SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to sections 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 2001
OR
[ ] Transition report pursuant to sections 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from _____ to _____
Commission file number 333-33639
EVERCOM, INC.
(Exact name of Registrant as specified in its charter)
Delaware 75-2680266
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8201 Tristar Drive
Irving, Texas 75063
(972) 988-3737
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of June 30, 2001, 30,770 shares of Class A common stock, par value $0.01
per share, and 400 shares of Class B common stock, par value $0.01 per share,
were issued and outstanding.
1
DOCUMENTS INCORPORATED BY REFERENCE
Exhibits to the following documents filed with the Securities and Exchange
Commission have been incorporated by reference in Part II of this Quarterly
Report on Form 10-Q:
1. Registration Statement on Form S-4 (File No. 333-33639);
2. Quarterly Report on Form 10-Q, dated as of August 14, 1998; and
3. Quarterly Report on Form 10-Q, dated as of May 12, 1999;
4. Quarterly Report on Form 10-Q, dated as of June 7, 2001.
2
EVERCOM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements................................. 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 12
Item 3. Quantitative and Qualitative Disclosures about
Market Risk.......................................... 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................... 29
Item 2. Changes in Securities and Use of Proceeds............ 29
Item 3. Defaults Upon Senior Securities...................... 29
Item 4. Submission of Matters to a Vote of Stockholders...... 29
Item 5. Other Information.................................... 29
Item 6. Exhibits and Reports on Form 8-K..................... 30
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, June 30,
2000 2001
-------------- ------------
ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 4,195,034 $ 5,725,496
Accounts receivable, net 38,302,469 40,457,456
Refundable income taxes 258,993 258,993
Inventories 4,167,609 5,024,511
Prepaid expenses and other current assets 668,623 654,096
Deferred income tax asset 1,802,826 1,773,382
-------------- ------------
Total current assets 49,395,554 53,893,934
PROPERTY AND EQUIPMENT, Net 27,069,245 27,117,925
INTANGIBLE AND OTHER ASSETS, Net 85,991,382 84,940,050
-------------- ------------
TOTAL $162,456,181 $165,951,909
============== ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable $ 21,122,288 $ 25,523,636
Income taxes payable 500,000 72,869
Accrued expenses 20,430,296 18,089,287
Current portion of long-term debt 13,776,766 13,750,000
-------------- ------------
Total current liabilities 55,829,350 57,435,792
LONG-TERM DEBT 152,750,000 145,375,000
OTHER LONG-TERM LIABLITIES 100,000
DEFERRED INCOME TAXES 1,802,826 1,773,382
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
STOCKHOLDERS' DEFICIT:
Preferred stock, Senior and First Preferred Series A, $.01 par value; 6,000 and
5,000 shares authorized, 5,925 and 5,000 shares issued and outstanding,
respectively (cumulative liquidation value of $5,925,000 and $5,000,000
respectively) as of December 31, 2000 and June 30, 2001 109 109
Common stock, $.01 par value; 50,000 shares authorized, 16,433 and 31,170 shares
issued and outstanding as of December 31, 2000 and June 30, 2001, respectively 164 311
Additional paid-in capital 25,206,414 35,390,171
Accumulated deficit (73,232,682) (74,022,856)
-------------- ------------
Total stockholders' deficit (48,025,995) (38,632,265)
-------------- ------------
TOTAL $162,456,181 $165,951,909
============== ============
See notes to consolidated financial statements
4
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Month Six Month
Period Ended Period Ended
June 30, June 30,
2000 2001 2000 2001
-------------- ------------ ------------ ------------
OPERATING REVENUE $59,026,245 $60,591,461 $118,411,665 $121,629,884
OPERATING EXPENSES:
Telecommunication costs 23,946,722 23,901,109 48,653,805 47,024,077
Facility commissions 18,949,902 20,428,622 37,727,809 40,065,758
Field operations and maintenance 1,545,622 1,875,495 3,276,767 3,702,661
Selling, general and administrative 4,504,953 5,094,187 8,888,374 9,908,871
Cost of equipment sales 240,524 134,623 354,098 1,143,536
Depreciation and impairment 2,048,628 3,120,614 4,015,022 5,167,838
Amortization of intangibles 4,056,808 2,789,318 8,530,767 5,718,023
-------------- ------------ ------------ ------------
Total operating expenses 55,293,159 57,343,968 111,446,642 112,730,764
-------------- ------------ ------------ ------------
OPERATING INCOME 3,733,086 3,247,493 6,965,023 8,899,120
INTEREST EXPENSE, Net 4,768,665 4,600,016 9,665,953 9,358,217
-------------- ------------ ------------ ------------
LOSS BEFORE INCOME TAXES (1,035,579) (1,352,523) (2,700,930) (459,097)
INCOME TAX EXPENSE 31,875 182,913 53,135 331,076
-------------- ------------ ------------ ------------
NET LOSS ($1,067,454) ($1,535,436) ($2,754,065) ($790,173)
PREFERRED STOCK DIVIDENDS
AND ACCRETION OF DISCOUNT 369,080 375,077 736,734 748,610
-------------- ------------ ------------ ------------
NET LOSS APPLICABLE
TO COMMON STOCK ($1,436,534) ($1,910,513) ($3,490,799) ($1,538,783)
============== ============ ============ ============
See notes to consolidated financial statements
5
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Month
Period Ended
June 30,
2000 2001
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss ($2,754,065) ($790,173)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation and impairment 4,015,022 5,167,838
Amortization of intangible assets, including deferred financing costs and bond discount 9,055,547 6,353,766
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable (1,777,546) (2,154,987)
Inventories 286,118 (1,877,723)
Prepaid expenses and other assets (234,725) (131,058)
Accounts payable 2,030,679 4,620,098
Accrued expenses (2,986,154) (2,893,597)
Income taxes 149,522 (427,131)
---------- ----------
Net cash provided by operating activities 7,784,398 7,867,033
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (5,366,080) (5,217,669)
Cash outflows for acquisitions (825,433) (1,728,613)
---------- ----------
Net cash used in investing activities (6,191,513) (6,946,282)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of credit facility amendment fees (611,865)
Repayment of debt (3,216,420) (7,401,766)
Proceeds from the issuance of common stock and warrants, net of expenses 8,623,342
---------- ----------
Net cash provided by (used in) financing activities (3,216,420) 609,711
---------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,623,535) 1,530,462
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,987,732 4,195,034
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $364,197 $5,725,496
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $9,088,421 $8,835,963
========== ==========
Cash paid for income taxes ($96,390) $758,207
========== ==========
NONCASH TRANSACTIONS:
Dividends payable $437,000 $491,625
========== ==========
Stock issued for acquisition of assets - $2,052,188
========== ==========
See notes to consolidated financial statements
6
EVERCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements as of June 30, 2001 for the three-
month and six-month periods ended June 30, 2000 and 2001 of Evercom, Inc. and
its subsidiaries (the "Company") have been prepared by the Company without
audit.
In the opinion of management, all necessary adjustments (which include only
normal recurring adjustments) to present fairly, in all material respects, the
consolidated financial position, results of operations, and cash flows as of and
for the respective periods, have been made. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with the
Company's 2000 consolidated financial statements contained in its Form 10-K as
filed with the Securities and Exchange Commission on June 1, 2001.
Comprehensive Income
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," became effective as of the first quarter of 1999. This
statement requires companies to report and display comprehensive income and its
components (revenues, expenses, gains, and losses). Comprehensive income
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. For the Company,
comprehensive income is the same as net loss reported in the statements of
consolidated operations, since there were no other items of comprehensive income
for the periods presented.
Business Combinations and Goodwill and Intangible Assets
On June 29, 2001, the Financial Accounting Standards Board (FASB) approved
for issuance SFAS No. 141, "Business Combinations," effective July 1 2001, and
SFAS No. 142, "Goodwill and Intangible Assets," effective January 1, 2002. SFAS
No. 141 prohibits pooling of interests accounting for acquisitions. SFAS No. 142
specifies that goodwill and some intangible assets will no longer be amortized,
but instead will be subject to periodic impairment testing. The Company is
evaluating the financial statement impact of SFAS No. 142.
Reclassifications
Certain reclassifications have been made in the three and six months ended
June 30, 2000 consolidated financial statements to conform to the
classifications used in the three and six months ended June 30, 2001.
7
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
December 31, June 30,
2000 2001
---------------------- ----------------------
(Unaudited)
Trade accounts receivable, net of advance payments of $289,385
and $0 at December 31, 2000 and June 30, 2001 respectively $41,028,861 $42,737,744
Advance commissions receivable 1,654,595 829,084
Recoverable Universal Service Fund fees 235,817 77,663
Employees and other 453,704 103,508
---------------------- ----------------------
43,372,977 43,747,999
Less allowance for unbillable and uncollectible chargebacks (5,070,508) (3,290,543)
---------------------- ----------------------
$38,302,469 $40,457,456
====================== ======================
At December 31, 2000 and June 30, 2001, the Company had advanced
commissions to certain inmate facilities of $1,758,299 and $1,067,678
(unaudited), which are recoverable from such facilities as a reduction of earned
commissions at specified monthly amounts. Amounts included in accounts
receivable represent the estimated recoverable amounts during the next fiscal
year with the remaining balance recorded in other assets.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31, June 30,
2000 2001
---------------------- -----------------------
(Unaudited)
Leasehold improvements $ 944,292 $ 962,103
Telephone system equipment 46,285,050 51,316,427
Vehicles 430,548 430,548
Office equipment 2,727,911 2,895,241
---------------------- -----------------------
50,387,801 55,604,319
Less accumulated depreciation (23,318,556) (28,486,394)
---------------------- -----------------------
$ 27,069,245 $ 27,117,925
====================== =======================
Depreciation and impairment - Depreciation and impairment for the six
months ended June 30, 2000 and 2001 includes depreciation expense of $4,015,022
and $4,147,017 respectively. Also included in depreciation and impairment for
the six months ended June 30, 2001 is an impairment loss of $1.0 million on
telephone system equipment removed from service. In addition, the Company has
revised the remaining useful lives of certain telephone-equipment.
8
4. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
December 31, June 30,
2000 2001
---------------------- ----------------------
(Unaudited)
Intangible assets:
Acquired telephone contracts $71,566,718 $73,718,700
Noncompete agreements 568,611 568,611
Deferred loan costs 9,042,247 9,654,112
Goodwill 84,730,834 87,118,881
Other intangibles 783,096 783,096
---------------------- ----------------------
166,691,506 171,843,400
Less accumulated amortization (81,221,978) (87,575,744)
---------------------- ----------------------
Total intangible assets 85,469,528 84,267,656
Deposits and other 418,150 433,800
Noncurrent portion of commission advances to facilities 103,704 238,594
---------------------- ----------------------
$85,991,382 $84,940,050
====================== ======================
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
December 31, June 30,
2000 2001
---------------------- ----------------------
(Unaudited)
Facility commissions $ 8,204,779 $ 7,414,555
Billing and collection fees 1,988,157 2,366,711
Accrued acquisition and financing costs 578,081 639,043
Accrued interest 541,530 428,040
Accrued excise taxes payable 1,958,017 1,696,546
Accrued dividends on preferred stock 2,142,434 2,634,059
Accrued payroll and bonuses 812,898 870,865
Accrued payable to joint venture partner 1,136,916 450,759
Deferred revenue 1,076,425 463,543
Other 1,991,059 1,125,166
---------------------- ----------------------
$20,430,296 $18,089,287
====================== ======================
9
6. LONG-TERM DEBT
The following is a summary of long-term debt:
December 31, June 30,
2000 2001
---------------------- ----------------------
(Unaudited)
Senior Notes $115,000,000 $115,000,000
Senior Credit Facility:
Revolving loan facility 13,500,000 13,000,000
Term loan acquisition facility 27,500,000 20,625,000
Additional term loan facility 5,500,000 5,500,000
Second additional term loan facility 5,000,000 5,000,000
Other 26,766
---------------------- ----------------------
166,526,766 159,125,000
Less current portion of long-term debt (13,776,766) (13,750,000)
---------------------- ----------------------
$152,750,000 $145,375,000
====================== ======================
Under the terms of the Senior Credit Facility, the term loan acquisition
facility is due in quarterly installments of $3,437,500, with the remaining
unpaid balance for all borrowings under the Senior Credit Facility being due on
December 31, 2002. Both the revolving and the term loan facilities are
collateralized by substantially all of the assets of the Company.
On June 29, 2001, the Company entered into an interest rate cap agreement
that has been designated as a hedge against the Company's variable interest rate
exposure under the Company's revolving and term loan agreement (the "Senior
Credit Facility"). At June 30, 2001, the interest rate cap has an aggregate
notional amount of $20.0 million, which matures in December 2002, and caps
interest on the London Interbank Offering Rate ("LIBOR") portion of the term
loan, up to the aggregate notional amount, at 7.5%, plus the applicable LIBOR
margin.
On May 30, 2001, and in conjunction with the commitment from existing
shareholders and other investors to purchase 12,000 shares of the Company's
Common stock for $750 per share, the Company and its Senior Credit Facility
lenders amended the Company's Senior Credit Facility. The amendment changed the
requirements and definitions of certain financial covenants through December 31,
2001 and increased the Company's ability to enter into capital lease
arrangements from $2.5 million to $5.0 million. Additionally, the amendment
waived the Senior Credit Facility Lender's rights to the proceeds from the May
30, 2001 issuance of common stock and waived all outstanding defaults under the
Senior Credit Facility. An amendment fee equal to 0.75% of outstanding
commitments, or $0.4 million, was paid to the Senior Credit Facility lenders to
effect this amendment. Additionally, the amendment increased all interest rates
under the Senior Credit Facility by 0.5% (50 basis points).
10
7. EQUITY
On April 10, 2001, the Company's Board of Directors approved a plan to
offer to sell 12,000 shares of the Company's Class "A" Common stock for $750 per
share to the Company's existing shareholders. The Company received $9 million of
proceeds from this offering on June 4, 2001. As part of this offer, subscribing
shareholders received their pro-rata share of warrants equal to 4.5% of the
Company's fully diluted common stock. The warrants expire on December 31, 2007
and are exercisable for the Company's Class "A" Common Stock at $750 per share .
8. ACQUISITION
On May 30, 2001, the Company acquired all of the capital stock of
FortuneLinx, Inc., for 2,736 shares of the Company's Class "A" Common stock. If
certain financial performance objectives are not achieved within the first
twelve months after the effective date of the acquisition, 1,368 of the shares
issued to acquire FortuneLinx will be forfeited by the sellers. Additionally,
options were issued to the sellers allowing them to purchase 456 shares of the
Company's Class "A" Common Stock at an exercise price of $2,000 per share. In
conjunction with the closing, a note payable to a FortuneLinx shareholder in the
principal amount of $0.8 million was repaid plus accrued interest.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the financial
statements and the notes thereto contained elsewhere in this report. Certain
information contained in the discussion and analysis set forth below includes
forward-looking statements that involve risks and uncertainties. See "Special
Note Regarding Forward-Looking Information; Risk Factors."
Overview
The Company is a provider of collect and prepaid calling services to local,
county, state, and private correctional facilities in the U.S. The Company
derives substantially all of its revenues from its operation of inmate
telecommunications systems located in correctional facilities in 43 states and
the District of Columbia.
The Company's inmate telecommunications services consist of collect and
prepaid calling services. The Company enters into multi-year agreements
(generally three to five years) with the correctional facilities, pursuant to
which the Company serves as the exclusive provider of telecommunications
services to inmates within each facility. In exchange for the exclusive service
rights, the Company pays a percentage of its revenue from each correctional
facility as a commission to that facility. Typically, the Company installs and
retains ownership of the telephones and related equipment and provides
additional services to correctional facilities that are tailored to the
specialized needs of the corrections industry and to the requirements of the
individual correctional facility, such as call activity reporting and call
blocking. The Company also generates revenues from public pay telephones that
are ancillary to its inmate telephone business.
The Company accumulates call activity data from its various installations
and bills its revenues related to this call activity through local exchange
carriers ("LECs") or through third-party billing services. In addition, the
Company accrues the related telecommunications costs for validating,
transmitting, billing and collection, and allowances for uncollectible accounts
based on historical experience.
The Company's traditional inmate business consists of collect and prepaid
calling services provided to correctional facilities. The Company also provides
its Solutions services, representing validation, fraud management and billing
services to third parties. The Company's largest Solutions customer is a major
RBOC. Under the terms of the agreement, the Company acquires at a discount the
related inmate accounts receivable from the RBOC for the calls that the Company
processes. When the receivables are purchased, the Company accepts
responsibility for all validation, uncollectible accounts, and billing and
collections costs, with no recourse to the RBOC. However, under the terms of the
agreement, all purchased receivables must be processed and validated through the
Company's call management and billing system. The Company's revenues from this
service equal the difference between the face value of the receivables purchased
and the amount it pays the RBOC for the discounted accounts receivable. Because
the Company's revenues associated with this contract represent only a percentage
of the face value of the receivables purchased, the associated uncollectible
account expense and billing and collection fees represent a much higher
percentage of revenue as compared to the Company's traditional inmate business.
Consequently, the Company's telecommunications costs represent a higher
percentage of revenue under this contract. There are minimal selling, general,
and administrative ("SG&A") costs associated with this contract. The contract
term is through January 31, 2003, and has no minimum volume commitment. The
Company pays no facility commissions under this agreement. In February, 2001,
the RBOC notified the Company of its plan to exit the inmate market by the end
of 2002 and consequently, the Company expects its revenues to gradually decline
from this contract over the next two years. The Company believes it is
reasonable to expect that some portion of the RBOC's customers will be converted
to Evercom's
12
traditional inmate business. The Company also provides Solutions services to
other inmate telecommunications companies and is anticipating expanding this
business.
The Company's principle operating expenses consist of (i)
telecommunications costs; (ii) commissions paid to correctional facilities,
which are typically expressed as a percentage of either gross or net revenues,
(iii) field operations and maintenance costs, which consist primarily of field
service on the Company's installed base of inmate telephones; and (iv) selling
general and administrative ("SG&A") costs.
Telecommunications Costs. The principle components of telecommunication
costs are long distance transmission costs, local access costs, third party
billing costs, and costs of uncollectible accounts. Historically, long distance
costs have consisted of charges for minutes of use purchased from interexchange
carriers ("IXCs"). The Company has also entered into agreements to lease lines
connecting urban areas and correctional facilities. Local access charges
consist of monthly line and usage charges paid to RBOCs and other LECs for
interconnection to the local network for local calls, which are computed on a
flat monthly charge plus, for certain LECs, on a per message or per minute usage
rate based on the time and duration of the call. Third-party billing charges
consist of payments to LECs and other billing service providers for billing and
collecting revenues from called parties. Expenses associated with uncollectible
accounts are a significant cost in providing inmate telecommunications services.
Commissions. The Company pays a percentage of its revenue from each
facility to that facility as a commission. Commissions are generally set for the
duration of the Company's multi-year contract with the facility, and in some
cases are subject to monthly minimum amounts. Commission rates are one of the
primary bases of competition for obtaining and retaining contracts. The
Company's ability to offer increasingly attractive commission rates to
facilities depends on its ability to control its operating expenses. Generally,
contracts for larger facilities have higher commission rates, but these higher
commission rates are typically offset by lower network charges, field
maintenance, and SG&A expenses as a percentage of revenue. The commission rates
paid by the Company have increased in each period, from 36.0% for the quarter
ended June 30, 2000 to 37.6% for the quarter ended June 30, 2001. This increase
is due primarily to higher facility commissions on renewals and new business.
Commission rates are expected to increase as a percentage of revenues in the
future. The overall commission percentage to total revenues of 33.7% for the
quarter ended June 30, 2001 includes the effect of Solutions services provided
under the Company's agreement with a major RBOC, under which no commissions are
paid.
Field Operations and Maintenance. Field operations and maintenance consist
of maintenance costs associated with inmate phones and related equipment. These
costs are relatively small and more constant components of operating expenses.
Selling, General and Administrative. SG&A expenses consist of corporate
overhead and selling expenses. These costs are also relatively small and more
constant components of operating expenses.
13
Results of Operations
The following table sets forth, for the three months and six months ended
June 30, 2000 and 2001, respectively, the results of operations of the Company.
Three Month Period Ended June 30, Six Month Period Ended June 30,
(Dollars in thousands) 2000 2001 2000 2001
---------------------------------------------------------------------------------------
Operating revenues $59,026 100.0% $60,591 100.0% $118,412 100.0% $121,630 100.0%
Operating expenses:
Telecommunication costs 23,947 40.6% 23,901 39.4% 48,654 41.1% 47,024 38.7%
Facility commissions 18,950 32.1% 20,429 33.7% 37,728 31.9% 40,066 32.9%
Field operations and maintenance 1,546 2.6% 1,875 3.1% 3,277 2.8% 3,703 3.0%
Selling, general and administrative 4,505 7.6% 5,094 8.4% 8,888 7.5% 9,909 8.1%
Cost of Equipment Sales 240 0.4% 135 0.2% 354 0.3% 1,143 0.9%
Depreciation and impairment 2,048 3.5% 3,121 5.2% 4,015 3.4% 5,168 4.2%
Amortization of intangibles 4,057 6.9% 2,789 4.6% 8,531 7.2% 5,718 4.7%
--------- ------ ------- ------ -------- ------ -------- -----
Total operating expenses 55,293 93.7% 57,344 94.6% 111,447 94.1% 112,731 92.7%
--------- ------ ------- ------ -------- ------ -------- -----
Operating income 3,733 6.3% 3,247 5.4% 6,965 5.9% 8,899 7.3%
Interest expense, net 4,768 8.1% 4,600 7.6% 9,666 8.2% 9,358 7.7%
--------- ------ ------- ------ -------- ------ -------- -----
Loss before income taxes (1,035) (1.8%) (1,353) (2.2%) (2,701) (2.3%) (459) (0.4%)
Income tax expense 32 0.0% 183 0.3% 53 0.0% 331 0.2%
--------- ------ ------- ------ -------- ------ -------- -----
Net Loss (1,067) (1.8%) (1,536) (2.5%) (2,754) (2.3%) (790) (0.6%)
========= ====== ======= ====== ======== ====== ======== =====
EBITDA $9,838 16.7% $9,157 15.1% $19,511 16.5% $19,785 16.3%
========= ====== ======= ====== ======== ====== ======== =====
Three Months Ended June 30, 2001 Compared to Three Months Ended June 30,
2000.
Operating Revenues. The Company's operating revenues increased by $1.6
million, or 2.6%, from $59.0 million for the three months ended June 30, 2000 to
$60.6 million for the three months ended June 30, 2001. The increase in
operating revenue was primarily in the Company's traditional inmate business as
a result of new sales initiatives.
Operating Expenses. Total operating expenses increased $2.0 million, from
$55.3 million for the three months ended June 30, 2000 to $57.3 million for the
three months ended June 30, 2001. Operating expenses as a percentage of
operating revenues increased 0.9% from 93.7% for the three months ended June 30,
2000 to 94.6% for the three months ended June 30, 2001. The increase in
operating expenses as a percentage of revenues is primarily due to the factors
discussed below.
Telecommunication costs were $23.9 million for the three months ended June
30, 2000 and 2001. Telecommunications costs represented 40.6% of operating
revenues for the three months ended June 30, 2000 and 39.4% of operating
revenues for the three months ended June 30, 2001. The increase in
telecommunications costs as a percentage of operating revenues is primarily due
to savings generated from new long distance contracts, partially offset by
increased expenses associated with uncollectible accounts that were due in part
to changes in policies and procedures by several of the Company's LEC billing
agents.
Facility commissions increased by $1.5 million, from $18.9 million for the
three months ended June 30, 2000 to $20.4 million for the three months ended
June 30, 2001. Facility commissions represented 32.1%
14
of operating revenues for the three months ended June 30, 2000 and 33.7% of
operating revenues for the three months ended June 30, 2001, an increase of
1.6%. Commission expense as a percentage of revenue for the Company's
traditional inmate business was 36.0% and 37.6% for the three months ended June
30, 2000 and 2001, respectively. This increase is due to competition for new
business and increased commission rates on renewals. Commission rates are
expected to continue to increase in the future.
Field operations and maintenance costs were $1.5 million for the three
months ended June 30, 2000 and $1.9 million for the three months ended June 30,
2001. Field operations and maintenance costs represented 2.6% of operating
revenues for the three months ended June 30, 2000, and 3.1% of operating
revenues for the three months ended June 30, 2001, an increase of 0.5%. The
increase as a percentage of operating revenues is primarily due to higher field
equipment repairs during the three months ended June 30, 2001.
SG&A costs increased by $0.6 million, from $4.5 million for the three
months ended June 30, 2000 to $5.1 million for the three months ended June 30,
2001. SG&A represented 7.6% of operating revenues for the three months ended
June 30, 2000 and 8.4% of operating revenues for the three months ended June 30,
2001, an increase of 0.8%. The increase is primarily due to increased staffing
to support enhancements to the Company's information systems and to execute new
sales initiatives.
Depreciation and impairment and amortization costs decreased by $0.2
million, from $6.1 million for the three months ended June 30, 2000 to $5.9
million for the three months ended June 30, 2001. During the three months ended
June 30, 2001, the Company recorded an impairment loss of $1.0 million on
telephone system equipment removed from service. Excluding this impairment,
depreciation and amortization costs represented 10.4% of operating revenues for
the three months ended June 30, 2000 and 8.1% of operating revenues for the
three months ended June 30, 2001, a decrease of 2.3%. The decrease as a
percentage of operating revenues is primarily due to amortization expense
associated with the acquisitions of inmate facility contracts by the Company.
The Company amortizes acquired inmate facility contracts over each contract's
remaining term at the acquisition date. As the contract terms expire, the
acquired inmate facility contracts become fully amortized and amortization
expense declines.
Operating Income. The Company's operating income decreased by $0.5 million,
from $3.7 million for the three months ended June 30, 2000 to $3.2 million for
the three months ended June 30, 2001, substantially due to the factors described
above. The Company's operating income margin decreased from 6.3% for the three
months ended June 30, 2000 to 5.4% for the three months ended June 30, 2001,
as a result of the factors described above.
Interest Expense, net. Interest expense, net decreased from $4.8 million
for the three months ended June 30,2000 to $4.6 million for the three months
ended June 30,2001. This decrease is primarily due to lower average debt
outstanding during the three months ended June 30, 2001.
Net Loss. The Company's net loss increased by $0.4 million, from $1.1
million for the three months ended June 30, 2000 to $1.5 million for the three
months ended June 30, 2001, primarily as a result of the factors described
above.
EBITDA. Earnings before interest, income taxes, depreciation, and
amortization ("EBITDA") decreased from $9.8 million for the three months ended
June 30, 2000 to $9.2 million for the three months ended June 30, 2001. EBITDA
as a percentage of operating revenues decreased from 16.7% for the three months
ended June 30, 2000 to 15.1% for the three months ended June 30, 2001, primarily
due to the factors described above. Although EBITDA is not a measure of
performance calculated in accordance with generally accepted accounting
principles, the Company has included information concerning EBITDA in the Form
10-Q because it is commonly used by certain investors and analysts as a measure
of a company's ability to service its debt obligations and is a
15
component of the Company's debt compliance ratios. EBITDA should not be used as
an alternative to, or be considered more meaningful than, operating income, net
income, or cash flows as an indicator of the Company's operating income. Two of
the Company's subsidiaries are subject to state income taxes. Consequently, the
Company accrues income tax expense even in a loss period.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Operating Revenues. The Company's operating revenues increased by $3.2
million, or 2.7%, from $118.4 million for the six months ended June 30, 2000 to
$121.6 million for the six months ended June 30,2001. The increase in operating
revenues was primarily due to an increase in the Company's traditional inmate
business as a result of new sales initiatives and the increased sales of
software and equipment.
Operating Expenses. Total operating expenses increased $1.3 million, from
$111.4 million for the six months ended June 30, 2000 to $112.7 million for the
six months ended June 30, 2001. Operating expenses as a percentage of operating
revenues decreased 1.4% from 94.1% for the six months ended June 30, 2000 to
92.7% for the six months ended June 30, 2001. The decrease in operating
expenses as a percentage of revenues is primarily due to the factors discussed
below.
Telecommunications costs decreased by $1.7 million, from $48.7 million for
the six months ended June 30, 2000 to $47.0 million for the six months ended
June 30, 2001. Telecommunications costs represented 41.1% of operating revenues
for the six months ended June 30, 2000 and 38.7% of operating revenues for the
six months ended June 30, 2001. The decrease in telecommunication costs as a
percentage of operating revenues is primarily due to savings generated from new
long distance contracts.
Facility commissions increased by $2.4 million, from $37.7 million for the
six months ended June 30, 2000 to $40.1 million for the six months ended June
30, 2001. Facility commissions represented 31.9% of operating revenues for the
six months ended June 30, 2000 and 32.9% of operating revenues for the six
months ended June 30, 2001, an increase of 1.0%. Commission expense as a
percentage of revenue for the Company's traditional inmate business was 35.6%
and 37.3% for the six months ended June 30, 2000 and 2001, respectively. This
increase is due to competition for new business and increased commission rates
on renewals. Commission rates are expected to continue to increase in the
future.
Field operations and maintenance costs were $3.3 million for the six months
ended June 30, 2000 and $3.7 million for the six months ended June 30, 2001.
Field operations and maintenance costs represented 2.8% of operating revenues
for the six months ended June 30, 2000 and 3.0% for the six months ended June
30, 2001, an increase of 0.2%. This increase as a percentage of operating
revenues is primarily due to higher field equipment repairs during the six
months ended June 30, 2001.
SG&A costs increased by $1.0 million, from $8.9 million for the six months
ended June 30, 2000 to $9.9 million for the six months ended June 30, 2001.
SG&A represented 7.5% of operating revenues for the six months ended June 30,
2000 and 8.1% of operating revenues for the six months ended June 30, 2001, an
increase of 0.6%. This increase is primarily due to increased staffing to
support enhancements to the Company's information systems and to execute new
sales initiatives. Additionally, the Company spent $0.2 million during the six
months ended June 30, 2001 for executive search fees.
Depreciation and impairment and amortization costs decreased by $1.6
million, from $12.5 million for the six months ended June 30, 2000 to $10.9
million for the six months ended June 30, 2001. During the six months ended June
30, 2001, the Company recorded an impairment loss of $1.0 million on telephone
system equipment removed from service. Excluding this impairment, depreciation
and amortization costs represented 10.6% of operating revenues for the six
months
16
ended June 30, 2000 and 8.1% of operating revenues for the six months ended June
30, 2001, a decrease of 2.5%. The decrease as a percentage of operating revenues
is primarily due to amortization expense associated with the acquisitions of
inmate facility contracts by the Company. The Company amortizes acquired inmate
facility contracts over each contract's remaining term at the acquisition date.
As the contract terms expire, the acquired inmate facility contracts become
fully amortized and amortization expense declines.
Operating Income. The Company's operating income increased by $1.9 million,
from $7.0 million for the six months ended June 30, 2000 to $8.9 million for the
six months ended June 30, 2001, substantially due to the factors described
above. The Company's operating income margin increased from 5.9% for the six
months ended June 30, 2000 to 7.3% for the six months ended June 30, 2001,
primarily as a result of the factors described above.
Interest Expense, net. Interest expense, net decreased from $9.7 million
for the six months ended June 30, 2000 to $9.4 million for the six months ended
June 30, 2001. This decrease is primarily due to lower average debt outstanding
during the six months ended June 30, 2001.
Net Loss. The Company's net loss decreased by $2.0 million, from a $2.8
million for the six months ended June 30, 2000 to $0.8 million for the six
months ended June 30, 2001, primarily as a result of the factors described
above.
EBITDA. EBITDA increased by $0.3 million from $19.5 million for the six
months ended June 30, 2000 to $19.8 million for the six months ended June 30,
2001. EBITDA as a percentage of operating revenues decreased from 16.5% for the
six months ended June 30, 2000 to 16.3% for the six months ended June 30, 2001,
primarily due to the factors described above. Although EBITDA is not a measure
of performance calculated in accordance with generally accepted accounting
principles, the Company has included information concerning EBITDA in the Form
10-Q because it is commonly used by certain investors and analysts as a measure
of a company's ability to service its debt obligations and is a component of the
Company's debt compliance ratios. EBITDA should not be used as an alternative
to, or be considered more meaningful than, operating income, net income, or cash
flows as an indicator of the Company's operating income. Two of the Company's
subsidiaries are subject to state income taxes. Consequently, the Company
accrues income tax expense even in a loss period.
17
Liquidity and Capital Resources
The Company anticipates that its principal uses of liquidity will be to
provide working capital, meet debt service requirements, and to repay principal
under the Senior Credit Facility (as defined). Regarding working capital, the
Company received notice that one of its billing agents intends to begin
remitting funds to the Company in 44 days as compared to their historical 30 day
payment schedule. This change would reduce the Company's end of month liquidity
by approximately $8 million. The billing agent has informally and tentatively
agreed not to make this change until, at the earliest, December of 2001. The
Company expects that its principal sources of funds will be cash flow from
operations, proceeds from the new equity issued on May 30, 2001, as further
discussed herein, and borrowings under the Senior Credit Facility. The Company
anticipates that its primary capital expenditures for the remainder of 2001 will
be approximately $6.6 million for capital items required to implement new
contracts and contract renewals entered into by the Company, upgrades to
integrated systems, and capital expenditures associated with acquisitions in
current and prior years. Total capital expenditures for the fiscal period ended
December 31, 2001 are expected to be $13.5 million. The Company does not have
material commitments for capital expenditures. Management believes that cash
flow from operations, borrowings on the Senior Credit Facility and proceeds from
the new equity issued on May 30, 2001 will be sufficient to fund the
requirements of the Company for at least the next twelve months.
On May 30, 2001, the Company acquired all of the capital stock of
FortuneLinx, Inc., for 2,736 shares of the Company's Class "A" Common stock.
If certain financial performance objectives are not achieved within the first
twelve months after the effective date of the acquisition, 1,368 of the shares
issued to acquire FortuneLinx will be forfeited by the sellers. Additionally,
options were issued to the sellers allowing them to purchase 456 shares of the
Company's Class "A" Common Stock at an exercise price of $2,000 per share. In
conjunction with the closing, a note payable to a FortuneLinx shareholder in the
principal amount of $0.8 million was repaid plus accrued interest.
Equity Offering and Senior Credit Facility Amendment
On April 10, 2001, the Company's Board of Directors approved a plan to
offer to sell 12,000 shares of the Company's Class "A" Common stock for $750 per
share to the Company's existing shareholders. The Company received $9 million
of proceeds from the issuance of this new equity on June 4, 2001. As part of
this offer each subscribing shareholder received their pro-rata share of
warrants equal to 4.5% of the Company's fully diluted common stock. The
warrants expire on May 30, 2007 and are exercisable for the Company's Class "A"
Common Stock at $750 per share.
On May 30, 2001, and in conjunction with the commitment from its existing
shareholders and other investors to purchase 12,000 shares of the Company's
Common stock for $750 per share, the Company and its Senior Credit Facility
lenders amended the Company's Senior Credit Facility. The amendment changed the
requirements and definitions of certain financial covenants through December 31,
2001 and increased the Company's ability to enter into capital lease
arrangements from $2.5 million to $5 million. Additionally, the amendment
waived the Senior Credit Facility Lender's rights to the proceeds from the May
30, 2001 issuance of common stock and waived all outstanding defaults under the
Senior Credit Facility. An amendment fee equal to 0.75% of outstanding
commitments, or $0.4 million, was paid to the Senior Credit Facility lenders to
effect this amendment. Additionally, the amendment increased all interest rates
under the Senior Credit Facility by 0.5% (50 basis points).
In March 1999, the Company raised $5 million of equity from its existing
shareholders and warrant holders and/or their affiliates through the issuance of
5,000 investment units at a price of $1,000 per unit. Each unit consists of one
share of newly authorized First Preferred Series "A" Stock and a warrant to
acquire one share of Common Stock for $1,000 per share. The First Preferred
Series "A" Stock is entitled to receive dividends at
18
the applicable First Preferred Series "A" Rate, payable quarterly commencing on
April 1, 1999. Such dividends are payable out of funds legally available
therefore, are payable only when, as, and if declared by the Board of Directors,
are cumulative, and, if undeclared or unpaid, shall bear interest at the
applicable First Preferred Series "A" Rate until paid. The First Preferred
Series "A" Rate will be 8% per annum through March 31, 2001, 10% per annum from
April 1, 2001 through June 30, 2001, and thereafter will increase by 0.5% for
each additional three months period up to a maximum of 16% per annum. The First
Preferred Series "A" Stock ranks senior to all classes of the Company's common
stock but ranks junior to the Senior Preferred Stock of the Company (the "Senior
Preferred Stock") with respect to dividend rights and rights upon liquidation.
The warrants have a strike price of $1,000 per share and will expire, if not
sooner exercised, on December 31, 2007. As a result of the issuance of the First
Preferred Series "A" Stock and warrants, the Company was required to obtain a
waiver from its Senior Credit Facility group of lenders that waived the lenders'
rights to the proceeds raised by the Company from the issuance.
In conjunction with the March 1999 equity offering, the preferred dividend
rates on the original Senior Preferred Stock were modified to mirror the
preferred dividend rates on the First Preferred Series "A" Stock.
Also in March 1999 and in conjunction with the issuance of the First
Preferred Series "A" Stock and warrants, the Company amended and restated its
Senior Credit Facility. The amendment increased the Company's borrowing
capacity under the term loan facility of the Senior Credit Facility by $5.5
million, which will bear interest at similar rates to the existing borrowings
under the Senior Credit Facility. The Company borrowed the additional $5.5
million in March 1999 and concurrently repaid $5 million under the revolving
portion of the Senior Credit Facility.
Net cash provided by operating activities increased by $0.1 million from
$7.8 million for the six months ended June 30, 2000, to $7.9 million for the six
months ended June 30, 2001. Operating income for the six months ended June 30,
2001, before consideration of depreciation and impairment and amortization,
increased by $0.3 million over the six months ended June 30, 2000, which was
offset by timing of certain cash receipts and disbursements in the normal course
of business.
Cash used in investing activities was $6.2 million for the six months ended
June 30, 2000 as compared to $6.9 million for the six months ended June 30,
2001, consisting primarily of both cash outflows for investments in new business
and customer contract renewals, $1.4 million to fund the acquisition of
FortuneLinx, and $0.3 million of acquisition costs relating to acquisitions made
in prior years.
Cash used in financing activities was $3.2 million for the six months ended
June 30, 2000 as compared to cash provided by financing activities of $0.6
million for the six months ended June 30, 2001, consisting primarily of net
proceeds raised through the issuance of common stock and new borrowings under
the Senior Credit Facility, offset by principal repayments under the Senior
Credit Facility.
The Senior Credit Facility, as amended on May 30, 2001, consists of (a)
$55.0 million term loan acquisition facility all of which has been borrowed and
upon which $34.4 million of scheduled principal payments had been made as of
June 30, 2001, (b) $10.5 million of additional term loan facilities which has
been borrowed as of June 30, 2001 (availability of a $2.5 million additional
term loan expired because the Company did not achieve certain financial
performance for the year ended December 31, 2000), and (c) a $25.0 million
revolving loan facility (which includes a $10.0 million letter of credit
facility) upon which $13.0 million had been borrowed as of June 30, 2001.
Scheduled principal payments under the Senior Credit Facility bear interest, at
the option of the Company, at either (i) the Base Rate (i.e., the higher of
Canadian Imperial Bank of Commerce's ("CIBC") reference rate or the overnight
federal funds rate plus 0.5%) plus a margin that varies from 150 to 350 basis
points, depending on the Company's Total Debt to EBITDA Ratio (as defined in the
Senior
19
Credit Facility); or (ii) the LIBOR plus a margin that varies from 275 to
450 basis points, depending on the Company's Total Debt to EBITDA Ratio.
The Senior Credit Facility requires quarterly interest payments to be made
on base rate loans and periodic interest-only payments based on the applicable
interest period on LIBOR loans, at least quarterly, in each case until maturity.
In addition, the Senior Credit Facility requires mandatory prepayments out of
the proceeds of certain equity or debt offerings, asset dispositions, receipt of
insurance proceeds not applied as provided in the Senior Credit Facility, and
receipts of funds from certain escrow accounts. Remaining scheduled principal
payments on the term loan facilities are approximately $6.9 million and $24.2
million during the years ended 2001, and 2002, respectively. All outstanding
principal and interest under the Senior Credit Facility is due December 31,
2002. The Senior Credit Facility is secured by substantially all the assets of
the Company and its subsidiaries. The Senior Credit Facility also requires the
Company to meet certain financial tests on a consolidated basis, some of which
may be more restrictive in future periods. Based on the Company's current
forecast, the Company will not be in compliance with certain financial tests as
of March 31, 2002. If the Company does not achieve the budgeted results included
in its current forecast for the remainder of 2001, the Company will not be in
compliance with certain financial tests prior to March 31, 2002. The Company's
failure to comply with its obligations under the Senior Credit Facility, or in
agreements relating to indebtedness incurred in the future, could result in an
event of default under such agreements, which could permit acceleration of the
related debt and acceleration of debt under other financing arrangements that
may contain cross-acceleration or cross-default provisions.
On June 29, 2001, the Company entered into an interest rate cap agreement
that has been designated as a hedge against the Company's variable interest rate
exposure under the Senior Credit Facility. At June 30, 2001, the interest rate
cap has an aggregate notional amount of $20.0 million, which matures in
December, 2002 and caps interest on the LIBOR portion of the term loan, up to
the aggregate notional amount, at 7.5%, plus the applicable LIBOR margin.
As of August 14, 2001, the Company had $9.2 million of available borrowing
capacity under the Senior Credit Facility and $1.9 million of cash.
As of June 30, 2001 the Company had approximately $159.1 million of long-
term indebtedness outstanding including the current portion, a deficit in
stockholders' equity of $38.5 million, and $5.7 million of cash.
As of June 30, 2001, the Company's long-term indebtedness included $115.0
million of 11.0% Senior Notes due 2007 (the "Senior Notes"), and $44.1 million
of indebtedness under the Senior Credit Facility.
The Company intends to evaluate additional acquisitions to expand its base
of installed inmate telephones and value added services and will continue to
evaluate possible acquisition opportunities. There can be no assurance that the
Company will have sufficient available capital resources to realize its
acquisition strategy. Such future acquisitions, depending on their size and the
form of consideration, may require the Company to seek additional debt or equity
financing.
Changes in Accounting Standards
SFAS No. 141 "Business Combinations," effective July 1, 2001, and SFAS No.
142 "Goodwill and Intangible Assets," effective January 1, 2002 were issued on
June 29, 2001. SFAS No. 141 prohibits pooling of interest accounting for
acquisitions. SFAS No. 142 specifies that goodwill and some intangible assets
will no longer be amortized, but instead will be subject to periodic impairment
testing. The Company is evaluating the financial statement impact of SFAS No.
142.
20
133 effective January 1, 2001. The adoption of SFAS 133 did not have a material
effect on the Company's financial position or results of operations.
Special Note Regarding Forward-Looking Information
Certain statements in this Quarterly Report Form 10-Q constitute forward-
looking statements. These forward-looking statements are all statements that
are not statements of historical fact or that might otherwise be considered
opinion, belief, or projection. These forward-looking statements involve known
and unknown risks, uncertainties, and other factors that may cause the actual
results, levels of activity, performance, or achievements of the Company, or
industry results, to be materially different from any future results, levels of
activity, performance, or achievements. The risks, uncertainties, and other
factors to which forward-looking statements are subject include, among others,
those set forth under the caption "Risk Factors" below.
Such factors include, without limitation, the following: competitors with
greater resources; risks associated with uncollectible accounts; risks
associated with carrying a large amount of debt; risks associated with our
limited operating history and accumulated deficits; risks associated with our
dependency on facilities-based carriers; risks associated with market growth
stagnating or declining; lack of patents and possible infringement;
technological change and new services; control by principal shareholders;
changes in the telecommunications industry; availability of key personnel; and
changes in or the failure to comply with, governmental regulations. All
subsequent written or oral forward-looking statements attributable to the
company or persons acting on its behalf are expressly qualified in their
entirety by such factors.
In some cases, forward-looking statements can be identified by terminology
such as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," or "continue" or the negative of such
terms or other comparable terminology. Although the Company believes that the
assumptions and expectations reflected in such forward-looking statements are
reasonable, as a result of the foregoing and other factors, no assurance can be
given as to future results, levels of activity, performance, or achievements,
and neither the Company nor any other person assumes responsibility for the
accuracy and completeness of such forward-looking statements. All forward-
looking statements included in the Quarterly Report on Form 10-Q are based on
information available to the Company on the date hereof, and the Company is
under no duty to update any of the forward-looking statements after the date
hereof.
Risk Factors
Our Competitors Have Greater Resources Than We Do
The inmate telecommunications industry is highly competitive. We compete
with numerous providers of inmate telephone services such as RBOCs, LECs, IXCs,
including major long distance carriers such as AT&T, MCI, and Sprint, and
independent public pay telephone and inmate telephone companies. Many of our
competitors are larger and better capitalized and have greater financial
resources available than we do. We believe that the principal competitive
factors in the inmate telecommunications market are
. rates of commissions paid to the correctional facilities;
. system features and functionality;
21
. system reliability and service;
. the ability to customize inmate call processing systems to the
specifications and needs of the particular correctional facility; and
. relationships with correctional facilities.
If we are required to pay higher commissions to retain our existing
contracts or obtain new contracts, there could be a material adverse effect on
us and on the value of our Senior Notes.
Historically, federal and state facilities, which are generally bid on a
system-wide basis, have been served by RBOCs, large LECs, and IXCs. These
providers have generally not, however, focused on the smaller city and county
correctional systems, which are typically negotiated on a facility-by-facility
basis. As a result, a significant portion of city and county correctional
facilities, which constitute a substantial majority of our customers, are served
by independent inmate telephone and independent public pay telephone companies.
A decision by RBOCs, large LECs, or IXCs to pursue actively contracts with city
and county correctional facilities could have a material adverse effect on us
and on the value of our Senior Notes.
Our ability to offer competitive commission rates depends on effectively
controlling costs, which in turn necessitates capital expenditures for software
and systems. If IXCs, RBOCs, and large LECs, which have significantly greater
financial resources than we do and are able to connect calls on their owned
networks for a negligible marginal cost, were to focus on the inmate
telecommunications market, we could face substantial competition and subsequent
increases in commission rates or reduction in market share, which could have a
material adverse effect on us and on the value of our Senior Notes.
Some of What We Bill is Uncollectible, and We May Underestimate This Number
We are required to carry a reserve on our books for future charge-backs
from LECs and third party clearinghouses for uncollectible amounts when such
amounts exceed the reserves initially withheld by the LECs and clearinghouses.
We set the reserves on our books using historical data on charge-backs for each
LEC or other billing service providers. The setting of these reserves requires
substantial use of estimation, and actual expenses associated with uncollectible
accounts could differ from our estimates. Factors that could cause actual
expenses associated with uncollectible accounts to vary from our estimates
include difficulties in estimating reserves for acquired contracts and
variations in expenses associated with uncollectible accounts among LECs. These
variations could potentially lead to an increase in our expenses associated with
uncollectible accounts, which could have a material adverse effect on us and on
the value of our Senior Notes.
Our Acquisition Strategy May Be Unsuccessful, and We Must Successfully Integrate
Companies That We Acquire
We constantly evaluate acquisition opportunities and are currently
evaluating possible acquisition candidates. We evaluate specific acquisition
opportunities based on market conditions and economic factors existing at the
time and intend to pursue favorable opportunities as they arise. We may
encounter increased competition for acquisitions in the future, which could
result in higher prices for acquisition candidates. We cannot assure you that we
will find suitable acquisition candidates at acceptable prices, have sufficient
available capital resources to realize our acquisition strategy, be successful
in entering
22
into definitive agreements for desired acquisitions, or that any such
acquisitions, if consummated, will prove to be advantageous to us.
The success of our growth strategy is also dependent on our ability to
integrate acquired operations into existing operations. In addition, our
success is dependent on our ability to expand internal operations. Our ability
to manage our anticipated future growth will depend on a number of factors,
including our ability to:
. evaluate new contract opportunities,
. monitor operations,
. control costs,
. maintain effective quality control,
. obtain satisfactory and cost- effective lease rights from interconnection
agreements with companies that own transmission lines, and
. expand our internal management, technical, and accounting systems.
Our rapid growth has placed, and our planned future growth will continue to
place, a significant strain on our financial, management, and operational
resources. We cannot assure you that the integration of the operations of
future acquisitions and continued expansion of internal operations will not
require the investment of capital or result in unforeseen difficulties or absorb
significant management resources at levels higher than that anticipated by our
management, or that we will realize meaningful economies of scale or operating
efficiencies from our acquisitions. In addition, acquisitions and the
establishment of new operations will entail considerable expenses in advance of
anticipated revenues and may cause substantial fluctuations in our operating
results.
Our failure to successfully integrate acquired operations could have a
material adverse effect on us and the value of our Senior Notes. Our acquisition
strategy results in the amortization of acquired contracts over a relatively
short period of time, generally one to three years. We had capitalized $73.7
million of acquired facility contracts as of June 30, 2001. As of June 30, 2001,
we had capitalized $87.1 million of goodwill. This could lead to operating
losses that could have a material adverse effect on us and on the value of our
Senior Notes.
We Are Carrying a Large Amount of Debt That Restricts Our Ability to Operate Our
Business
We have significant debt and debt service obligations. Our Senior Credit
Facility with Canadian Imperial Bank of Commerce as an agent for a syndicate of
lenders provides for (a) a term loan acquisition facility of $55.0 million (b)
an additional $10.5 million term loan facility and (c) a revolving loan facility
of $25.0 million (which includes a $10.0 million letter of credit facility). In
addition, on June 27, 1997, we sold $115,000,000 principal amount of 11% Senior
Notes due 2007. At June 30, 2001, we had approximately $159.1 million of
long-term debt outstanding (including current maturities).
Our significant debt level will have several important consequences to
holders of our Senior Notes, including, but not limited to, the following:
23
. we will be required to dedicate a substantial portion of our cash flow from
operations to the payment of interest and principal repayment obligations
in connection with the Senior Notes, the Senior Credit Facility, and other
permitted indebtedness thereby reducing the funds available for our
operations, capital expenditures, and other purposes;
. our debt level and the covenants contained in the Senior Credit Facility
and the indenture with respect to the Senior Notes will limit our ability
to obtain additional financing, pay dividends, repurchase stock, make
investments, grant liens, and take other actions that may be in the best
interests of our stockholders; and
. our substantial debt level may make us more vulnerable to economic
fluctuations, limit our ability to withstand competitive pressures, and
reduce our flexibility in responding to changing business and economic
conditions.
In addition, our indebtedness under the Senior Credit Facility bears
interest at floating rates, which could adversely affect our ability to service
our debt if interest rates rise.
We cannot assure you that we will be able to meet our debt service
obligations. If we are unable to generate sufficient cash flow or otherwise
obtain funds necessary to make required payments, or if we otherwise fail to
comply with the various covenants contained in our debt obligations, we would be
in default under the terms thereof, which would permit the holders of such
indebtedness to accelerate the maturity thereof and could cause defaults under
our other indebtedness. Our ability to repay or refinance our obligations with
respect to our indebtedness will depend on our future financial and operating
results, which in turn, will be subject to prevailing economic and competitive
conditions and to certain financial, business, and other factors, many of which
are beyond our control.
We Have a Limited Operating History and Have Accumulated Deficits
We were founded in December 1996. Accordingly, we have a limited operating
history upon which an evaluation of us and our prospects can be based. We
believe that our future success will depend on our ability to significantly
increase revenues, which we cannot assure you will happen. Additionally, our
limited operating history makes the accurate prediction of future operating
results difficult or impossible, and we cannot assure you that our revenues will
increase or even continue at their current level or that we will maintain
profitability or generate cash from operations in future periods. As of
June 30, 2001, we had an accumulated deficit of $74.0 million. We may
experience losses in the future which could have a material adverse effect on us
and on the value of our Senior Notes.
We Are Dependent On Transmission Facilities-Based Carriers
We do not own telecommunications transmission lines. Accordingly,
telephone calls made from correctional facilities are connected through
transmission lines that we lease under a variety of
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arrangements with transmission facilities-based long distance carriers, some of
which are or may become our competitors. Our calls are transmitted via
facilities leased on a per minute or monthly basis. Accordingly, we are
vulnerable to increases in our cost basis. If there is an increase in demand for
telecommunications services (for example, data services) beyond the increase in
supply of transmission facilities, our costs could increase, which could have a
material adverse effect on us and on the value of our Senior Notes.
Changes in Regulation Could Adversely Affect Our Business
The inmate telecommunications industry is regulated by both the Federal
Communications Commission (the "FCC") and state public utility commissions. Our
operations are also significantly affected by the regulation of other
telecommunications businesses, including LECs and IXCs. Changes in the laws and
regulations governing our business or other telecommunications businesses could
have a material adverse effect on us and on the value of our Senior Notes.
At the federal level, the industry is currently in a period of substantial
regulatory change in the aftermath of the Telecommunications Act of 1996 (the
"Telecom Act"), which, among other things, directed the FCC to restructure and
to change the regulatory framework of the pay telephone industry, including the
inmate telephone industry. Because the FCC is still in the process of
implementing its new regulations, and because several aspects of rule changes
proposed by the FCC are subject to requests for reconsideration, clarification,
and final resolution in related proceedings, the ultimate effect of regulatory
changes on our business is uncertain.
In addition to adopting regulations implementing the Telecom Act, the FCC
also recently adopted new regulations for interstate calls requiring inmate
telephone service providers to announce to called parties, before the called
party incurs any charges, that rate quotes may be obtained by dialing no more
than two digits or remaining on the line. We were required to come into
compliance with these new rules by October 1, 1999, and we believe that we are
substantially in compliance. Regulatory authorities do have authority to impose
fines and other sanctions for any violation of these rules. These new
regulations could result in an increase in our costs by slightly increasing the
non-billable network hold time for interstate collect calls. In addition, the
announcement of rate quotes may lead to called parties refusing to accept calls.
The exact effect of the new regulations is difficult to predict, as it will
depend in large part on how frequently called parties opt to receive a rate
quote.
We charge relatively high rates for completing inmate collect, and prepaid
calls. Many states have set maximum rates that can be charged for inmate
collect calls. If regulators reduce the rates that may be charged, there could
be a material adverse effect on us and on the value of our Senior Notes.
Our Market Growth May Stagnate or Decline
Our future growth could be affected by negative trends in the growth of the
number of correctional facilities or the number of prisoners. If the societal
and political trends that have led to this
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growth rate abate, the growth of the corrections industry could stagnate or
decline, and this would have a material adverse effect on us and on the value of
our Senior Notes. In particular, if the drug laws or mandatory sentencing laws
that have been enacted in the last decade are repealed or reduced in scope,
there could be an adverse effect on the growth of the inmate population, which
could effect our future success and the value of our Senior Notes. In addition,
state prison authorities in the State of Texas have adopted policies severely
restricting the making of telephone calls by inmates in state correctional
facilities. The adoption of similar policies by other states could severely
reduce the size of the inmate telecommunications market and have a material
adverse effect on us and on the value of our Senior Notes.
Our New Business Line is Unproven For Us and May Prove Unsuccessful
We are pursuing a new line of business that we call the "Solutions"
business. The Solutions business is similar to the capabilities and services
that we provide to one of the RBOCs today. The foundation of our Solutions
business is our intelligent call management, billing, and fraud control
capabilities. We are strengthening the underlying Solutions applications, and
have been successful in creating interest with potential new customers as
evidenced by recent new contract activity. We have limited experience in
obtaining contracts to provide, and in providing, such services to third
parties, and we cannot assure you that we will be successful in either of these
endeavors. Our failure to secure opportunities to provide these services to
third parties, to successfully provide these services, or to generate revenues
from these services could have a material adverse effect on our future success
and on the value of our Senior Notes.
If We Cannot Recruit and Retain Key Personnel, We Will Have Difficulty Executing
Our Strategy
Our success is dependent on the efforts of certain of our officers, senior
management, technical, and other personnel, and on our ability to continue to
attract, retain, and motivate qualified personnel. The competition for such
employees is intense, and we believe that it would be difficult to replace the
expertise and experience of such persons in the event that the services of one
or more such persons were to become unavailable. Accordingly, the loss of the
services of one or more of these individuals without adequate replacement could
have a material adverse effect on us and our ability to implement our business
strategy and to achieve our goals, and could have a material adverse effect on
the value of our Senior Notes. In addition, our failure to attract and retain
additional management to support our business strategy could also have a
material adverse effect on us.
We Lack Patents and Might Be Challenged For Infringement
None of our internally developed call processing technology has been
patented. Accordingly, such technology and intellectual property rights could
infringe on other parties' intellectual property rights and could be contested
or challenged. We have received notice from two parties that certain features of
our call processing technology may infringe upon such parties' patents. A
competitor holds certain patents, which, if valid, might be relevant to our call
processing technology and such competitor has recently consolidated the
ownership of certain intellectual property which may increase the likelihood of
a claim of infringement. Should our call processor or any material feature
thereof be determined to violate applicable patents, we would be
26
required to cease using the technology or features or seek to obtain appropriate
licenses (which the Company may not be able to obtain) for the use of such
technology, either of which could have a material adverse effect upon us and on
the value of our Senior Notes.
We Have Governmental Entities As Customers
Our customers include state and local governmental entities responsible for
the administration and operation of correctional facilities. We are subject,
therefore, to the administrative policies and procedures employed by, and the
regulations that govern the activities of, these governmental entities,
including policies, procedures, and regulations concerning the procurement and
retention of contract rights and the provision of services. We cannot assure
you that our operations will not be adversely affected by the policies and
procedures employed by, or the regulations that govern the activities of, these
governmental entities or that we will not be limited in our ability to secure
additional customer contracts, renew existing customer contracts, or consummate
acquisitions as a result of such policies, procedures, and regulations.
Our Business Experiences Rapid Technological Change and New Services
The telecommunications industry has been characterized by rapid
technological advancements, frequent new service introductions, and evolving
industry standards. Management believes that our future success will depend on
its ability to anticipate and respond to such changes and new technology. We
cannot assure you that we will not be materially adversely affected by the
introduction and acceptance of new technology. Some of our technology, such as
our call processor technology, has not yet been implemented in all of the
facilities that we service.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were no material changes from the information reported in the
Company's Form 10-K.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is from time to time a party to legal proceedings that arise in
the ordinary course of business. Management does not believe that the
resolution of any threatened or pending legal proceedings will have a material
adverse affect on the Company.
None of the Company's internally developed call processing technology has
been patented. Accordingly, such technology and intellectual property rights
could infringe on other parties' intellectual property rights and could be
contested or challenged. The Company has received notice from two parties that
certain features of the Company's call processing technology may infringe upon
such parties' patents. A competitor holds certain patents, which, if valid,
might be relevant to our call processing technology and such competitor has
recently consolidated the ownership of certain intellectual property which may
increase the likelihood of a claim of infringement. Should the Company's call
processor or any material feature thereof be determined to violate applicable
patents, the Company would be required to cease using the technology or features
or to seek to obtain appropriate licenses (which the Company may not be able to
obtain) for the use of such technology.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
This item is not applicable to the Registrant.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Description of Exhibit
--- ----------------------
3.1 Certificate of Incorporation of the Company (filed as Exhibit 3.1 to the Company's
Registration Statement No. 333-33639 and incorporated herein by reference).
3.2 Bylaws of the Company (filed as Exhibit 3.2 to the Company's Registration Statement No.
333-33639 and incorporated herein by reference).
3.3 Certificate of Amendment to Restated Certificate of Incorporation of the Company, dated as
of July 23, 1998 (filed as Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q, dated
as of August 14, 1998 and incorporated herein by reference).
3.4 Certificate of Amendment to Restated Certificate of Incorporation of the Company, dated as
February 11, 1999. (filed as Exhibit 3.4 to the Company's Quarterly Report on Form-10-Q
dated as of May 12, 1999 and incorporated herein by reference).
4.1 Indenture, dated as of June 27, 1997, between the Company and U.S. Trust Company of Texas,
N.A. (filed as Exhibit 4.1 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.2 Form of Note (contained in Indenture filed as Exhibit 4.2 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.3 Form of Subsidiary Guaranty (contained in Indenture filed as Exhibit 4.3 to the Company's
Registration Statement No. 333-33639 and incorporated herein by reference).
4.4 Registration Rights Agreement, dated as of June 27, 1997, between the Company and the
Initial Purchaser (filed as Exhibit 4.4 to the Company's Registration Statement No.
333-33639 and incorporated herein by reference).
4.5 Registration Rights Agreement, dated as of December 27, 1996m by and among the Company and
certain Holders named therein (filed as Exhibit 4.5 to the Company's Registration Statement
No. 333-33639 and incorporated herein by reference).
4.6 Shareholders Agreement, dated as December 27, 1996, by among the Company and certain Persons
named therein (filed as Exhibit 4.6 to the Company's Registration Statement No. 333-33639
and incorporated herein by reference).
4.7 Warrant Agreement, dated as of December 27, 1996, between the Company and CIBC Wood Gundy
Ventures, Inc. (filed as Exhibit 4.7 to the Company's Registration Statement No. 333-33639
and incorporated herein by reference).
4.8 Warrant Agreement, dated as of December 27, 1996, between the Company and Gregg L. Engles
(filed as Exhibit 4.8 to the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
4.9 Warrant Agreement, dated as of December 27, 1996, between the Company and Gregg L. Engles
(filed as Exhibit 4.9 to the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
4.10 Warrant Agreement, dated as of December 27, 1996, between the Company and Gregg L. Engles
(filed as Exhibit 4.10 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.11 Warrant Agreement, dated as of December 27, 1996, between the Company and Onyx Talton
Partners, L.P. (filed as Exhibit 4.11 to the Company's Registration Statement No. 333-33639
and incorporated herein by reference).
4.12 Warrant Agreement, dated as of December 27, 1996, between the Company and Onyx Talton
Partners, L.P. (filed as Exhibit 4.12 to the Company's Registration Statement No. 333-33639
and incorporated herein by reference).
30
4.13 Warrant Agreement, dated as of December 27, 1996, between the Company and Onyx Talton
Partners, L.P. (filed as Exhibit 4.13 to the Company's Registration Statement No. 333-33639
and incorporated herein by reference).
4.14 Warrant Agreement, dated as of December 27, 1996, between the Company and Joseph P. Urso
(filed as Exhibit 4.14 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.15 Warrant Agreement, dated as of December 27, 1996, between the Company and Joseph P. Urso
(filed as Exhibit 4.15 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.16 Warrant Agreement, dated as of December 27, 1996, between the Company and Joseph P. Urso
(filed as Exhibit 4.16 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.17 Warrant Agreement, dated as of December 27, 1996, between the Company and Todd W. Follmer
(filed as Exhibit 4.17 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.18 Warrant Agreement, dated as of December 27, 1996, between the Company and Todd W. Follmer
(filed as Exhibit 4.18 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.19 Warrant Agreement, dated as of December 27, 1996, between the Company and Todd W. Follmer
(filed as Exhibit 4.19 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
4.20 Form of Warrant Agreement, dated as of March 12, 1999 (filed as Exhibit 4.20 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999 and
incorporated herein by reference).
4.21 Form of Warrant Agreement, dated as of May 30, 2001 (filed as Exhibit 4.21 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 and incorporated herein
by reference).
10.1 Amendment No. 5 to Second Amended and Restated Credit Agreement, dated as of May 30, 2001,
among the Company, and certain lenders named therein, and Canadian Imperial Bank of Commerce
(filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2001 and incorporated herein by reference).
* Filed herewith.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the period subject to this
Quarterly Report on Form 10-Q.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EVERCOM, INC.
By:/s/ RICHARD FALCONE
Richard Falcone
Chief Executive Officer
By:/s/ KEITH KELSON
Keith Kelson
Chief Financial Officer
Date: August 14, 2001
32