, the Company was unable to reconcile 

 

12

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outstanding invoice balances with PRTC.  In October 2001, the PRTC agreed to pay a $325,000 refund to theCompany in the form of a service credit. At December 31, 2000 the Company hadaccrued a $250,000 liability to settle this dispute.

In February 2002, the TRB issued a clarification of its earlier rateregulation orders and informed the PRTC that the mandated rate was not to beincreased for additional charges for such items as subscriber linecharges.  The Company believes it haspaid approximately $400,000 in subscriber line charges and touchtone fees andis in the process of filing for a refund. No receivable amounts have been included in the Company's financialstatements, and there can be no assurances that any amount will be realized bythe Company in connection with this refund claim.

 

**Liquidityand Capital Resources**

For the year ended December 31, 2001 the Company’s operatingactivities provided  $579,000, theproceeds from sales of equipment were $20,000, the proceeds from a bank note(by Advants) secured $104,000 and the proceeds from the sale of Advants stockwas less than $1,000.  Purchases ofequipment used $41,000, payments to secure site locations used $55,000.  In addition $437,000 was used to repurchasecommon stock resulting in a $170,000 increase in cash balances.

 

**ITEM7.****     FINANCIALSTATEMENTS**

 

The followingfinancial information of the Company is included as follows:

 
|                                                                                             | **Page** |
|--------------------------------------------------------------------------------------------------|----------|
| Report of Independent Auditors                                                                   | F-1      |
| Consolidated Financial Statements:                                                               |     |
| Consolidated Balance Sheets for Years Ended December 31, 2001 and  2000                          | F-2      |
| Consolidated Statements of Operations for Years Ended December 31,  2001 and 2000                | F-3      |
| Consolidated Statements of Shareholders’ Equity for Years Ended  December 31, 2001 and 2000 | F-4      |
| Consolidated Statements of Cash Flows for Years Ended December 31,  2001 And 2000                | F-5      |
| Notes to Consolidated Financial Statements                                                       | F-7      |

 

**ITEM8.****     CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

13

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**PART III**

 

**ITEM 9****.  DIRECTORS, EXECUTIVEOFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OFTHE EXCHANGE ACT**

 

**Directors**

 

The followingdiscussion sets forth certain information concerning the directors of theCompany.

 

*Gary S. Kohler* isa founder of the Company and since its inception in 1989 has served as Chairmanof the Board of Directors. Mr. Kohler is a partner and portfolio manager for Pyramid Trading,L.P., which he joined in October 1999. Prior to that he served as a managing director of Second Avenue CapitalManagement, a money management company, from December 1998 through September1999.  Prior to that he served asPresident of Kohler Capital Management from October 1997 through November 1998.From July to October 1997, Mr. Kohler was a partner in Tarmachan Holdings,Inc.  From 1984 through June 1997, Mr.Kohler was Vice President and Portfolio Manager at Okabena Company.  Mr. Kohler serves on the Board of Printware,Inc., a publicly traded printing equipment manufacturer.  Mr. Kohler has an M.B.A. degree fromCornell University and a B.A. degree from the University of Minnesota.  Mr. Kohler is the brother ofJack S. Kohler.

 

*Jeffrey R. Paletz*is a founder of the Company, has been a director since its inception and hasbeen President since 1991.  Prior tofounding the Company in 1989, Mr. Paletz was employed for 13 years atSportsman’s Guide, a mail order retailer, where he oversaw the computer dataoperations.  Mr. Paletz has aB.S. degree in Business from the University of Minnesota.

 

*Robert A. Hegstrom*became a director of the Company in June 1997. In January 1997, Mr. Hegstrom joined Northwest Mortgage Services,Inc. and served as Chairman, President and Chief Executive Officer until itssale in March 2000.  Prior to that, hewas a private investor for two years and, from October 1979 to January 1995, hewas Executive Vice President of Green Tree Financial Corporation.  Mr. Hegstrom is also a director of ExcelsiorFinancial and Dermatrends Corp.

 

*Michael Wigley*became a director of the Company in January 1998.  Since 1989 Mr. Wigley has been President and Chief ExecutiveOfficer of Great Plains Companies, Inc., a diversified holding company. Mr.Wigley has an M.B.A. from Harvard Business School, a M.S. from StanfordUniversity and B.S. and B.C.E degrees from the University of Minnesota.  Mr. Wigley serves on the Boards of severalprivate companies and non-profit organizations, and is a regent of LutherCollege.

 

**BoardCommittees and****Actions**

 

During calendaryear 2001, the Board of Directors met 4 times and each director attended allmeetings. The Board of Directors has two standing committees, a Compensation Committee and an Audit Committee.During 2001, the Compensation Committee met once and the Audit Committee mettwice.

 

The CompensationCommittee reviews and make recommendations to the Board of Directors regardingsalaries, compensation and benefits of executive officers of the Company andadministers the Company’s 1997 Long-Term Incentive and Stock Option Plan. TheCommittee members are Robert A. Hegstrom, Gary S. Kohler and Jeffrey R. Paletz.

 

The AuditCommittee is responsible for recommending the appointment of a firm ofindependent public accountants to audit the books and records of the Companyand its subsidiaries, reviews the internal and external financial reporting ofthe Company and the scope of the independent audit.  The Committee members are Michael Wigley, Robert A. Hegstrom andGary S. Kohler.

 

The Board ofDirectors acts as the nominating committee. See “Information Concerning directors and Nominees — Nomination ofDirectors”

 

14

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**Director Compensation**

 

No cashcompensation is paid to the Company’s directors.  Independent, non-employee directors (Mr. Hegstrom andMr. Wigley) upon reelection receive an option to purchase $75,000 ofCommon Stock, valued as of the annual shareholders meeting.  The options are pursuant to the Company’s1997 Long-Term Incentive and Stock Option Plan, are exercisable upon grant andhave five-year term and an exercise price equal to the fair market value of theCommon Stock as of the date of grant. No options will be issued to employee directors for their service asdirectors.

 

**Nomination of Directors**

 

The Board ofDirectors acts as the nominating committee for selecting the Board’s nomineesfor election as directors.  The Boarddoes not intend to consider nominees recommended by shareholders.  Directors of the Company are electedannually to serve until the next annual meeting of shareholders or until theirsuccessors are duly elected.  TheCompany knows of no arrangements or understandings between a director ornominee and any other person pursuant to which he has been selected as adirector or nominee. The only family relationship between any of the nominees,directors or executive officers of the Company is between Gary S. Kohler andJack S. Kohler, who are brothers.

 

**Executive****Officers**

 

The followingdiscussion sets forth information about the executive officers of the Companywho are not directors.

 

*Jack S. Kohler* hasbeen 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 andaccounting positions at Cargill, Inc. Mr. Kohler has a B.S. degree in Accounting from the University ofMinnesota. Mr. Kohler is the brother of Gary S. Kohler.

 

**ITEM10. EXECUTIVE COMPENSATION**

 

The followingtable and accompanying footnotes set forth certain summary information,relating to the three years ended December 31, 1999, 2000 and 2001, withrespect to the Company’s Chief Executive Officer.

** **
|                             |   | **Annual Compensation** |   | **Long-Term  Compensation  Awards** |    |         |   |
|----------------------------------|--------|-------------------------|--------|-------------------------------------|---------|--------------|--------|
| **Name and Principal  Position** |   | **Year**                |   | **Salary($)**                       |    | **Bonus($)** |   | **Other Annual Compensation($)** |   | **Securities  Underlying  Options/SARs(#)** |   | **All Other   Compensations** |   |
| Jeffrey R. Paletz,  President    |   | 2001                    |   | $                                   | 108,000 |         |   |   | — |   | — |   | — |   |
|                             |   | 2000                    |   | 108,000                             |    | $            | 32,000 |   | — |   | — |   | — |   |
|                             |   | 1999                    |   | 108,375                             |    |         |   | — |   | — |   | — |   |
|                                  |        |                         |        |                                     |         |              |        |  |  |  |  |  |  |  |  |

 

**Agreementswith Executives**

** **

The Company has noemployment agreements.

 

15

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**ITEM11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The followingtable sets forth information as of December 31, 2001, regarding thebeneficial ownership of shares of Common Stock of the Company by each directorand executive officer of the Company, by all directors and executive officersof the Company as a group, and by each shareholder known by the Company to ownbeneficially more than five percent (5%) of the outstanding shares of theCompany’s Common Stock. Unless otherwise noted, each person or group identifiedpossesses sole voting and investment power with respect to such shares.

 
| **Name and Address of Beneficial Owner**                                          |   | **Number of  Shares  Beneficially Owned (1)** |   | **Percent of  Outstanding Shares (2)** |   |
|-----------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|----------------------------------------|--------|
| Andrew Redleaf (3)  3033 Excelsior Blvd.  Minneapolis, Minn.  55416          |   | 445,063                                       |   | 14.7                                   | %      |
|                                                                              |   |                                          |   |                                   |   |
| Perkins Capital  Management (3)  730 East Lake Street  Wayzata, Minn.  55391 |   | 292,936                                       |   | 9.6                                    | %      |
|                                                                              |   |                                          |   |                                   |   |
| Melvin Graf (4)  2601 Abbey Hill Dr.  Minnetonka, Minn. 55305                     |   | 213,334                                       |   | 7.0                                    | %      |
|                                                                              |   |                                          |   |                                   |   |
| ***Directors, nominees and executive officers:***                                 |   |                                          |   |                                   |   |
|                                                                              |   |                                          |   |                                   |   |
| Gary S. Kohler (5)(6)(9)                                                          |   | 918,460                                       |   | 30.3                                   | %      |
| Jeffrey R. Paletz                                                                 |   | 342,358                                       |   | 11.3                                   | %      |
| Jack S. Kohler (6)                                                                |   | 264,500                                       |   | 8.2                                    | %      |
| Robert A. Hegstrom (7)                                                            |   | 171,341                                       |   | 5.4                                    | %      |
| Michael Wigley (7)(8)(9)                                                          |   | 448,666                                       |   | 13.6                                   | %      |
| All directors, nominees and executive officers as a group (5 persons)             |   | 1,517,318                                     |   | 54.9                                   | %      |

 

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(1)     Each person has sole voting power and soledispositive power with respect to all outstanding shares, except as otherwisenoted or disclosed by the beneficial owners in the Schedule 13G filingdescribed at footnote 3 below.

 

(2)     Based on 3,035,735 shares outstanding atMarch 31, 2001.  Such amount does notinclude 2,038,139 shares of common stock issuable upon exercise of stockoptions and warrants.  Each figureshowing the percentage of outstanding shares owned beneficially has beencalculated by treating as outstanding and owned the shares which could bepurchased by the indicated person(s) within 60 days upon the exercise ofexisting stock options or warrants.

 

(3)               Reflectsinformation included on either Schedules 13D or 13G filed with the Securitiesand Exchange Commission.

 

(4)               Includes 13,334shares held by Miriam Graf.  Mr. Grafdisclaims beneficial ownership of such shares.

 

(5)               Includes 40,000shares held by Gary S. Kohler as custodian for the benefit of hischildren.  Mr. Kohler disclaimsbeneficial ownership of such shares.

 

(6)               Includes 200,000shares currently owned by Gary S. Kohler, who has granted Jack S. Kohler anoption to purchase such shares.

 

(7)               Includes options toacquire 166,341 shares from the Company.

 

(8)               Includes 95,325shares currently owned by Gary S. Kohler, who has granted Michael Wigley anoption to purchase such shares.

 

(9)               Includes 17,000shares held by Mike Wigley’s three children. Mr. Wigley disclaims beneficial ownership of such shares.

** **

16

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**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Section 16(a) of theSecurities Exchange Act of 1934, as amended, requires the Company’s officers,directors, and persons who own more than ten percent of a registered class ofthe Company’s equity securities to file certain reports regarding ownership of,and transactions in, the Company’s securities with the Securities and ExchangeCommission (the “SEC”).  These officers,and directors and stockholders are also required by SEC rules to furnish theCompany with copies of all Section 16(a) reports that are filed with theSEC.  Based solely on a review of copiesof such forms received by the Company, the Company believes that for the yearended December 31, 2001, all Section 16(a) reports required to be filed by theCompany’s executive officers, directors and 10% stockholders were filed on atimely basis, except a Form 4 filed by Jeff Paletz on June 14, 2001 which wasdue no later than June 10, 2001.

 

**ITEM12. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

The informationconcerning certain relationships and related transaction is set forth in theProxy Statement under the heading “Certain Transactions”, which information isincorporated herein by reference. The Company has an arrangement withGary S. Kohler, the Company’s Chairman of the Board, pursuant to whichMr. Kohler advises the Company’s management on an as-needed basis.  The consulting fees paid to Mr. Kohlerfor rendering this service for the year ended December 31, 2001 totaled$28,800.

 

From July 1, 2000 untilJanuary 2, 2002, the Company invested $2,000,000 in Whitebox Arbitrage Fund,LLC.  Andrew Redleaf, a holder of morethan 10% of the Company’s stock, is President of Whitebox Advisors, Inc., whichis the general partner of Whitebox Arbitrage Fund, LLC.

 

17

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**PART IV**

 

**ITEM13.  EXHIBITS AND REPORTS ON FORM 8-K**

 

**(a)           Exhibits.  See “Exhibit Index” on page following signatures.**

 

**(b)           Reports on Form 8–K**

 

18

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**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|   | **ChoiceTel  Communications, Inc.** |
|--------|-------------------------------------|
|   |                                |
|   | Date: March 29, 2002                |
|   | By /s/                              | Gary S. Kohler |   |
|   |                                | Gary S. Kohler |

 

Chairman of the Board of Directors

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 

Power of Attorney

 

Each person whose signature appears below constitutesand appoints **Jeffrey R. Paletz** and **Jack S. Kohler** as his true and lawfulattorneys-in-fact and agents, each acting alone, with full power ofsubstitution and resubstitution, for him and in his name, place and stead, inany and all capacities, to sign any and all amendments to this Annual Report onForm 10-KSB and to file the same, with all exhibits thereto, and otherdocuments in connection therewith, with the Securities and Exchange Commission,granting unto said attorneys-in-fact and agents, each acting alone, full powerand authority to do and perform each and every act and thing requisite andnecessary to be done in and about the premises, as fully to all intents andpurposes as he might or could do in person, hereby ratifying and confirming allsaid attorneys-in-fact and agents, each acting alone, or his substitute orsubstitutes, may lawfully do or cause to be done by virtue thereof.

 

| **Signature** |               | **Title** |                                        | **Date** |
|---------------|--------------------|-----------|---------------------------------------------|----------|
|          |               |      |                                        |     |
| /s/           | Gary S. Kohler     |      | Director                                    |     | March 29, 2002 |
|          | Gary S. Kohler     |      |                                        |     |   |
|          |               |      |                                        |     |
| /s/           | Jeffrey R. Paletz  |      | President and  Director                     |     | March 29, 2002 |
|          | Jeffrey R. Paletz  |      |                                        |     |   |
|          |               |      |                                        |     |
| /s/           | Jack S. Kohler     |      | Vice President  and Chief Financial Officer |     | March 29, 2002 |
|          | Jack S. Kohler     |      |                                        |     |   |
|          |               |      |                                        |     |
| /s/           | Robert A. Hegstrom |      | Director                                    |     | March 29, 2002 |
|          | Robert A. Hegstrom |      |                                        |     |   |
|          |               |      |                                        |     |
| /s/           | Michael Wigley     |      | Director                                    |     | March 29, 2002 |
|          | Michael Wigley     |      |                                        |     |   |

 

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**SECURITIES AND EXCHANGE COMMISSION**

**Washington D.C.**

 

**EXHIBIT INDEX TO FORM 10-KSB**

** **

**OF**

 

**CHOICETEL COMMUNICATIONS, INC.**

 

For the FiscalYear Ended December 31, 2001

 

Commission File Number:0-230 17

 
| **Exhibit**

**No.** |   | **Description**                                                                                                                                                                                                                                                                           |
|----------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                                                                                                                                                      |
| 2.1                  |   | Agreement and Plan of Reorganization, dated as of  February 27, 2002, by and among Sontra Medical, Inc., CC Merger Corp. and  ChoiceTel Communications, Inc (incorporated by reference to Exhibit 2.1 of  the Registrant’s 8-K filed on March 5, 2002.)                              |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 3.1                  |   | Amended and Restated Articles of Incorporation  (incorporated by reference to Exhibit 3.1 of the Registrant’s Registration  Statement on Form SB-2; Registration No. 333-29969)                                                                                                      |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 3.2                  |   | Bylaws (incorporated by reference to Exhibit 3.2 of  the Registrant’s Registration Statement on Form SB-2; Registration No.  333-29969)                                                                                                                                              |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 4.2                  |   | Form of Redeemable Warrant Agreement with Norwest  Bank Minnesota, National Association, including certificate representing the  Redeemable Warrants (incorporated by reference to Exhibit 4.2 of the  Registrant’s Registration Statement on Form SB-2; Registration No. 333-29969) |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 10.1*                |   | 1997 Long-Term Incentive and Stock Option Plan  (incorporated by reference to Exhibit 10.1 of the Registrant’s Registration  Statement on Form SB-2; Registration No. 333-29969)                                                                                                     |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 10.3 *               |   | Bonus Program (incorporated by reference to Exhibit  10.3 of the Registrant’s Registration Statement on Form SB-2; Registration  No. 333-29969)                                                                                                                                      |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 10.17*               |   | Employment Agreement with Jeffrey R. Paletz, dated  as of April 15, 1997 (incorporated by reference to Exhibit 10.17 of the  Registrant’s Registration Statement on Form SB-2; Registration No. 333-29969)                                                                           |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 10.19*               |   | Employment Agreement with Jack S. Kohler, dated as  of April 15, 1997 (incorporated by reference to Exhibit 10.19 of the  Registrant’s Registration Statement on Form SB-2; Registration No. 333-29969)                                                                              |
|                 |   |                                                                                                                                                                                                                                                                                      |
| 24                   |   | Power of Attorney (included on the signature page of  this Form 10-KSB)                                                                                                                                                                                                                   |

 

----

*   Management contract orcompensatory plan or arrangement.

** Filed herewith.

 

----

 

 

 

 

 

 

 

 

INDEPENDENT AUDITORS’ REPORT

 

 

Board of Directors

ChoiceTelCommunications, Inc.

Minneapolis,Minnesota

 

 

We have auditedthe accompanying consolidated balance sheets of ChoiceTel Communications, Inc.and Subsidiary as of December 31, 2001 and 2000, and the related consolidatedstatements of operations, shareholders’ equity, and cash flows for the yearsthen ended.  These financial statementsare the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates of America. Those standards require that we plan and perform the auditto obtain reasonable assurance about whether the financial statements are freeof material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion,the financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of ChoiceTel Communications, Inc.and Subsidiary as of December 31, 2001 and 2000, and the consolidated resultsof its operations and its cash flows for the years then ended, in conformitywith accounting principles generally accepted in the United States of America.

 

 

 

 

 
| /s/ Schechter Dokken Kanter Andrews & Selcer Ltd. |   |
|-------------------------------------------------------|--------|

 

 

Minneapolis,Minnesota

March 14, 2002

 

F-1

----

 
|                                             |   |          |                | **CONSOLIDATED** |   |
|--------------------------------------------------|--------|---------------|---------------------|------------------|--------|
| **CHOICETEL COMMUNICATIONS, INC.**               |   |          | **BALANCE  SHEETS** |             |
| **AND SUBSIDIARY**                               |   |          |                | **DECEMBER  31** |   |
|                                             |   |          |                |             |   |
|                                             |   | **2001**      |                | 2000             |   |
|                                             |   |          |                |             |   |
| ***Assets:***                                    |   |          |                |             |   |
| Current assets:                                  |   |          |                |             |   |
| Cash and cash equivalents                        |   | **$**         | **751,059**         |             | $      | 580,926 |   |
| Investments                                      |   | **2,454,084** |                | 2,203,306        |   |
| Receivables                                      |   | **278,066**   |                | 521,072          |   |
| Prepaid and other assets                         |   | **325,354**   |                | 228,054          |   |
| Deferred taxes                                   |   | **493,000**   |                | 1,873,000        |   |
|                                             |   |          |                |             |   |
| Total current assets                             |   | **4,301,563** |                | 5,406,358        |   |
|                                             |   |          |                |             |   |
| Property and equipment, net                      |   | **1,843,101** |                | 2,307,683        |   |
| Other assets                                     |   | **67,292**    |                | 30,591           |   |
|                                             |   |          |                |             |   |
|                                             |   | **$**         | **6,211,956**       |             | $      | 7,744,632 |   |
|                                             |   |          |                |             |   |
| ***Liabilities and shareholders’ equity:*** |   |          |                |             |   |
| Current liabilities:                             |   |          |                |             |   |
| Accounts payable                                 |   | **$**         | **15,468**          |             | $      | 1,788,235 |   |
| Accrued expenses                                 |   | **241,920**   |                | 588,888          |   |
|                                             |   |          |                |             |   |
| Total current liabilities                        |   | **257,388**   |                | 2,377,123        |   |
|                                             |   |          |                |             |   |
| Shareholders’ equity                        |   | **5,954,568** |                | 5,367,509        |   |
|                                             |   |          |                |             |   |
|                                             |   | **$**         | **6,211,956**       |             | $      | 7,744,632 |   |

 

 

 

 

 

See notes toconsolidated financial statements.

 

 

 

F-2

----

 
|                                           |   |                         |          | **CONSOLIDATED** |   |
|------------------------------------------------|--------|------------------------------|---------------|------------------|--------|
| **CHOICETEL COMMUNICATIONS, INC.**             |   | **STATEMENTS OF OPERATIONS** |          |
| **AND SUBSIDIARY**                             |   | **YEARS ENDED DECEMBER 31**  |          |
|                                           |   |                         |          |             |   |
|                                           |   | **2001**                     |          | 2000             |   |
|                                           |   |                         |          |             |   |
| Service revenue                                |   | **$**                        | **3,807,325** |             | $      | 4,408,542 |   |
| Cost of service                                |   | **1,416,455**                |          | 1,883,101        |   |
|                                           |   |                         |          |             |   |
| Gross margin                                   |   | **2,390,870**                |          | 2,525,441        |   |
|                                           |   |                         |          |             |   |
| Selling, general and administrative expenses   |   | **2,177,647**                |          | 4,004,614        |   |
| Loss from impairment and sale of assets        |   |                         |          | 3,776,783        |   |
| Amortization and write-off of goodwill         |   |                         |          | 1,061,735        |   |
| Adjustment of accrued sales tax liability      |   |                         |          | (508,876         | )      |
| Deferred loss                                  |   |                         |          | 66,280           |   |
|                                           |   |                         |          |             |   |
| Total operating expenses                       |   | **2,177,647**                |          | 8,400,536        |   |
|                                           |   |                         |          |             |   |
| Operating income (loss)                        |   | **213,223**                  |          | (5,875,095       | )      |
|                                           |   |                         |          |             |   |
| Other income                                   |   |                         |          |             |   |
| Gain on sale of subsidiary, net                |   | **1,893,515**                |          |             |   |
| Investment income                              |   | **250,778**                  |          | 203,306          |   |
| Interest income, net                           |   | **15,327**                   |          | 107,807          |   |
|                                           |   |                         |          |             |   |
|                                           |   | **2,159,620**                |          | 311,113          |   |
|                                           |   |                         |          |             |   |
| Income (loss) before income taxes              |   | **2,372,843**                |          | (5,563,982       | )      |
|                                           |   |                         |          |             |   |
| Provision for income tax (benefit)             |   | **1,368,734**                |          | (1,751,000       | )      |
|                                           |   |                         |          |             |   |
| Income (loss) before minority interest         |   | **1,004,109**                |          | (3,812,982       | )      |
|                                           |   |                         |          |             |   |
| Minority interest                              |   |                         |          | 791,654          |   |
|                                           |   |                         |          |             |   |
| Net income (loss)                              |   | **$**                        | **1,004,109** |             | $      | (3,021,328 | ) |
|                                           |   |                         |          |             |   |
| Earnings (loss) per share:                     |   |                         |          |             |   |
| Net income (loss), basic and diluted           |   | **$**                        | **.31**       |             | $      | (0.93 | ) |
|                                           |   |                         |          |             |   |
| Weighted average number of shares outstanding: |   |                         |          |             |   |
| Basic                                          |   | **3,220,728**                |          | 3,245,016        |   |
|                                           |   |                         |          |             |   |
| Diluted                                        |   | **3,235,985**                |          | 3,245,016        |   |

 

 

 

 

 

See notes toconsolidated financial statements.

 

F-3

----

 
| **CONSOLIDATED STATEMENTS**                             |   |
|---------------------------------------------------------|--------|
| **OF SHAREHOLDERS’ EQUITY**                        |   |
| **CHOICETEL  COMMUNICATIONS, INC.**                     |   |   |   |   |   | **YEARS ENDED** |   |
| **AND  SUBSIDIARY**                                     |   |   |   |   |   | **DECEMBER 31, 2001 AND 2000** |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
|                                                    |   | **15,000,000 shares authorized, $.01 par** |   |   |   |   |   |   |   |
|                                                    |   | **Shares** |   | **Amount** |   | **Additional**

**paid-in**

**capital** |   | **Accumulated**

**deficit** |   | **Total** |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Balance, January 1, 2000                                |   | 2,926,906 |   | $ | 29,269 |   | $ | 6,181,621 |   | $ | (36,019 | ) | $ | 6,174,871 |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of  minority shares of subsidiary              |   |   |   |   |   | 135,000 |   |   |   | 135,000 |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of  stock options for services                 |   |   |   |   |   | 38,000 |   |   |   | 38,000 |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of  common stock                               |   | 618,793 |   | 6,188 |   | 2,285,741 |   |   |   | 2,291,929 |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Repurchase of  common stock                             |   | (137,618 | ) | (1,376 | ) | (249,587 | ) |   |   | (250,963 | ) |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                |   |   |   |   |   |   |   | (3,021,328 | ) | (3,021,328 | ) |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Balance,  December 31, 2000                             |   | 3,408,081 |   | 34,081 |   | 8,390,775 |   | (3,057,347 | ) | 5,367,509 |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of stock in connection with sale of subsidiary |   | **20,000** |   | **200** |   | **19,800** |   |   |   | **20,000** |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of  common stock                               |   | **100** |   | **1** |   | **124** |   |   |   | **125** |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Repurchase of  common stock                             |   | **(392,386** | **)** | **(3,924** | **)** | **(433,251** | **)** |   |   | **(437,175** | **)** |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                              |   |   | ** ** |   |   |   |   | **1,004,109** |   | **1,004,109** |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Balance,  December 31, 2001                             |   | **3,035,795** |   | **$** | **30,358** |   | **$** | **7,977,448** |   | **$** | **(2,053,238** | **)** | **$** | **5,954,568** |   |

 

 

 

See notes toconsolidated financial statements.

 

F-4

----

 

 
|                                                                                      |   | **CONSOLIDATED**             |          |
|-------------------------------------------------------------------------------------------|--------|------------------------------|---------------|
| **CHOICETEL COMMUNICATIONS, INC.**                                                        |   | **STATEMENTS OF CASH FLOWS** |          |
| **AND SUBSIDIARY**                                                                        |   | **YEARS ENDED DECEMBER 31**  |          |
|                                                                                      |   |                         |          |   |   |
|                                                                                      |   | **2001**                     |          | **2000** |   |
|                                                                                      |   |                         |          |   |   |
| Cash flows from operating activities:                                                     |   |                         |          |   |   |
| Net income (loss)                                                                         |   | **$**                        | **1,004,109** |   | $ | (3,021,328 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |   |                         |          |   |   |
| Deferred taxes                                                                            |   | **1,380,000**                |          | (1,571,000 | ) |
| Depreciation                                                                              |   | **277,286**                  |          | 392,055 |   |
| Amortization and goodwill write-off, net                                                  |   | **18,299**                   |          | 770,542 |   |
| Stock based compensation issued                                                           |   |                         |          | 38,000 |   |
| Stock issued in connection with sale of subsidiary                                        |   | **20,000**                   |          |   |   |
| Minority interest loss                                                                    |   |                         |          | (791,654 | ) |
| (Gain) loss on disposals, net                                                             |   | **(1,893,515**               | **)**         | 1,449,336 |   |
| Impairment loss                                                                           |   |                         |          | 2,744,184 |   |
| Increase in value of investments                                                          |   | **(250,778**                 | )             | (203,306 | ) |
| Changes in operating assets and liabilities:                                              |   |                         |          |   |   |
| Coin in phone                                                                             |   |                         |          | 98,455 |   |
| Income tax receivable                                                                     |   |                         |          | (180,000 | ) |
| Receivables                                                                               |   | **242,870**                  |          | 942,634 |   |
| Prepaid expenses                                                                          |   | **(97,300**                  | **)**         | (33,745 | ) |
| Accounts payable                                                                          |   | **(78,162**                  | **)**         | 1,723,548 |   |
| Accrued expenses                                                                          |   | **(43,959**                  | **)**         | (1,758,870 | ) |
| Income tax payable                                                                        |   |                         |          | (221,000 | ) |
|                                                                                      |   |                         |          |   |   |
| Net cash provided by operating activities                                                 |   | **578,850**                  |          | 377,851 |   |
|                                                                                      |   |                         |          |   |   |
| Cash flows from investing activities:                                                     |   |                         |          |   |   |
| Purchase of:                                                                              |   |                         | ** **    |   |   |
| Site contracts                                                                            |   | **(55,000**                  | **)**         |   |   |
| Equipment                                                                                 |   | **(40,681**                  | **)**         | (3,836,481 | ) |
| **S**hort-term  investments                                                               |   |                         |          | (2,000,000 | ) |
| Proceeds from sale of equipment and rental contracts                                      |   | **19,514**                   | ** **    | 2,071,200 |   |
| Proceeds from sale of Advants                                                             |   | **500**                      | ** **    |   |   |
|                                                                                      |   |                         | ** **    |   |   |
| Net cash used in investing activities                                                     |   | **(75,667**                  | **)**         | (3,765,281 | ) |
|                                                                                      |   |                         |          |   |   |
| Cash flows from financing activities:                                                     |   |                         |          |   |   |
| Proceeds from issuance of:                                                                |   |                         |          |   |   |
| Common stock in subsidiary                                                                |   |                         |          | 225,000 | ** ** |
| Common stock                                                                              |   | **125**                      |          | 2,106,308 |   |
| Proceeds of note payable                                                                  |   | **104,000**                  |          |   |   |
| Repurchase of common stock                                                                |   | **(437,175**                 | **)**         | (250,963 | ) |
| Principal payments on long-term debt                                                      |   |                         |          | (387,475 | ) |
| Payment in notes payable                                                                  |   |                         |          | (47,858 | ) |
|                                                                                      |   |                         | ** **    |   |   |
| Net cash provided by (used in) financing activities                                       |   | **(333,050**                 | **)**         | 1,645,012 |   |
|                                                                                           |        |                              |               |  |  |  |  |

 

See notes toconsolidated financial statements.

 

F-5

----

 

 
|                                                                                 |   |                         |          | **CONSOLIDATED** |    |
|--------------------------------------------------------------------------------------|--------|------------------------------|---------------|------------------|---------|
| **CHOICETEL COMMUNICATIONS, INC.**                                                   |   | **STATEMENTS OF CASH FLOWS** |          |
| **AND SUBSIDIARY**                                                                   |   | **YEARS ENDED DECEMBER 31**  |          |
|                                                                                 |   |                         |          |             |    |
|                                                                                 |   | **2001**                     |          | **2000**         |    |
|                                                                                 |   |                         |          |             |    |
| Net increase (decrease) in cash and cash equivalents                                 |   | **$**                        | **170,133**   |             | $       | (1,742,418 | ) |
|                                                                                 |   |                         |          |             |    |
| Cash and cash equivalents, beginning                                                 |   | **580,926**                  |          | 2,323,344        |    |
|                                                                                 |   |                         |          |             |    |
| Cash and cash equivalents, ending                                                    |   | **751,059**                  |          | $                | 580,926 |   |
|                                                                                 |   |                         |          |             |    |
| Supplemental disclosure of cash flow information:                                    |   |                         |          |             |    |
| Cash paid for interest                                                               |   |                         |          | $                | 4,584   |   |
|                                                                                 |   |                         |          |             |    |
| Supplemental cash flow information:                                                  |   |                         |          |             |    |
|                                                                                 |   |                         |          |             |    |
| Non-cash investing and financing activities:                                         |   |                         |          |             |    |
|                                                                                 |   |                         |          |             |    |
| Note payable settled partially by prepaid expenses                                   |   |                         |          | $                | 302,142 |   |
|                                                                                 |   |                         |          |             |    |
| Common stock issued in non-cash transactions                                         |   | **$**                        | **20,000**    |             | $       | 185,621 |   |
|                                                                                 |   |                         |          |             |    |
| The gain on  disposal of subsidiary includes the elimination of the following items: |   |                         |          |             |    |
|                                                                                 |   |                         |          |             |    |
| Accounts payable                                                                     |   | **$**                        | **1,694,605** |             |    |   |
| Accrued expenses                                                                     |   | **303,009**                  |          |             |    |
| Sale of equipment                                                                    |   | **(219,986**                 | )             |             |    |
| Issuance of notes payable                                                            |   | **104,000**                  |          |             |    |
| Receivables and other                                                                |   | **11,387**                   |          |             |    |
|                                                                                 |   |                         |          |             |    |
|                                                                                 |   | **$**                        | **1,893,015** |             |    |   |

 

 

 

See notes toconsolidated financial statements.

 

F-6

----

 

|                                | NOTES TO  CONSOLIDATED      |
|-------------------------------------|-----------------------------|
|                                | FINANCIAL  STATEMENTS       |
| **CHOICETEL  COMMUNICATIONS, INC.** | YEARS ENDED                 |
| **AND SUBSIDIARY**                  | DECEMBER  31, 2001 AND 2000 |

 
| 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   | Nature of business and  discontinued operations: |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| Nature of business:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |                                             |
| ChoiceTel Communications, Inc. and Subsidiary (the Company) includes  a formerly 80% owned subsidiary, Advants, Inc.

(formerly Public Internet Access Holdings Corporation).  The Company’s primary business is  providing pay phone related 

service in Puerto Rico. ChoiceTel Communications, Inc. increased its  ownership interest in Advants, Inc. (Advants) from 60%

to 80% during 2000 mainly by providing a significant investment in  Advants common stock.  Advants was in  the business of

providing public internet access through kiosks located in perceived  high traffic areas such as gas stations and supermarkets.

Advants had minimal revenue and incurred large expenses for hardware  and software in development.  Advants’  total

liabilities exceed total assets by approximately $1.7 million as of  December 31, 2000.  Advants was sold  in May 2001. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                             |
| Discontinued operations:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |                                             |
| The Company decided to discontinue its pay phone operations in  December 1999 (measurement date).  The  Company had

estimated it would realize an overall gain on the disposal of  discontinued operations. In 1999, the Company sold all of its

phones in two territories in separate transactions totaling  approximately $6,400,000. In March 2000, the Company sold its

operations in the Eastern United States for approximately $2,000,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                             |
| During 2001 the Company unsuccessfully sought buyers for its Puerto Rican  operations. Consequently, the Company has

reclassified items reported in 2000 as components of discontinued  operations as continuing since the attempted disposal period

had spanned multiple periods. There is no change in the Company’s  total reported earnings from 2000 as a result of this

change and the Company continues to make efforts to sell the  operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                             |
| 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   | Summary of significant  accounting policies:     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| Principles of  consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |                                             |
| The consolidated financial statements for 2001 and 2000 include the  accounts of ChoiceTel Communications, Inc., and its 80%

owned subsidiary, Advants.   All material intercompany balances have been eliminated. The Company  sold its investment in

Advants in May 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                             |
| Concentration of credit  risk:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                             |
| The Company maintains its cash in bank deposit accounts at financial  institutions where balances, at times, may exceed federally

insured limits.  It is  management’s opinion that the risk of loss is minimal.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                             |
| The Company has an investment with Whitebox Statistical Arbitrage  Fund, LP, a fund with a stated objective of providing

superior short-term risk adjusted returns through the use of a  statistical arbitrage trading strategy. This investment is neither

guaranteed nor insured. Consequently, the entire investment is  subject to market risk.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                             |
| Property and equipment  and depreciation methods:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |                                             |
| Property and equipment is recorded at cost. Depreciation is being  provided by the straight-line method over the estimated useful

lives generally between 5 and 10 years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |        |                                                  |        |  |  |

 

 

 

F-7

----

 
| Impairment of assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| During 2000 the Company determined that substantially all of the  assets of Advants and related goodwill had become

impaired, as defined by Statement of Financial Accounting Standards  No. 121 (SFAS No. 121) *Accounting for Impairment*

*of  Long-Lived Assets and for Long-Lived Assets to Be Disposed Of*.  The impaired assets included public access  Internet

kiosks, related equipment and capitalized software development costs.  Pursuant to the requirements of SFAS No. 121, the

Company had recorded an impairment loss on these assets.                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |   |
| Income taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |   |
| Income taxes are provided for the tax effects of transactions  reported in the financial statements and consist of taxes currently

due plus deferred taxes.   Deferred taxes are recognized from differences between the tax basis  of assets and liabilities and

their reported amounts in the financial statements.  The deferred tax assets and liabilities  represent the future tax expense of

those differences.                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |   |
| For 2001, the Company will file a consolidated tax return that  includes Advants from January 1 through May 8, 2001. For tax

purposes, the Company has made an election that will enable the  Company to carry forward substantially all of the net

operating losses incurred by Advants from its inception through May  8, 2001.                                                                                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |   |
| For 2000, the Company filed a consolidated tax return that includes  Advants for the period August 1, 2000 through December

31, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |   |
| Stock-based  compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |   |
| The Company accounts for its stock options in accordance with the  provisions of Accounting Principles Board Opinion No. 25

(APB No. 25), *Accounting for Stock Issued to Employees*,  and related interpretations.  As such,  compensation expense is

recorded on the date of grant only if the current market price of the  underlying stock exceeded the exercise price. The

Company has also adopted SFAS No. 123, *Accounting for Stock-Based  Compensation*, which permits entities to recognize

the expense over the vesting period of the fair value of all  stock-based awards on the date of grant.            |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |   |
| Alternatively, SFAS No. 123 allows entities to continue to apply the  provisions of APB No. 25 and provide proforma net

income disclosures for employee stock option grants as if the  fair-value based method defined in SFAS No. 123 had been

applied.  The Company has  elected to continue to apply the provisions of APB No. 25 and provide the  proforma disclosure

provisions of SFAS No. 123.                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |   |
| Earnings per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
| The Company adopted SFAS No. 128, *Earnings per Share*.  Basic earnings per common share are based  on the weighted

average number of common shares outstanding in each year.  Diluted earnings per common share assume  that outstanding

common shares were increased by shares issuable upon exercise of  stock options and warrants for which market price

exceeds exercise price, less shares which could have been purchased  by the Company with related proceeds.   This

calculation added 15,257 and zero shares to the diluted weighted  average shares outstanding for 2001 and 2000,

respectively. |

 

 

F-8

----

 
| Earnings per share  (continued):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |                                          |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|
| Stock options and warrants for 1,085,282 shares for December 31,  2000, were not used in the calculation of diluted earnings

per share because they were antidilutive.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                          |
| Cash equivalents:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                          |
| The Company  considers all highly liquid investments with original maturities of three  months or less to be cash equivalents.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                          |
| Use of estimates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                          |
| The preparation  of financial statements in conformity with generally accepted accounting  principles requires management to

make estimates  and assumptions that affect certain reported amounts and disclosures.  Accordingly, the actual amounts

could differ  from those estimates. Any adjustments applied to estimated amounts are  recognized in the year in which such

adjustments are  determined.  Estimates that are  susceptible to significant change are contingencies, asset impairment, and

deferred taxes.                                                                                                                                                                                                                                                                                   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                          |
| 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   | Related party  transactions:                  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| During 2000, the Company invested $2,000,000 in Whitebox Arbitrage  Fund, LP.  A holder of more than 10%  of the

Company’s common stock is the President of Whitebox Advisors, Inc.,  which is the general partner of Whitebox Arbitrage

Fund, LP.  The value of the  investment at December 31, 2001 is $2,454,084. The investment was redeemed by  the Company

on January 1, 2002 for cash of the same amount.                                                                                                                                                                                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                          |
| 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   | Write-off of goodwill  and asset impairments: |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| During the fourth quarter of 2000, management determined that the  Company’s efforts to penetrate the public access Internet

kiosk business were not going to generate a cash flow sufficient to  support the cost of the related assets.   Consequently, the

Company wrote-off goodwill generated in 2000 of approximately  $1,062,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                          |
| Additionally, in the fourth quarter of 2000, the Company recorded  asset impairments of $2,744,184.   These asset impairments

were required to reduce the carrying value of the Company’s Internet  kiosks, related equipment and related capitalized

software development costs.   The reported values of the profitable assets were determined from an  analysis of projected

undiscounted cash flows, which were no longer deemed adequate to  support the value of the goodwill or of the assets. 

Reported values of most of the assets were based upon salvage values  net of costs required for disposal.   These write-downs

relate to substantially all of the assets of Advants and related  goodwill generated by common stock purchases of Advants by 

ChoiceTel Communications, Inc. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |                                          |
| 5.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   | Property and equipment:                       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |        |                                               |  |  |  |  |  |

 
|                      |   | **2001**      |          | 2000      |   |
|---------------------------|--------|---------------|---------------|-----------|--------|
|                      |   |          |          |      |   |
| Office equipment          |   | **$**         | **97,868**    |      | $      | 129,603 |   |
| Telephones and  equipment |   | **2,335,739** |          | 2,346,048 |   |
| Kiosks                    |   |          |          | 154,500   |   |
| Accumulated  depreciation |   | **(590,506**  | )             | (372,468  | )      |
|                      |   | **1,843,101** |          | 2,257,683 |   |
| In process software       |   |          |          | 50,000    |   |
|                      |   |          |          |      |   |
|                      |   | **$**         | **1,843,101** |      | $      | 2,307,683 |   |

 

 

F-9

----

 
| 6.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   | Commitments and  contingencies: |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| Phone locations:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| The Company rents phone locations from merchants and property owners  under varying lease terms, usually ten years,

generally cancelable by the Company upon 30 days notice.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| Consulting agreement:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| The Company paid a director/shareholder $28,800 for certain  consulting services in each year 2001 and 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| Leases:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| The Company leases its corporate   offices and its Puerto Rico offices under a lease which became  month-to-month in 2002.

Rent expense was $44,132 and $121,878 for the years ended December  31, 2001 and 2000, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| Contingencies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| Sales tax:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| During 2000, the Company reached a settlement with the Minnesota  Department of Revenue covering all sales tax liabilities

during the period the Company operated pay phones in the State of  Minnesota.  As a result of the  settlement the Company

recognized a $509,000 gain.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| Lawsuits:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| The Company has been named in several lawsuits for unpaid bills of  Advants, as well as for claims of promissory estoppel and

other matters.  The Company  intends to defend these lawsuits and believes that the likelihood of an  unfavorable outcome is

remote. Further, the Company does not believe that any loss pursuant  to these claims will have a material effect on the

financial statements. Consequently, no provision has been made in the  financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| The Company was  unable to reconcile outstanding invoice balances during the period of March  1998 to May 2000 because

line rates were  in dispute with PRTC. At December 31, 2000 the Company had accrued a $250,000  liability which was

believed to be  adequate to cover any losses resulting from resolution of this matter. During  2001, the matter was resolved

with a credit of  $325,000 issued to the Company by PRTC which the Company is using to offset  future phone bills.  The

unused credit  approximates $177,000 at December 31, 2001 and is included in prepaid  expenses.                                                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| In 2000, the Company entered into an agreement to settle certain  other claims by issuing 46,560 shares of common stock and a

$175,000 payment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                            |
| 7.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   | Stock options and  warrants:    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                            |
| On April 11, 1997, the  Company’s Board of Directors adopted the 1997 Long-Term Incentive and Stock  Option Plan (the Plan).  The Plan  provides for the issuance of incentive stock options and non-qualified stock  options to key employees and directors of the Company.  The total number of shares of common stock  authorized and reserved for issuance under the Plan is 350,000 shares.  The exercise price for each incentive  stock option granted under the Plan may not be less than the fair market  value of the common stock on the date of the grant, except in the case of  incentive stock options.  In this case  the optionee owns greater than 10% of the total combined voting power of all  classes of capital stock of the Company, in which the exercise price may not  be less than 110% of the fair market value of the common stock on the date of  the grant. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |        |                                 |        |  |

 

 

 

F-10

----

 
| The exercise price for  each non-qualified option may not be less than 85% of the fair market value  of the common stock on the date of grant. Unless otherwise determined by the  Board, incentive options granted under the Plan have a maximum duration of 10  years, non-qualified options and awards have a maximum duration of 15  years.   Vesting is based on such terms and conditions as the Board shall  determine. |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| The proforma effects of  options issued to employees are as follows:                                                                                                                                                                                                                                                                                                                                                                     |

 

 

|                                   |   | **As  reported** |          | **Proforma** |   |
|----------------------------------------|--------|------------------|---------------|--------------|--------|
| 2001:                                  |   |             |          |         |   |
| Net income                             |   | **$**            | **1,004,109** | ** **   | **$**  | **973,252** | ** ** |
|                                   |   |             |          |         |   |
| Income per share, primary and diluted. |   | **$**            | **.31**       |         | **$**  | **.30** |   |
|                                   |   |             |          |         |   |
| 2000:                                  |   |             |          |         |   |
| Net loss                               |   | $                | (3,021,328    | )            | $      | (3,025,968 | ) |
|                                   |   |             |          |         |   |
| Loss per share                         |   | $                | (.93          | )            | $      | (.93 | ) |

 

Assumptions usedto estimate the fair value of options issued to employees using the BlackScholes model are as follows:

 

|                     |   | **2001**   |   | 2000    |   |
|--------------------------|--------|------------|--------|---------|--------|
|                     |   |       |   |    |   |
| Estimated:               |   |       |   |    |   |
| Risk free  interest rate |   | **3.00**   | %      | 5.13    | %      |
| Life                     |   | **1 year** |   | 4 years |   |
| Volatility               |   | **98.64**  | %      | 0.00    | %      |
| Dividends                |   | **0.00**   | %      | 0.00    | %      |

 

 

Information withrespect to options outstanding as of December 31 is summarized as follows:

 
|                                                            |   | **2001**      |              | **2000**                                   |     |
|-----------------------------------------------------------------|--------|---------------|-------------------|--------------------------------------------|----------|
|                                                            |   | **Shares**    |              | **Weighted  average**

**exercise  price** |     | Shares |   | Weighted average

exercise  price |   |
|                                                            |   |          |              |                                       |     |   |   |   |   |
| Outstanding at beginning of year                                |   | **345,824**   | ** **        | **$**                                      | 3.02     |   | 252,666 | ** ** | **$** | 3.21 | ** ** |
| Granted                                                         |   | **142,858**   | ** **        | **0.92**                                   |     | 123,158 |   | 3.18 |   |
| Exercised                                                       |   |          |              |                                       |     |   |   |   |   |
| Forfeited                                                       |   | **(90,000**   | **)**             | **2.36**                                   |     | (30,000 | ) | 5.75 |   |
|                                                            |   |          |              |                                       |     |   |   |   |   |
| Outstanding at end of year                                      |   | **398,682**   | ** **        | **$**                                      | **2.29** |   | 345,824 |   | $ | 3.02 |   |
|                                                            |   |          |              |                                       |     |   |   |   |   |
| Range of  exercise prices of options outstanding at December 31 |   | **$**         | **0.92 -  $5.00** |                                       |     |   | $ | 2.25 - $5.00 |   |   |   |
|                                                            |   |          |              |                                       |     |   |   |   |   |
| Options exercisable at year end                                 |   | **398,682**   |              |                                       |     | 342,491 |   |   |   |
|                                                            |   |          |              |                                       |     |   |   |   |   |
| Weighted average remaining life                                 |   | **3.0 years** |              |                                       |     | 2.4 years |   |   |   |
|                                                                 |        |               |                   |                                            |          |  |  |  |  |  |  |  |  |

 

 

 

F-11

----

 
| At December 31, the  Company has the following outstanding warrants: |
|----------------------------------------------------------------------|

 
|                                       |   |          |   |      |   | Weighted average |   |
|--------------------------------------------|--------|---------------|--------|-----------|--------|------------------|--------|
|                                       |   | **2001**      |   | 2000      |   | exercise price   |   |
|                                       |   |          |   |      |   |             |   |
| Issued as part of units in public offering |   | **800,000**   |   | 800,000   |   | $                | 9.50   |   |
|                                       |   |          |   |      |   |             |   |
| Granted to underwriter in public offering  |   | **160,000**   |   | 160,000   |   | 8.95             |   |
|                                       |   |          |   |      |   |             |   |
| Granted to underwriter in private offering |   | **629,457**   |   | 629,457   |   | 4.95             |   |
|                                       |   |          |   |      |   |             |   |
| Granted to investment relations company    |   | **50,000**    |   | 100,000   |   | 7.00             |   |
|                                       |   |          |   |      |   |             |   |
| Outstanding at year end                    |   | **1,639,457** |   | 1,689,457 |   |             |   |
|                                       |   |          |   |      |   |             |   |
| Warrants exercisable at year end           |   | **1,639,457** |   | 1,689,457 |   | $                | 7.68   |   |
|                                       |   |          |   |      |   |             |   |
| Weighted average remaining life            |   | **1.7 years** |   | 2.9 years |   |             |   |

 

 

 

F-12

----

 

 
| 8. |   | Income taxes: |   |
|----|--------|---------------|--------|

 

 

|                                                 |   | **2001**      |          | 2000       |   |
|------------------------------------------------------|--------|---------------|---------------|------------|--------|
|                                                 |   |          |          |       |   |
| Provisions (benefits) calculated at statutory rates: |   |          |          |       |   |
| Deferred:                                            |   |          |          |       |   |
| Federal                                              |   | **$**         | **910,000**   |       | $      | (1,925,000 | ) |
| State                                                |   | **160,000**   |          | (339,000   | )      |
|                                                 |   |          |          |       |   |
|                                                 |   | **1,070,000** |          | (2,264,000 | )      |
|                                                 |   |          |          |       |   |
| Valuation  allowance                                 |   | **299,000**   |          | 513,000    |   |
|                                                 |   |          |          |       |   |
|                                                 |   | **$**         | **1,369,000** |       | $      | (1,751,000 | ) |

 

The deferred taxasset and deferred tax liability consist of the following at December 31:

 

|                             |   | **2001**      |          | 2000      |   |
|----------------------------------|--------|---------------|---------------|-----------|--------|
|                             |   |          |          |      |   |
| Deferred tax  asset (liability): |   |          |          |      |   |
| Net operating  loss carryforward |   | **$**         | **1,705,000** |      | $      | 981,000 |   |
| PRTC settlement                  |   |          |          | 100,000   |   |
| Depreciation                     |   | **(401,000**  | )             | (230,000  | )      |
| Amortization                     |   | **34,000**    |          | 425,000   |   |
| Accrued expenses                 |   | **20,000**    |          | 25,000    |   |
| Impairment loss                  |   |          |          | 1,138,000 |   |
|                             |   | **1,358,000** |          | 2,439,000 |   |
| Valuation allowance              |   | **865,000**   |          | 566,000   |   |
|                             |   |          |          |      |   |
|                             |   | **$**         | **493,000**   |      | $      | 1,873,000 |   |

 

The Company hasavailable loss carryforwards of $4,265,000 that expire beginning in 2020.

 

Utilization of thedeferred tax asset of $493,000 disclosed above is dependent on future taxableprofits in excess of profits arising from existing taxable temporarydifferences.  Assets have beenrecognized based on management’s estimate of projected future taxable incomeprior to the anticipated transaction discussed in Footnote 10 below.  The 2001 valuation considers the ability ofSontra Medical to utilize the net operating loss carryforwards after its mergerwith the Company.

 
| 9. |   | Financial instruments: |   |
|----|--------|------------------------|--------|

 

The Company’sfinancial instruments recorded on the balance sheet include cash, investments,accounts receivable and accounts payable. Because of their short maturity, thecarrying amount of cash, investments, accounts receivable and accounts payableapproximates fair value.

 
| 10. |   | Subsequent events: |   |
|-----|--------|--------------------|--------|

 

On February 28,2002, the Company announced that it had entered into an Agreement Plan ofReorganization (the “Merger Agreement”), dated as of February 27, 2002, withSontra Medical, Inc., a Delaware development stage medical technology corporation.Pursuant to the Merger Agreement, the Company’s recently incorporated,wholly-owned subsidiary, CC Merger Corp., a Delaware corporation, will mergewith and into Sontra Medical. Sontra Medical will be the surviving corporationand become a wholly-owned subsidiary of ChoiceTel. On the closing date of theMerger, the outstanding shares of Sontra Medical’s stock will be converted intothe right to receive newly-issued shares of ChoiceTel common stock based on anexchange ratio of 0.2347 shares of ChoiceTel common stock for each share ofSontra Medical stock.

 

 

F-13

----

 

 

The exchange ratiois subject to adjustment in certain circumstances as set forth in the MergerAgreement. After completion of the transaction, the shareholders of SontraMedical will own approximately 71% of ChoiceTel and ChoiceTel shareholders willown approximately 29% of ChoiceTel. Outstanding rights to purchase stock ofSontra Medical will also be converted into the rights to purchase ChoiceTelcommon stock at the same exchange ratio.

 

The transaction,which is anticipated to be tax-free to the shareholders of both companies, andwhich will be accounted for as a reverse merger, is expected to close late inthe second fiscal quarter, subject to regulatory approvals, approval by theshareholders of both companies, and customary closing conditions. The holdersof approximately 60% of ChoiceTel’s outstanding shares of common stock haveagreed to vote their shares in favor of the Merger, and the holders ofapproximately 85% of Sontra Medical’s outstanding shares of capital stock haveagreed to vote their shares in favor of the Merger.

 

 

 

 

F-14

----