SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number ______
EVERCOM, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 75-2680266
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
8201 Tristar Drive
Irving, Texas 75063
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code -- 972/988-3737
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Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
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11 % Series B Senior Notes Not Applicable
Due June 30, 2007
Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of Class)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ] Not Applicable.
2
As of December 31, 1998, the market value for the voting and non-voting
common equity held by non-affiliates of the registrant was $0.
As of March 15, 1999, 15,933 shares of Class A common stock, par value
$0.01 per share, were issued and outstanding, and 400 shares of Class B common
stock, par value $0.01 per share, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Exhibits to the following documents filed with the Securities and Exchange
Commission have been incorporated by reference in Part IV of this Annual Report
on Form 10-K:
1. Registration Statement on Form S-4 (File No. 333-33639);
2. Quarterly Report on Form 10-Q, dated as of August 14, 1998;
3. Quarterly Report on Form 10-Q, dated as of November 16, 1998; and
4. Quarterly Report on Form 10-Q/A, dated as of November 18, 1998.
3
EVERCOM, INC.
Table of Contents
Form 10-K Report
December 31, 1998
Part I Page
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Item 1. Business...................................................................................... 5
Item 2. Properties.................................................................................... 13
Item 3. Legal Proceedings............................................................................. 13
Item 4. Submission of Matters to a Vote of Security Holders........................................... 13
Part II
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Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................... 14
Item 6. Selected Financial Data....................................................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................................... 17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................... 26
Item 8. Financial Statements and Supplementary Data................................................... 27
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................................................... 84
Part III
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Item 10. Directors and Executive Officers of the Registrant............................................ 85
Item 11. Executive Compensation........................................................................ 87
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 91
Item 13. Certain Relationships and Related Transactions................................................ 92
Part IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................. 94
Signatures.................................................................................................. 98
4
PART I
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ITEM 1. BUSINESS
General
Evercom, Inc. (the "Company") is the largest independent provider of
collect, prepaid, and debit calling services to local, county, state, and
private correctional facilities in the U.S. As of December 31, 1998, the Company
served 2,073 correctional facilities in 43 states.
The Company's inmate telecommunications business consists of owning,
operating, servicing, and maintaining a system of automated operator switches
and telephones located in correctional facilities. Generally, inmates may make
only collect, prepaid, and debit calls from correctional facilities, which
generates revenue per phone line in excess of industry averages for a typical
business phone line. The Company generally enters into multi-year agreements
with correctional facilities pursuant to which the Company serves as exclusive
provider of telecommunications services to inmates within the facility. In
exchange for the exclusive service rights, the Company pays a percentage of its
revenues from each correctional facility to that facility as a commission.
Typically, the Company installs and retains ownership of the telephones and
related equipment.
Significant costs typically associated with providing telecommunication
services to correctional facilities include uncollectible accounts, network, and
billing expenses. The Company has developed an integrated call management and
billing system to help control these expenses. This system limits inmates to
collect, prepaid, or debit calls; validates and evaluates the payment history
and account status of each number dialed; confirms that the destination number
has not been blocked; and processes call records for billing through a third
party. To facilitate billing, the Company has entered into 29 separate
agreements with regional bell operating companies ("RBOCs") and local exchange
carriers ("LECs"), allowing the Company to bill directly through the RBOCs and
LECs rather than utilizing third party billing services. Management believes
that direct billing arrangements expedite the billing and collections process
and increases collectibility.
The Company uses its experience in billing, collection, and control of
uncollectible accounts to offer specialized billing and collection services to
other inmate telecommunications service providers. In May 1998, the Company
entered into a contract with a major RBOC, under which the Company performs all
of the validation, billing, and collection services for the RBOC's inmate calls,
and began processing call traffic under the contract. Under the terms of the
contract, the Company receives call traffic from 428 facilities. In addition,
the Company offers call processing services for a major interexchange carrier
("IXC"). The Company continues to pursue additional opportunities to market
these services to RBOCs, LECs, IXCs, and other inmate telecommunications
providers.
The Company was formed in December 1996 to consummate the acquisitions
of AmeriTel Pay Phones, Inc. ("AmeriTel") and Talton Telecommunications
Corporation and its subsidiary ("Talton Telecommunications"). The Company was
formed by Engles Urso Follmer ("EUF") Talton, an affiliate of Engles Urso
Follmer Capital Corporation ("EUFCC"), a private investment banking and
consulting firm. In addition to the acquisition of its predecessors, AmeriTel
and Talton Telecommunications, the Company also acquired the operations of Tri-
T, Inc. ("Tataka") on April 2, 1997, Security Telecom Corporation ("STC") on
June 27, 1997, Correctional Communications Corporation ("CCC") on July 31, 1997,
the inmate payphone division of Communications Central, Inc. ("InVision") on
October 6, 1997, the inmate payphone division of North American InTeleCom
("NAI") on December 1, 1997, the inmate payphone division of Peoples Telephone
Company ("PTC") on December 18, 1997, the inmate payphone division of ILD
Teleservices, Inc. ("ILD") on January 1, 1998, MOG Communications, Inc. ("MOG")
on February 1, 1998, and Saratoga Telephone Co. Inc. ("Saratoga") on July 1,
1998 (collectively, the "Acquisitions").
Special Note Regarding Forward-Looking Information
Certain statements in this Annual Report on Form 10-K 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 expressed or implied by such
forward-looking statements. The risks, uncertainties, and other factors to which
forward-statements are subject include, among others, those set
5
forth under the caption "Risk Factors" in the Prospectus of the Company dated
September 10, 1998, which is available from the Company, from the Securities and
Exchange Commission at prescribed rates, and at the web-site www.sec.gov. Such
factors include, without limitation, the following: competitors with greater
resources; risks associated with uncollectible accounts; risks associated with
anticipated growth; risks associated with market growth stagnating or declining;
risks related to potential Year 2000 problems; lack of patents and possible
infringements; 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 this Annual Report on
Form 10-K 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.
Industry Overview
The U.S. has one of the highest incarceration rates of any country in
the world. According to U.S. Department of Justice statistics, the number of
inmates incarcerated in federal and state prisons and in city and county
correctional facilities increased from approximately 1.1 million at June 30,
1990 to approximately 1.8 million at June 30, 1998. Of this total, approximately
two-thirds were housed in state and federal prisons, with the remainder in city
and county facilities. The statistics also reflect that the number of inmates
incarcerated in the U.S. increased by 4.4% between June 1997 and June 1998.
The inmate telecommunications industry places unique demands on
telecommunications systems and service providers. Security and public safety
concerns associated with inmate telephone use require that correctional
facilities use call processor technology, which allows the facilities to control
inmate access to certain telephone numbers and to monitor inmate telephone
activity. In addition, concerns regarding fraud and the called parties' failure
to pay for inmate collect calls require systems and procedures unique to this
industry.
Inmate telephones in the U.S. are operated by a large and diverse group
of service providers. Large telecommunications companies such as RBOCs, other
LECs, and IXCs such as AT&T Corp. ("AT&T"), MCI WorldCom, and Sprint Corporation
provide inmate telecommunications in addition to other services. In addition,
independent public pay telephone and inmate telephone companies also focus on
this market segment. The Company estimates that, as of December 31, 1998, the
inmate telecommunications market represented approximately $1.6 billion in gross
revenues annually.
Companies compete for the right to serve as the exclusive provider of
inmate calling services within a particular correctional facility. Most city or
county correctional facilities (typically fewer than 250 beds) award contracts
on a facility-by-facility basis, while most state prison systems award contracts
on a system-wide basis. Generally, contracts are awarded pursuant to a
competitive bidding process.
The Company targets the corrections industry by tracking when the
telecommunications contracts for significant inmate facilities in the U.S. are
up for bid. The Company monitors which federal, state, county, and city
contracts are coming up for renewal and how much revenue is expected to be
generated by each of those contracts.
6
Operations
Contracts
The Company has contracts to provide inmate telecommunications services
on an exclusive basis to correctional facilities ranging in size from small,
municipal jails to large, state-operated facilities, as well as other types of
confinement facilities, including juvenile detention centers, private
correctional facilities, and halfway houses. The Company's contracts have multi-
year terms, and typically contain renewal options. The Company's contracts
generally provide for automatic renewal unless terminated by written notice a
specified period of time before the end of a contract term.
Marketing and Customer Service
The Company has historically focused its marketing efforts on local and
county correctional facilities. Local and county facilities house inmates for
shorter durations than federal and state prisons and generally have higher
inmate call volumes. The Company's competitors in bidding for contracts to
serve local and county correctional facilities are usually small, regionally
focused independent providers. For larger local and county correctional
facility contracts, the Company may also compete with the local RBOC. In August
1998, the Company, in a relationship with Public Communications Services, Inc.
("PCS"), was awarded the federal contract for 14 Immigration and Naturalization
Service ("INS") facilities, representing approximately 6,640 beds.
The Company seeks new contracts by participating in competitive bidding
processes and by negotiating directly with correctional facilities. The Company
markets its inmate telecommunications services through a sales staff largely
made up of former law enforcement officials and others with experience in the
corrections and telecommunications industries who understand the specialized
needs of correctional facilities. The Company's marketing strategy emphasizes
the knowledge, experience, and reputation of the Company in the inmate
telecommunications industry, its high level of service, and the additional
specialized products and services offered by the Company to its correctional
facility customers. In addition to conducting in-person sales calls on the
operators of correctional facilities, the Company participates in trade shows
and is active in local law enforcement associations.
The Company provides and installs the inmate telephone system in each
correctional facility at no cost to the operator of the facility and generally
performs all maintenance activities. The Company utilizes a geographically
dispersed staff of field service technicians and independent telecommunications
services contractors, which allows the Company to respond quickly (typically
within 24 hours) to service interruptions. In addition, the Company has the
ability to make some repairs remotely through electronic communication with the
installed equipment without the need of an on-site service call.
Products and Services
The Company has developed its products and services to meet the needs of
the inmate telecommunications market. The Company offers the following products
and services as part of its core inmate telecommunications business:
. Inmate Collect Call Services. The Company provides collect call services
on an exclusive basis to its inmate facility customers during the term
of the facility's contract. The majority of calls made by inmates from
correctional facilities are collect calls, with the balance of the calls
being prepaid and debit card calls. The Company's collect call revenues
comprise a majority of the Company's total revenues.
. Prepaid and Debit Card Services. The Company also provides both prepaid
and debit card services to inmates and called parties. The Company sells
debit cards to correctional facilities at a discount to their face
value, which facilities in turn sell the cards at face value to inmates
at those facilities. Prepaid call services allow the recipient of an
inmate call to pay in advance for collect calls placed to the recipient,
while debit card services allow inmates to pay in advance for telephone
calls placed by that inmate. Both prepaid and debit card services have
no associated uncollectible account expenses and minimal billing and
collection costs. The Company's prepaid and debit card services revenues
comprise a small percentage of the Company's revenues, but these
revenues are expected to increase as a percentage of total revenue.
7
. Billing Services. The Company uses its experience in billing and
collections and management of uncollectible accounts to offer
specialized billing and collection services for other inmate
telecommunications service providers. The Company is pursuing
opportunities to market these services to RBOCs, LECs, IXCs, and other
inmate telecommunications providers. In May 1998, the Company entered
into a contract with a major RBOC, under which the Company performs
all of the validation, billing, and collection services for the RBOC's
inmate calls, and began processing call traffic under this contract.
Under the terms of the agreement, the Company acquires at a discount the
related 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, 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. The contract term is three years
and has no minimum volume commitment.
. Additional Value Added Services. The Company offers value added services
on a customized, facility by facility basis. These services include the
use of the Company's computer-based specialized law enforcement
management system ("LEMS"), which includes jail management, victim
notification, and prisoner profile software packages. LEMS is a key
selling point for the Company to potential customers and will also be
marketed to its existing customers. The Company also offers jail
training services that include Company-sponsored training seminars for
jail personnel on a variety of topics, including safety and fraud
detection.
Billing Arrangements
The Company uses direct and third party billing agreements to bill and
collect phone charges. Under direct billing agreements with LECs, the LEC
includes collect call charges for the Company's services on the local telephone
bill sent to the called party. The Company generally receives payment from the
LEC for such calls 30 to 60 days after the end of the month in which the call is
submitted to the LEC for billing. The payment received by the Company is net of
a service fee, write-offs of uncollectible accounts, and an estimated reserve
for future uncollectible accounts.
Unlike many smaller independent service providers with lower
telecommunications traffic, the Company has been able to enter into direct
billing agreements in most of its markets because of the Company's high market
penetration. The Company's increased telecommunications traffic has enabled the
Company to enter into 29 direct billing arrangements that enabled the Company to
direct bill approximately 89% of its operating revenues in December 1998.
Management believes that direct billing agreements expedite the billing and
collection process and increase collectibility.
In the absence of a direct billing arrangement, the Company bills and
collects its fees through a third-party billing and collection clearinghouse
that in turn has a billing and collection agreement with the LEC. When the
Company employs a third-party billing and collection clearinghouse, the account
proceeds are forwarded by the various LECs to the clearinghouse, which then
forwards the proceeds to the Company, less a processing fee that varies from 2%
to 3% of billed revenues. The Company also has a central billing office that
receives all call records and then enters them into the Company's call activity
data base.
The Company's specialized call management and billing system integrates
its direct billing arrangements with LECs with its call blocking, validation,
and customer inquiry procedures. Through the use of this system, the Company
believes that it has incurred lower levels of expenses associated with
uncollectible accounts than its competitors. This system has also provided the
Company with the opportunity to market its billing and collection services to
third parties. In May 1998 the Company entered into a contract with a major
RBOC, under which the Company performs all of the validation, billing, and
collection services for inmate call records supplied by the RBOC. In addition,
the Company provides call processing services for a major IXC. The Company
intends to pursue opportunities to market these systems to third parties such as
RBOCs, LECs, IXCs, and other inmate telecommunication providers.
8
Systems
The Company currently utilizes a call management and billing system that
consists of purchased and internally developed software applications on
specialized equipment. This system limits inmates to collect, prepay, or debit
calls, validates and verifies the payment history and account status of each
number dialed for billing purposes, and confirms that the destination number has
not been blocked. The Company also installs its internally developed call
management system ("CAM") within new facilities that require special features
such as call monitoring and recording capability.
The Company's database of telephone numbers and call activity provides
valuable data to assist the Company in reducing unbillable and uncollectible
accounts and allows the Company to provide extensive call activity reports to
correctional facilities and enforcement authorities. These include reports of
frequently called numbers, calls of longer than normal duration, and calls by
more than one inmate to the same number, which can assist law enforcement
authorities in connection with ongoing investigations.
Other Operations
The Company owns, operates, services, and maintains a system of
microprocessor controlled public pay telephones that are ancillary to its inmate
telecommunications business, and occasionally installs public pay telephones as
an accommodation to, or pursuant to a contract requirement imposed by, its
correctional facility customers.
Competition
In the inmate telecommunications business, the Company competes with
numerous independent providers of inmate telephone systems, RBOCs, LECs, and
IXCs. Many of the Company's competitors are larger and better capitalized with
significantly greater financial resources than the Company. The Company believes
that the principal competitive factors in the inmate telecommunications industry
are (i) rates of commissions paid to the correctional facilities; (ii) system
features and functionality; (iii) system reliability and service; (iv) the
ability to customize inmate call processing systems to the specific needs of the
particular correctional facility; and (v) relationships with correctional
facilities.
Inmate telephones in the U.S. are operated by a large and diverse group
of service providers. Large telecommunications companies such as RBOCs, other
LECs, and IXCs such as AT&T, MCI WorldCom, and Sprint Corporation provide inmate
telecommunications in addition to other services. In addition, independent
public pay telephone and inmate telephone companies also focus on this market
segment.
Regulation
The inmate telephone industry is regulated at the federal level by the
Federal Communications Commission (the "FCC") and at the state level by the
public utility commissions of the various states. In addition, from time to
time, legislation may be enacted by Congress or the various state legislatures
that affects the telecommunications industry generally and the inmate telephone
industry specifically. Court decisions interpreting applicable laws and
regulations may also have a significant effect on the inmate telephone industry.
Changes in existing laws and regulations, as well as the adoption of new laws
and regulations applicable to the activities of the Company or other
telecommunications business, could have a material adverse effect on the
Company.
Federal Regulation
Prior to 1996, the federal government's role in the regulation of the
inmate telephone industry was limited. The enactment of the Telecommunications
Act of 1996 (the "Telecom Act"), however, marked a significant change in the
scope of
9
federal regulation of inmate telephone service. Section 276 of the Telecom Act
directed the FCC to implement rules to overhaul the regulation of the provision
of pay telephone service, which Congress defined to include the provision of
inmate telephone service.
Before adoption of the Telecom Act, LECs generally included inmate
telephone operations as part of their regulated local exchange telephone company
operations. This allowed the LECs to pool revenue and expenses from their
monopoly local exchange operations with revenue and expenses from their inmate
telephone operations. This commingling of operations made possible the
subsidization of the LECs' inmate operations through other regulated revenues.
The LECs were also able to shift certain costs from their inmate operations to
their local exchange monopoly accounts. In particular, the LECs were able to
pool the bad debt from their inmate operations with their other bad debt.
Because inmate telephone providers act as their own carrier, they bear the risk
of fraudulent calling and uncollectible calls and other bad debt. Bad debt is
substantially higher in the inmate telephone industry than in other segments of
the telecommunications industry. The LECs' practice of pooling bad debt shifts
the high costs of bad debt from inmate telephone operations to the expense
accounts of other LEC operations, presenting a vehicle for the cross-
subsidization of the LECs' inmate operations, which, in turn, has allowed the
LECs to offer commissions to correctional facilities that are significantly
higher than those that independent inmate telephone providers can offer.
Section 276 directed the FCC to adopt regulations to end the LECs'
subsidization of their inmate telephone operations from regulated revenues.
Congress also directed the FCC to ensure that the LECs could not discriminate in
favor of their own operations to the competitive detriment of independent inmate
telephone providers. Finally, Congress required the FCC to ensure that all
inmate telephone providers were fairly compensated for "each and every" call
made from their telephones.
To carry out its Congressional mandate, the FCC adopted regulations
requiring all LECs to transfer their inmate telephone operations from their
regulated accounts to the LECs' unregulated accounts no later than April 15,
1997. While the FCC's rules implementing Section 276 are designed to eliminate
cross-subsidization and cost-shifting, there are significant questions regarding
their ultimate effect. For example, it is unclear whether the FCC's rules will
fully prevent the shifting of bad debt from inmate operations to the LECs'
regulated accounts. Since the bad debt arises from the charges for collect
calls, which have traditionally been regulated carrier activities, the FCC has
not yet finally resolved exactly how the bad debt from inmate operations will be
allocated between regulated and unregulated accounts.
The FCC also addressed the one-time transfer of existing inmate
telephone operation assets from the LECs' regulated accounts to the unregulated
accounts established for inmate telephone operations. The FCC ordered the
transfer of those assets at their net book value rather than at their fair
market value. The inmate telecommunications industry had argued to the FCC that
the transfer should be accomplished at the assets' fair market value, including
the value of the contracts between the LECs' inmate operations and correctional
facilities. The net book value of those assets is much lower than their fair
market value. As a result of the below market valuation of the assets, the LECs'
inmate telephone operations may be able to post nominally higher returns on
their assets than they would otherwise be able to and hence relieve operating
pressures for returns on assets. This also could result in a competitive
advantage for the LECs with respect to access to capital markets compared with
the Company and other independent inmate telephone providers.
To eliminate discrimination, the FCC required, among other things, that
the LECs' inmate telephone operations take any tariffed services from its
regulated operations at the tariffed rate for the service, rather than the
actual cost of the service. Before the Telecom Act, the LECs' inmate operations
were able to take these services at some variant of their underlying costs
without regard to the tariffed rate being charged to independent providers.
Under the Telecom Act, the LECs' inmate operations must take tariffed services
on an arm's length basis, at tariffed rates that are subject to regulatory
approval. Further, the rates for the tariffed services offered to both the LECs'
inmate telephone operations and independent inmate telephone providers must be
developed on a consistent basis. The test that the FCC has mandated for the
pricing of services to both independent inmate telephone providers and the LECs'
own inmate operations will require a reexamination of existing rates and may
lead to a rate reduction for services in some instances, while it is also
possible that the rate reexamination may result in some rate increases. In
either event, the requirement for a consistent methodology for developing rates
should substantially reduce LEC opportunities for unfavorable rate
discrimination against independent inmate telephone providers like the Company.
The FCC did allow the LECs to offer certain non-tariffed services, for
example, repair and installation services, to the LECs' inmate operations on a
cost-sharing basis, which could result in some cost advantage to the LECs'
inmate operations. The LECs are free to price these services at full market
rates to independent inmate
10
telephone providers. Independent inmate telephone providers are not, however,
dependent on the LEC for these services, as they are with telephone lines;
independent inmate telephone providers can provide services like repair and
installation with their own staff or contractors.
To ensure "fair compensation" for inmate telephone providers, the FCC
held that it was not required to prescribe compensation for collect calls
because inmate providers act as their own carriers and collect the revenue from
those calls directly from called parties. The inmate telephone industry had
argued to the FCC, however, that because of state-mandated ceilings on the rates
for intrastate collect calls, inmate telephone providers could not recover
adequate revenue for those calls, and accordingly, had sought an "inmate system
compensation charge" in addition to the charges collected for carrying the call.
See "--State Regulation."
Because of continuing restrictions stemming from the 1984 divestiture of
the RBOCs by AT&T, the RBOCs are not able to carry long distance traffic. Prior
to the Telecom Act, the RBOCs were also precluded from choosing a long distance
carrier for calls originating from facilities where the RBOCs provided the
inmate telephone service and receiving commission revenue from that carrier.
Instead, carriers were selected by, and paid commissions directly to, the
individual correctional facilities being served by RBOCs.
Pursuant to the Telecom Act, the FCC decided that the RBOCs would be
allowed to choose their own carrier for their traffic from a given correctional
facility. As a result, the RBOCs may gain the ability to negotiate higher
commission rates to be paid to them from their contracted carrier by aggregating
traffic from several facilities into a single contract with the carrier.
Many aspects of the FCC's rules implementing Section 276 are currently
the subject of further proceedings by the FCC. In particular, two important
issues are back before the FCC as the result of a court challenge in which the
FCC voluntarily sought, and the court granted, a remand to the FCC for further
proceedings. The first of those issues is the FCC's decision not to prescribe
compensation for inmate collect calls. If the FCC ultimately decides to
prescribe compensation, the Company could potentially benefit from the ability
to collect additional revenue. It is not possible to predict whether the FCC
will prescribe compensation and the degree to which the Company could benefit,
if at all, would depend on the exact compensation scheme ultimately prescribed
by the FCC for inmate collect calls.
The second important issue before the FCC on remand is the FCC's
decision to include only inmate telephone equipment and not the collect calling
service itself in the inmate telephone services that the RBOCs must provide on a
nonregulated basis. As a result of this ruling, the RBOCs have to some extent
remained able to subsidize and discriminate in favor of their inmate calling
operations. In particular, so long as the RBOCs can continue to define their
inmate collect calling service as part of their regulated operations, they may
be commingling that bad debt with bad debt from other services. It cannot be
predicted how the FCC will rule on this issue on remand. However, if the FCC
reverses its stance and defines nonregulated inmate calling services to include
inmate collect calls, the Company could potentially benefit from a reduction in
the ability of its RBOC competitors to subsidize and discriminate in favor of
their inmate operations.
Because of the further proceedings pending before the FCC, the ultimate
effects of the rule changes mandated by the Telecom Act are uncertain. In
particular, the extent to which the FCC's rules designed to eliminate
subsidization and discrimination by the LECs prove to be effective will
significantly affect the level of competition faced by the Company in the inmate
telecommunications market.
Apart from its proceedings to implement the Telecom Act, the FCC also
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. The Company must come into compliance with these new
rules by October 1, 1999. The Company's existing systems already have the
capability to perform this function. These new regulations could result in an
increase in the Company's costs by slightly increasing the non-billable network
hold time for interstate collect calls. Also, since the Company may comply with
the new federal requirement by implementing rate disclosure on all calls,
including intrastate calls, the new regulations may lead to slight increases in
the costs for all inmate collect calls carried by the Company. 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.
Significantly, the FCC adopted the rate disclosure option in lieu of the
so-called "Billed Party Preference" proposal that had been pending before the
FCC for several years. Under that plan, inmate telephone service providers would
have been required to send their interstate inmate collect calls to the called
party's pre-subscribed carrier, thereby bypassing the
11
opportunity for the inmate telephone service provider to receive revenue from
the calls. The Company believes that the rate quote regulations adopted by the
Commission are a preferable alternative to Billed Party Preference, which would
potentially have had a much more adverse effect on the Company's business.
State Regulation
The most significant state involvement in the regulation of inmate
telephone service is the limit on the maximum rates that can be charged for
intrastate collect calls set by most states, referred to as "rate ceilings."
Since collect calls are generally the only kind of calls that can be made by
inmates in correctional facilities, the state-imposed rate ceilings on those
calls can have a significant effect on the Company's business.
In many states, the rate ceilings on inmate collect calls within the
originating LEC's service area are tied to the rates charged by the LEC and
subject to state regulatory approval. Thus, where the LEC chooses not to raise
its rates, independent inmate telephone providers are precluded from raising
theirs. Prior to the passage of the Telecom Act, the LECs had less incentive to
raise their rates than independent inmate telephone providers because the LECs
were able to subsidize their inmate telephone operations and discriminate in
their favor, as described above. See "--Federal Regulation." It is possible
that as a result of the FCC's new rules designed to eliminate such subsidies,
some LECs may choose to file with their state commissions to raise their rates
for inmate collect calls. If this occurs, the Company and other independent
inmate telephone providers could also raise their rates. It is difficult to
predict the extent to which the LECs will raise their rates.
For calls going outside the originating LEC's service area, there may be
state rate ceilings tied to the rates of the largest IXCs. In some cases, these
rate ceilings can also make sufficient cost recovery difficult. In general, the
cost recovery problems that arise from rate ceilings tied to IXC rates are not
as severe as the difficulties created by rate ceilings tied to LEC rates.
In its rulemaking implementing the Telecom Act, the FCC declined to
address these state rate ceilings. The FCC ruled that inmate telephone providers
must first seek relief from the state rate ceilings at the state level. The
outcome of any such proceedings at the state level, if undertaken, is uncertain.
Further, it is uncertain whether the FCC would intervene or if so, how, in the
event a state failed to provide relief. This issue is part of the currently
pending FCC remand proceeding.
In addition to imposing rate caps, the states regulate other aspects of
the inmate calling industry. While the degree of regulatory oversight varies
significantly from state to state, state regulations generally establish minimum
technical and operating standards to ensure that public interest considerations
are met. Among other things, most states have established rules that govern
registration requirements, notice to called parties of the identity of the
service provider in the form of postings or verbal announcements, and
requirements for rate quotes upon request. In some jurisdictions, in order for
the Company to operate its inmate telephones and public pay telephones, it is
necessary to become certificated and to file tariffs with the appropriate state
regulatory authority.
Tradenames
The Company has two registered trademarks, Security Telecom
Corporation(R) and STC(R) and has developed or acquired a number of additional
unregistered tradenames that it uses in its business. Although the use of these
trademarks and tradenames has created goodwill in certain markets, management
does not believe that the loss of these trademarks and tradenames would have a
material adverse effect on the Company's operations. The Company also has a
registration application pending for the tradename Evercom and certain
derivatives thereof.
Environmental
The Company is subject to certain federal, state, and local
environmental regulations. Management does not expect environmental compliance
to have a material effect on the Company's capital expenditures, earnings, or
competitive position in the foreseeable future.
Employees
As of December 31, 1998, the Company had approximately 316 employees.
12
ITEM 2. PROPERTIES
The Company's principal executive offices are located in, and a portion
of its operations are conducted from, leased premises located at 8201 Tristar
Drive, Irving, Texas 75063. The Company also has three additional regional
facilities from which it conducts its operations located in Selma, Alabama;
Louisville, Kentucky; and Lee's Summit, Missouri, all of which are leased.
ITEM 3. 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 effect on the Company.
The Company was unsuccessful in obtaining a Federal Bureau of Prisons
contract, and has appealed the award. There can be no assurances that the
Company will be successful in appealing this award.
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. 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 these features or to obtain appropriate licenses for
the use of such technology.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's annual meeting held on June 24, 1998, the following
matters were voted upon:
1. Name change of the Company from "Talton Holdings, Inc." to "Evercom, Inc."
Votes for: 14,010 Votes Against: 0 Did Not Vote: 1,790
2. Approval of the Company's 1998 Stock Option Plan.
Votes for: 14,010 Votes Against: 0 Did Not Vote: 1,790
13
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is currently no established public trading market for the
Registrant's issued and outstanding capital stock.
As of December 31, 1998, there were forty-eight holders of the Company's
Class A common stock (the "Common Stock") and four holders of the Company's
Class B common stock (the "Class B Common Stock").
There have been no cash dividends declared on the Common Stock from the
period January 1, 1996 through December 31, 1998. The Indenture (the
"Indenture") governing the Company's Series A and Series B Senior Notes Due 2007
and the Company's senior credit facility, as amended and restated (the "Senior
Credit Facility") contain certain restrictive covenants that are likely to
materially limit the future payment of dividends on the Common Stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The following table sets forth information with respect to all
securities sold by the Company for the Company's last fiscal year that were not
registered under the Securities Act of 1933, as amended, (the "Securities Act").
All securities sold and not registered were sold in transactions not involving a
public offering under Section 4(2) of the Securities Act.
SECURITIES SOLD DATE PERSON ACQUIRING AMOUNT CONSIDERATION USE OF PROCEEDS TERMS OF
SECURITIES CONVERSION OF
EXERCISE
- --------------------------------------------------------------------------------------------------------------------------------
Convertible 02/18/98 former shareholders 158-1/3 shares additional consideration Acquisition $6,000.00 strike
Note of MOG for asset acquisition of Business price per share
Communications, Inc.
- --------------------------------------------------------------------------------------------------------------------------------
14
ITEM 6. SELECTED FINANCIAL DATA - (in thousands)
Effective December 1, 1996, the Company became the holding company for the
operations of AmeriTel and Talton Telecommunications. The Company accounted for
these acquisitions using the purchase method of accounting. Accordingly, the
Company's consolidated financial statements included the operations of AmeriTel
and Talton Telecommunications only for periods after December 1, 1996.
The following selected consolidated financial data of the Company for each
of the two years ended December 31, 1998 and the one month ended December 31,
1996, and the selected combined financial data of the Company's predecessors for
the years ended December 31, 1994 and 1995 and for the eleven months ended
November 30, 1996, have been derived from the Company's and its predecessors'
audited financial statements.
The selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and the notes thereto
included elsewhere in this Form 10-K.
15
COMBINED PREDECESSORS THE COMPANY
--------------------------------------------- -----------------------------------------
ELEVEN MONTHS ONE MONTH
ENDED ENDED
YEARS ENDED DECEMBER 31, NOVEMBER 30, DECEMBER 31, YEARS ENDED DECEMBER 31,
------------------------- ----------------------------
1994 1995 1996 1996 1997 1998
----------- ------------ -------------- ------------ ------------- ------------
Operating Data:
Operating revenues $ 23,892 $ 40,326 $ 53,663 $ 5,506 $ 91,773 $ 225,293
Operating expenses:
Telecommunciation costs 11,761 18,673 23,317 2,299 37,871 99,843
Facility commissions 3,901 9,595 13,962 1,455 25,724 71,206
Field operations and maintenance 1,044 1,467 1,816 219 4,543 7,817
Selling, general and administrative 2,571 4,089 3,921 372 8,540 17,661
Depreciation and impairment 965 1,359 1,538 111 2,219 6,692
Amortization of intangibles 1,392 1,605 1,746 741 14,243 26,339
Restructuring and other charges - - 684 - 400 1,743
----------- ----------- ----------- ------------ ------------ -----------
Total operating expenses 21,634 36,788 46,984 5,197 93,540 231,301
----------- ----------- ----------- ------------ ------------ -----------
Operating income (loss) 2,258 3,538 6,679 309 (1,767) (6,008)
Other (income) expenses:
Interest expense, net 745 1,360 1,469 612 11,138 19,638
Other, net (134) (52) 27 (20) (76) (236)
----------- ----------- ----------- ------------ ------------ -----------
Total other (income) expense 611 1,308 1,496 592 11,062 19,402
----------- ----------- ----------- ------------ ------------ -----------
Income (loss) before income taxes and
extraordinary loss 1,647 2,230 5,183 (283) (12,829) (25,410)
Income tax (benefit) expense (11) 891 1,917 (23) (642) 476
----------- ----------- ----------- ------------ ------------ -----------
Income (loss) before extraordinary
loss 1,658 1,339 3,266 (260) (12,187) (25,886)
Extraordinary loss - - 52 - 4,740 -
----------- ----------- ----------- ------------ ------------ -----------
Net income (loss) $ 1,658 $ 1,339 $ 3,214 $ (260) $ (16,927) $ (25,886)
=========== =========== =========== ============ ============ ===========
OTHER DATA:
EBITDA (1) $ 4,749 $ 6,554 $ 9,936 $ 1,181 $ 14,771 $ 27,259
Net cash provided (used) by operating
activities 3,445 4,069 7,300 (1,419) 6,048 4,258
Net cash used in investing activities (9,976) (8,022) (7,515) (47,252) (90,757) (23,384)
Net cash provided (used) by financing
activities 6,668 4,827 (547) 48,966 92,193 13,039
Capital expenditures (2) 3,223 4,669 2,804 269 8,063 13,592
Ratio of earnings to fixed charges (3) 3.0 2.5 4.2 -- -- --
Deficiency of earnings to fixed charges -- -- -- $ 283 $ 12,829 $ 25,410
BALANCE SHEET DATE (AT END OF PERIOD)
Cash and cash equivalents $ 419 $ 1,293 $ 531 $ 294 $ 7,778 $ 1,692
Total assets 17,639 26,592 34,708 80,134 189,388 191,466
Total debt (including current
maturities) 10,750 15,074 14,845 63,315 166,736 180,483
Total stockholders' equity (deficit) 2,027 4,850 9,361 6,481 (10,020) (36,113)
___________
(1) For the purpose of this Form 10-K, EBITDA means income before interest,
income taxes, depreciation, and amortization. Although EBITDA is not a
measure of performance calculated in accordance with generally accepted
accounting principles, the Company has included information concerning
EBITDA in this Form 10-K 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 flow as an indicator
of the Company's operating performance.
(2) Capital expenditures include only amounts expended for purchases of
property and equipment and the implementation of facilitiy contracts and
excludes cash outflows for acquisitions.
(3) Earnings are defined as earnings (loss) before income taxes from continuing
operations and fixed charges. Fixed charges are defined as interest expense
and a portion of rental expense representing the interest factor, which the
Company estimates to be one-third of rental expense, and amortization of
deferred financing expense. This calculation is a prescribed earnings
coverage ratio intended to present the extent to which earnings are
sufficient to cover fixed charges, as defined.
16
ITEM 7. 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."
Overview
The Company is the largest independent provider of collect, prepaid, and
debit 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 approximately 43 states. As of December 31, 1998, the Company
served 2,073 correctional facilities in 43 states.
The Company derives substantially all of its revenues from its operation
of inmate telecommunications systems located in correctional facilities in 43
states. The Company's inmate telecommunications services consist of collect
call, prepaid, and debit card 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 LECs
or through third-party billing services. In addition, the Company accrues the
related telecommunications costs for validating, transmitting, billing and
collection, and line and long-distance charges, along with commissions payable
to the facilities, and allowances for uncollectible accounts based on historical
experience.
The Company's traditional inmate business consists of collect, prepaid,
and debit calling services provided to correctional facilities. In May 1998, the
Company began providing validation, billing, and collection services for the
inmate calls of a major RBOC. Under the terms of the agreement, the Company
acquires at a discount the related 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 three years and has no
minimum volume commitment. The Company pays no facility commissions under this
agreement.
The Company's principal operating expenses consist of (i)
telecommunication costs; (ii) commissions paid to correctional facilities, which
are typically expressed as a percentage of either gross or net revenues, fixed
for the term of the agreements with the facilities, and in some cases are
subject to monthly minimum amounts; (iii) field operations and maintenance
costs, which consist primarily of field service on the Company's installed base
of inmate telephones; and (iv) SG&A costs.
Telecommunication Costs. The principal 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 IXCs. The
Company entered into an agreement to lease lines connecting urban areas
and correctional facilities in the state of North Carolina. Given the Company's
relatively high level of traffic in North Carolina, management believes that
transmission via leased lines will be more economical than acquiring minutes of
use.
17
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, and 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. The Company believes
that it experiences faster payments and lower expenses associated with
uncollectible accounts when using direct billing than when using other billing
service providers. 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. Commission
rates are the principal basis 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 23.8% in 1995 to
31.6% in 1998. This increase is due primarily to higher facility commissions on
contracts obtained by the Company through acquisitions, competition for larger
facilities, and increased commission rates on renewals. Commission rates are
expected to gradually increase as a percentage of revenues in the future. The
overall commission percentage to total revenues of 31.5% in 1998 includes the
effect of the billing and collection 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 expense. These costs are also relatively small and more
constant components of operating expenses.
Restructuring Costs. The Company is currently integrating its acquired
operations into its existing operations, which resulted in a restructuring
charge in September 1998 of $1.4 million. The restructuring charge was lowered
by $0.2 million in the fourth quarter, primarily due to the final determination
of the number of employees terminated, the unanticipated subletting of certain
facilities, and a refinement of expected legal and other costs.
Company History. The Company became the holding company for the
operations of its predecessors, AmeriTel and Talton Telecommunications,
effective December 1, 1996. The Company also acquired the operations of Tataka
on April 2, 1997, STC on June 27, 1997, CCC on July 31, 1997, InVision on
October 6, 1997, NAI on December 1, 1997, PTC on December 18, 1997, ILD on
January 1, 1998, MOG on February 1, 1998, and Saratoga on July 1, 1998. Because
the Company's acquisitions of its predecessors have been accounted for using the
purchase method of accounting, the Company's results of operations reflect the
operations of AmeriTel and Talton Telecommunications only subsequent to December
1, 1996. In addition to the acquisitions of its predecessors, the Company has
also completed the Acquisitions, which have also been accounted for using the
purchase method of accounting, and the Company's results of operations therefore
reflect the operations of these companies only subsequent to the effective dates
of their respective acquisitions. Management believes that the growth of the
Company and its predecessors, AmeriTel and Talton Telecommunications, through
acquisitions makes meaningful period-to-period comparison of historical results
of operations difficult. Consequently, management believes that the investor is
presented with more meaningful information through discussion of the Company and
its predecessors on a combined basis, for the periods discussed below.
18
Results of Operations
The following table sets forth, for the periods indicated, the combined
historical results of operations of the Company and AmeriTel and Talton
Telecommunications, without any adjustments to historical results to reflect
changes in depreciation and amortization resulting from purchase accounting
evaluations, as follows:
Year ended December 31, 1996........... Combined results of operations of the
predecessors, AmeriTel and Talton
Telecommunications, for the eleven
months ended November 30, 1996 and of
the Company for the one month ended
December 31, 1996
Years ended December 31, 1997 and 1998.. Consolidated results of operations of
the Company for the periods
These above described combined results of operations include the
results of operations of the acquired entities in the Company's results of
operations only for the periods subsequent to their acquisition dates.`
Years Ended December 31,
-------------------------------------------------------------------------------
1996 1997 1998
---------------------- --------------------------- --------------------------
(Dollars in thousands)
Operating revenues ...................... $59,169 100.0% $ 91,773 100.0% $225,293 100.0%
Operating expenses:
Telecommunication costs ................ 25,616 43.3 37,871 41.3 99,843 44.3
Facility commissions ................... 15,417 26.1 25,724 28.0 71,206 31.6
Field operations and maintenance ....... 2,035 3.4 4,543 5.0 7,817 3.5
Selling, general, and administrative..... 4,293 7.3 8,540 9.3 17,661 7.8
Depreciation and impairment.............. 1,649 2.8 2,219 2.4 6,692 3.0
Amortization of intangibles ............ 2,487 4.2 14,243 15.5 26,339 11.7
Restructuring and other charges.......... 684 1.2 400 0.4 1,743 0.8
------- ---- -------- ------ -------- ------
Total operating expenses ................ 52,181 88.3 93,540 101.9 231,301 102.7
------- ---- -------- ------ -------- ------
Operating income (loss) ................. 6,988 11.7 (1,767) (1.9) (6,008) (2.7)
Other (income) expense:
Interest expense, net .................. 2,081 3.5 11,138 12.1 19,638 8.7
Other, net ............................. 7 (0.0) (76) 0.0 (236) (0.1)
------- ---- -------- ------ -------- ------
Total other expense ..................... 2,088 3.5 11,062 12.1 19,402 8.6
------- ---- -------- ------ -------- ------
Income (loss) before income taxes and
extraordinary loss ..................... 4,900 8.2 (12,829) (14.0) (25,410) (11.3)
Income tax expense (benefit) ............ 1,894 3.2 (642) (0.7) 476 0.2
------- ---- -------- ------ -------- ------
Income (loss) before extraordinary loss... 3,006 5.0 (12,187) (13.3) (25,886) (11.5)
Extraordinary loss ...................... 52 0.1 4,740 5.1 -- --
------- ---- -------- ------ -------- ------
Net income (loss) ....................... $ 2,954 4.9% $(16,927) (18.4)% $(25,886) (11.5)%
======= ==== ======== ====== ======== ======
EBITDA .................................. $11,117 18.8% $ 14,771 16.1% $ 27,259 12.1%
Year Ended December 31, 1998 (Consolidated Results of Operations of the Company)
compared to year ended December 31, 1997 (Consolidated Results of Operations of
the Company)
Operating Revenues. The Company's operating revenues increased by $133.5
million, or 145.5%, from $91.8 million for the year ended December 31, 1997 to
$225.3 million for the year ended December 31, 1998. The increase in operating
revenues was primarily due to acquisitions by the Company of CCC, InVision, and
PTC between July and December 1997 and of ILD, MOG and Saratoga in 1998. Since
its inception, the Company has acquired contracts for 1,888 facilities through
the Acquisitions and has added additional facilities by winning new contracts
for county, local, and state facilities. As of December 31, 1998 the Company
served 2,073 correctional facilities in 43 states. The Company's contract with
the State of Alabama was not renewed, and the Company estimates that this will
result in a reduction in revenue and EBITDA in fiscal year 1999 of $8.2 million
and $1.5 million, respectively, when compared to fiscal year 1998.
19
Operating Expenses. Total operating expenses increased by $137.8
million, or 147.3%, from $93.5 million in 1997 to $231.3 million in 1998.
Operating expenses as a percentage of operating revenues increased by 0.8% from
101.9% for the year ended December 31, 1997 to 102.7% for the year ended
December 31, 1998. The increase in operating expenses as a percentage of
revenues is primarily due to factors discussed below.
Telecommunication costs increased by $61.9 million, from $37.9 million
in 1997 to $99.8 million in 1998. Telecommunication costs represented 41.3% of
operating revenues in 1997 and 44.3% of operating revenues in 1998, an increase
of 3.0%. The percentage increase is due in part to higher levels of
uncollectible accounts associated with the Company's acquisitions subsequent to
June 30, 1997, which are located in geographic regions that exhibit higher
uncollectible rates. The percentage increase is also due to the increase in
competitive local exchange carrier ("CLEC") activity. These CLECs increased the
Company's unbillable expense, because in most cases the CLECs are unable to bill
the Company's traffic. The Company is responding to this problem by offering
prepaid services to these customers. The Company's overall telecommunications
costs as a percentage of revenues of 44.3% for 1998 include the effect of the
Company's billing and collection services provided to a major RBOC as discussed
in "General" in Item 2. These billing and collection services exhibit higher
telecommunication costs as a percentage of revenue than the Company's
traditional inmate business.
Facility commissions increased by $45.5 million, from $25.7 million in
1997 to $71.2 million in 1998. Facility commissions represented 28.0% of
operating revenues in 1997 and 31.6 % in 1998, an increase of 3.6%. This
increase as a percentage of revenue is primarily due to increased facility
commissions under contracts obtained by the Company through acquisitions, the
competition in larger facilities, and increased commission rates on renewals.
Facility commissions are expected to gradually increase as a percentage of
revenue in the future. The overall commission percentage to total revenue of
31.6% in 1998 includes the effect of the billing and collection services
provided to a major RBOC as discussed in "General" in Item 2.
Field operations and maintenance costs increased by $3.3 million, from
$4.5 million in 1997 to $7.8 million in 1998. Field operations and maintenance
costs represented 5.0% of operating revenues in 1997 and 3.5% of operating
revenues in 1998, a decrease of 1.5%. The dollar increase is primarily due to
costs associated with servicing the acquired facilities and the new contract
facilities. Field operations and maintenance costs as a percentage of revenue
was 3.3% for the fourth quarter 1998 compared to 3.4% for the third quarter
1998. This decrease is due to the integration activities completed by the
Company in the fourth quarter.
SG&A costs increased by $9.2 million, from $8.5 million in 1997 to $17.7
million in 1998. SG&A represented 9.3% of operating revenues in 1997 and 7.8%
of operating revenues in 1998, a decrease of 1.5%. The dollar increase in SG&A
costs is primarily due to the increased infrastructure necessary to support the
Acquisitions. SG&A costs as a percentage of revenue was 7.3% for the fourth
quarter 1998 compared to 8.0% for the third quarter 1998. This percentage
decrease is mainly due to the integration activities completed by the Company in
the fourth quarter.
Total depreciation and amortization costs increased by $16.5 million,
from $16.5 million in 1997 to $33.0 million in 1998. Depreciation and
amortization costs represented 17.9% of operating revenues in 1997 and 14.7% of
operating revenues in 1998, a decrease of 3.2%. The dollar increase is primarily
due to additional amortization expense associated with the inmate facility
contracts acquired in the Acquisitions. Amortization resulting from purchase
accounting of the Acquisitions is and will continue to be a substantial portion
of the Company's operating expenses.
The Company integrated its acquired operations into its existing
operations, which resulted in a restructuring charge of $1.4 million in
September 1998. The restructuring charge was lowered by $0.2 million in the
fourth quarter, primarily due to the final determination of the number of
employees terminated, the unanticipated subletting of certain facilities, and a
refinement of expected legal and other costs. In December 1998, the Company
wrote-off approximately $0.5 million related to the postponement of the
Company's initial public offering.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $8.3 million from $11.1 million in 1997 to $19.4
million in 1998. The increase was primarily due to interest expense associated
with the indebtedness incurred by the Company in connection with the
Acquisitions.
Net Loss. The Company's net loss increased by $9.0 million, from $16.9
million in 1997 to $25.9 million in 1998 as a result of the factors described
above.
EBITDA. Earnings before interest, income taxes, depreciation and
amortization ("EBITDA") increased by $12.5 million from $14.8 million in 1997 to
$27.3 million in 1998. EBITDA as a percentage of operating revenues decreased
from 16.1% in 1997 to 12.1% in 1998 due to the factors described above. Although
EBITDA is not a measure of performance
20
calculated in accordance with generally accepted accounting principles, the
Company has included information concerning EBITDA in this Form 10-K 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. Several of the Company's
subsidiaries are subject to state income taxes. Consequently, the Company
accrues income tax expense even in a loss period.
Year Ended December 31, 1997 (Consolidated Results of Operations of the Company)
Compared to Year Ended December 31, 1996 (Combined Results of Operations of the
Company's Predecessors, AmeriTel And Talton Telecommunications, for the Eleven
Months Ended November 30, 1996 and of the Company for the One Month Ended
December 31, 1996)
Operating Revenues. The Company's operating revenues increased by $32.6
million, or 55.1%, from $59.2 million for the year ended December 31, 1996 to
$91.8 million for the year ended December 31, 1997. The increase in operating
revenues was primarily due to acquisitions of the Company of STC, CCC, InVision,
NAI, and PTC during 1997, and new contract installations. Specifically, the
Company acquired inmate telephone contracts at 128 facilities in 14 states from
STC; 23 facilities in 3 states from CCC; 568 facilities in 37 states from
InVision; 57 facilities in 5 states from NAI; and 82 facilities in 10 states
from PTC.
Operating Expenses. Total operating expenses increased $41.3 million,
from $52.2 million in 1996 to $93.5 million in 1997. Operating expenses as a
percentage of operating revenues increased 13.6% from 88.3% for the year ended
December 31, 1996 to 101.9% for the year ended December 31, 1997. The increase
in operating expenses as a percentage of revenues is primarily due to the
factors discussed below.
Telecommunication costs increased by $12.3 million, from $25.6 million
in 1996 to $37.9 million in 1997. Telecommunication costs represented 43.3% of
operating revenues in 1996 and 41.3% of operating revenues in 1997, a decrease
of 2.0%. The dollar increase is primarily due to the acquisitions by the Company
of STC, CCC, InVision, NAI, and PTC during 1997, and new contract installations.
The decrease as a percentage of operating revenues is primarily due to lower
billing and collection costs as a result of direct billing arrangements entered
into with various major LECs and lower relative costs for long distance as a
result of new long distance agreements.
Facility commissions increased by $10.3 million, from $15.4 million in
1996 to $25.7 million in 1997. Facility commissions represented 26.1% of
operating revenues in 1996 and 28.0% of operating revenues in 1997, an increase
of 1.9%. The increase is primarily due to higher commission rates for certain
contracts associated with the Acquisitions, as well as higher commission
percentages paid as a result of periodic increases in percentages paid to
existing customers as contracts are renewed.
Field operation and maintenance costs increased by $2.5 million, from
$2.0 million in 1996 to $4.5 million in 1996. Field operation and maintenance
costs represented 3.4% of operating revenues in 1996 and 5.0% of operating
revenues in 1997, an increase of 1.6%. The dollar increase is primarily due to
an increase in the costs associated with servicing acquired facilities.
SG&A increased by $4.2 million, from $4.3 million in 1996 to $8.5
million in 1997. SG&A represented 7.3% of operating revenues in 1996 and 9.3% of
operating revenues in 1997, an increase of 2.0%. The increase in SG&A as a
percentage of operating revenues is primarily due to the increased
infrastructure necessary to support the Company's acquisitions and the Company's
more aggressive sales efforts. The Company's SG&A for 1997 was affected by the
significant acquisition activity during the period.
Total depreciation and amortization costs increased by $12.4 million,
from $4.1 million in 1996 to $16.5 million in 1997. Depreciation and
amortization costs represented 7.0% of operating revenues in 1996 and 17.9% of
operating revenues in 1997, an increase of 10.9%. The dollar increase is
primarily due to additional amortization expense associated with the
acquisitions by the Company of inmate facility contracts, and the Acquisitions.
The Company incurred an expense of $400,000 in 1997 related to external
costs associated with the Company's application for the Federal Board of Prisons
contract. The Company was unsuccessful in obtaining the contract. The contract
award has been appealed, however, the Company has expensed all costs associated
with the bid.
21
The Company incurred a non-recurring expense of $684,000 in 1996 related
to $434,000 in bonuses paid by AmeriTel prior to its acquisition by the Company
and $250,000 paid by AmeriTel to settle a lawsuit. Such expense represented 1.2%
of operating revenues in 1996.
Operating Income (Loss). The Company's operating income decreased by
$8.8 million, from $7.0 million in 1996 to an operating loss of $1.8 million in
1997 primarily as a result of increases in depreciation and amortization due to
the Acquisitions. Also, as a result of the depreciation and amortization, the
Company's operating income margin decreased from 11.7% in 1996 to an operating
loss of 1.9% in 1997.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $9.0 million from $2.1 million in 1996 to $11.1
million in 1997. The increase was primarily due to interest expense associated
with indebtedness incurred by the Company in connection with acquisitions and
completion of the June 1997 offering (the "Notes Placement") of $115,000,000
principal amount 11% Senior Notes due 2007 (the "Senior Notes").
Extraordinary Loss. The Company incurred an extraordinary loss of $4.7
million in 1997 due to the write-off of the unamortized deferred loan costs and
the unamortized discount related to the senior subordinated notes originally
issued by Canadian Imperial Bank of Commerce ("CIBC"), which were repaid in
connection with the acquisitions of AmeriTel and Talton Telecommunications (the
"Senior Subordinated Notes") with the net proceeds the Notes Placement. In
1996, one of the Company's predecessors incurred an extraordinary loss of
approximately $52,000 in conjunction with the extinguishment of debt.
Net Income (Loss). The Company's net income decreased by $20.0 million,
from $3.0 million in 1996 to a net loss of $17.0 million in 1997 as a result of
the factors described above.
EBITDA. EBITDA increased by $3.7 million from $11.1 million in 1996 to
$14.8 million in 1997. EBITDA as a percentage of operating revenues decreased
from 18.8% in 1996 to 16.1% in 1997 due to the factors described above.
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. The Company expects that its principal sources
of funds will be cash flow from operations and borrowings under the Senior
Credit Facility. The Company anticipates that its primary capital expenditures
will be for capital items required to implement new contracts entered into by
the Company and alternative network solutions, although the Company does not
have material commitments for capital expenditures. Management believes that
cash flow from operations (if any) and from the Senior Credit Facility will be
sufficient to fund the requirements of the Company for at least the next 12
months.
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 will be entitled to receive dividends at the applicable First
Preferred Series A Rate, payable quarterly commencing on April 1, 1999. Such
dividends will be payable out of funds legally available therefor, 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 month
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
22
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.
As of March 26, 1999, the Company had $13.5 million of available
borrowing capacity 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 candidates. 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, or both.
Net cash provided by operating activities was $4.3 million for the year
ended December 31, 1998, as compared to net cash provided by operating
activities of $6.0 million for the year ended December 31, 1997. Net cash
provided by operating activities was $5.9 million for the year ended December
31, 1996. Net cash provided by operating activities in 1998 declined from 1997
primarily due to working capital required to fund the Company's growth in its
traditional inmate business.
Cash used in investing activities was $23.4 million for the year ended
December 31, 1998, as compared to $90.8 million for the year ended December 31,
1997. Cash used in investing activities in 1998 consisted primarily of $7.0
million to fund the acquisitions of ILD, MOG and Saratoga, $4.7 million in
payments related to acquisitions made in 1997 and $13.6 million for new
business, contract renewals and infrastructure improvements. Cash used in
investing activities in 1997 consisted primarily of cash outflows for
acquisitions. Cash used in investing activities was $54.8 million in 1996,
consisting primarily of cash outflows for acquisitions.
Cash provided by financing activities was $13.0 million for the year
ended December 31, 1998, as compared to $92.2 million in 1997. Cash provided by
financing activities in 1998 consisting primarily of new borrowings under the
Senior Credit Facility offset by $5.5 million of repayments of the term loan
portion of the Senior Credit Facility and $0.5 million of preferred dividends
paid. Cash provided by financing activities in 1997 consisted primarily of the
issuance of the Senior Notes, the borrowing of $50.5 million under the Senior
Credit Facility and offset by the repayment of amounts borrowed under the
Company's previous credit facility, the Senior Subordinated Notes, and
subordinated notes issued in connection with the acquisition of Talton
Telecommunications (the "Talton Notes"). Net cash provided by financing
activities was $48.4 million in 1996.
The Senior Credit Facility consists of (a) a $55.0 million term loan
acquisition facility, (b) a $5.5 million additional term loan facility, and (c)
a $25.0 million revolving loan facility (which includes a $5.0 million letter of
credit facility). Scheduled principal payments under the term loan facilities
may not be reborrowed. Amounts borrowed under the Senior Credit Facility bear
interest, at the option of the Company, at either (i) the Base Rate (i.e., the
higher of CIBC's reference rate and the overnight federal funds rate plus 0.5%)
plus a margin that varies from 75 to 225 basis points, depending on the
Company's Total Debt to EBITDA Ratio (as defined in the Senior Credit Facility);
or (ii) the LIBO rate plus a margin that varies from 200 to 350 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 LIBO rate 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.
Scheduled principal payments on the term loan facility are approximately $9.7
million, $12.4 million, $13.8 million, and $13.8 million during the years ended
1999, 2000, 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.
As of December 31, 1998, the Company had approximately $180.5 million of
long-term indebtedness outstanding, including (i) $115.0 million of the Senior
Notes outstanding at an interest rate of 11.0%, (ii) $64.0 million of
indebtedness under the Senior Credit Facility, and (iii) $1.5 million of other
indebtedness consisting primarily of deferred acquisitions costs and capital
leases. As of December 31, 1998, the Company had available borrowing capacity
under the revolving credit portion of its Senior Credit Facility of
approximately $8.5 million, subject to borrowing base limitations and certain
conditions.
On June 30, 1998, the Company entered into an interest rate cap
agreement that has been designated as a hedge against the Company's variable
interest rate exposure on its loan under the Senior Credit Facility. At December
31, 1998, the interest
23
rate cap has an aggregate notional amount of $30.0 million, which matures in
June 2001, and caps interest on the LIBO rate portion of the term loan, up to
the aggregate notional amount, at 7.5%, plus the applicable LIBO rate margin.
As of December 31, 1998 the Company was not in compliance with one of
its financial covenant ratios under the Senior Credit Facility and was
consequently required to obtain a waiver of default letter from its group of
lenders. This ratio, the fixed charge coverage ratio, which is a measure of the
Company's debt service, capital expenditures, and income tax obligations to its
free cash flow (as defined), was subsequently modified in the March 1999
amendment to the Senior Credit Facility. Based on this modification, the
Company is currently in compliance with its debt covenants and would have been
in compliance as of December 31, 1998.
The Senior Credit Facility and the Indenture contain numerous
restrictive covenants including, among others, limitations on the ability of the
Company to incur additional indebtedness, to create liens and other
encumbrances, to make certain payments and investments, to sell or otherwise
dispose of assets, or to merge or consolidate with another entity. 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 years. 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. In
addition, because interest under the Senior Credit Facility accrues at floating
rates, the Company remains subject to interest rate risk with respect to a
significant portion of its indebtedness.
Income Taxes
Since the Company's acquisitions of AmeriTel, Talton Telecommunications,
MOG, and Saratoga were stock purchases, the Company was required to retain the
tax bases of AmeriTel, Talton Telecommunications, MOG, and Saratoga in the
assets acquired. As a result, the Company will not be entitled to a tax
deduction for the amortization of goodwill or the depreciation and amortization
of certain other tangible and intangible assets related to these acquisitions.
The Company has provided deferred income tax liabilities for differences in the
financial accounting and tax bases of its tangible and identifiable intangible
assets. However, in accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," future
amortization of non-deductible goodwill will be treated as a permanent
difference in the Company's financial statements.
Accounting Pronouncements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued in June 1998, and requires recognition of all derivative
financial instruments as either assets or liabilities in consolidated balance
sheets at fair value and determines the method(s) of gain/loss recognition. SFAS
No. 133 is effective for fiscal years beginning after June 15, 1999. The Company
is currently evaluating the effect that it may have on the Company's
consolidated financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") released Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
requires the capitalization of certain expenditures for software that is
purchased or internally developed. SOP No. 98-1 is effective for fiscal years
beginning after December 15, 1998. The Company believes that the adoption of
this SOP will have no material effect on the financial position, results of
operations, or cash flows of the Company.
In April 1998, the AICPA released SOP 98-5, "Reporting on the Costs of
Start-Up Activities." SOP 98-5 generally requires costs of start-up activities
to be expensed instead of being capitalized and amortized. SOP 98-5 is effective
for fiscal years beginning after December 15, 1998. The Company expects that the
adoption of this SOP will have no material effect on the financial position,
results of operations, or cash flows of the Company.
24
Information Systems And The Year 2000
The following statements and all other statements made in this Annual
Report on Form 10-K with respect to the Company's Year 2000 processing
capabilities or readiness are "Year 2000 Readiness Disclosures" in conformance
with with the Year 2000 Information and Readiness Disclosure Act of 1998 (Public
Law 105-271, 112 Stat. 2386).
Some computers, software, and other equipment include computer code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of these systems could fail to operate or fail to produce
correct results if "00" is interpreted to mean 1900, rather than 2000. These
problems are widely expected to increase in frequency and severity as the year
2000 approaches, and are commonly referred to as the "Year 2000 Problem."
Assessment. The Year 2000 Problem affects computers, software, and other
equipment used, operated, or maintained by the Company. Accordingly, the Company
has organized a program team comprised of internal and external staff
responsible for monitoring the assessment and remediation status of the
Company's Year 2000 projects and reporting such status to the Company's
Executive Committee. This project team is currently assessing the potential
effect of, and costs of remediating, the Year 2000 Problem for the Company's
internal systems.
For reporting purposes, the Company is using a methodology involving the
following six phases: Discovery, Assessment, Planning, Remediation, Testing, and
Implementation. At December 31, 1998, the Discovery and Assessment phases were
substantially complete for all program areas. The target completion date for
priority items by remaining steps are as follows: Planning - March 1999;
Remediation - May 1999; Testing - July 1999; and Implementation - August 1999.
Internal Infrastructure. The Company believes that it has identified
most of the major computers, software applications, and related other equipment
used in connection with its internal operations that must be modified, upgraded,
or replaced in order to minimize the possibility of a material disruption to its
business from the Year 2000 Problem. The Company has commenced the process of
modifying, upgrading, and replacing major systems that have been assessed as
adversely affected, and expects to complete this process before the occurrence
of any material disruption of its business. However, there can be no assurance
in this regard.
Systems Other than Information Technology Systems. In addition to
computers and related systems, the operation of office and facilities equipment,
such as fax machines, photocopiers, telephone switches, security systems,
elevators, and other common devices may be affected by the Year 2000 Problem.
The Company is currently assessing the potential effect of, and costs of
remediating, the Year 2000 Problem on its office and facilities equipment.
The Company estimates the total cost to the Company of completing any
required modifications, upgrades, or replacements of these internal systems to
be approximately $0.3 million, almost all of which the Company believes will be
incurred during 1999. This estimate is being monitored and will be revised as
additional information becomes available.
Based on the activities described above, the Company does not believe
that the Year 2000 Problem will have a material adverse effect on the Company's
business or results of operations. In addition, the Company has not deferred any
material information technology projects as a result of its Year 2000 Problem
activities.
Customers and Suppliers. The Company has initiated communications with
its customers and third party suppliers of the major computers, software, and
other equipment used, operated, or maintained by the Company to identify and, to
the extent possible, resolve issues involving the Year 2000 Problem. However,
the Company has limited or no control over the actions of these customers and
third party suppliers. Thus, while the Company expects that it will be able to
resolve any significant Year 2000 Problems with these systems, there can be no
assurance that these customers and suppliers will resolve any or all Year 2000
Problems with these systems before the occurrence of a material disruption to
the business of the Company or any of its clients. Any failure of these third
parties to timely resolve Year 2000 Problems with their systems could have a
material adverse effect on the Company's business, financial condition, and
results of operations.
Most Likely Consequences of Year 2000 Problem. The Company expects to
identify and resolve all Year 2000 Problems that could have a material adverse
affect on its business operations. However, management believes that it is not
possible to determine with complete certainty that all Year 2000 Problems
affecting the Company or its clients have been identified or corrected. The
number of devices that could be affected and the interactions among these
devices are simply too numerous. In addition, no one can accurately predict how
many Year 2000 Problem-related failures will occur or the severity, duration, or
25
financial consequences of these perhaps inevitable failures. As a result,
management believes that the following consequences are possible:
. a significant number of operational inconveniences and inefficiencies
for the Company and its clients that will divert management's time and
attention and financial and human resources from ordinary business
activities;
. a lesser number of serious systems failures that will require
significant efforts by the Company or its clients to prevent or
alleviate material business disruptions;
. several routine business disputes and claims for pricing adjustments or
penalties by clients due to Year 2000 Problems, which will be resolved
in the ordinary course of business; and
. a few serious business disputes alleging that the Company failed to
comply with the terms of contracts or industry standards of performance,
some of which could result in litigation or contract termination.
Contingency Plans. The Company is currently developing contingency plans
to be implemented if its efforts to identify and correct Year 2000 Problems
affecting its internal systems are not effective. The Company expects to
complete its contingency plans by June 1999. Depending on the systems affected,
these plans could include accelerated replacement of affected equipment or
software; short- to medium-term use of backup sites, equipment, and software;
increased work hours for Company personnel; use of contract personnel to correct
on an accelerated schedule any Year 2000 Problems that arise or to provide
manual workarounds for information systems; and other similar approaches. If the
Company is required to implement any of these contingency plans, it could have a
material adverse effect on the Company's financial condition and results of
operations.
Disclaimer. The discussion of the Company's efforts, and management's
expectations, relating to Year 2000 compliance are forward-looking statements.
The Company's ability to achieve Year 2000 compliance, and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' ability to modify proprietary software, and unanticipated problems
identified in the ongoing compliance review.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company uses fixed and variable rate debt to partially finance
budgeted expenditures. These agreements expose the Company to market risk
associated with changes in interest rates. The Company does not hold or issues
derivative financial instruments for trading purposes. On June 30, 1998, the
Company entered into an interest rate cap agreement that has been designated as
a hedge against the Company's variable interest rate risk exposure under the
Senior Credit Facility. At December 31, 1998, the interest rate cap has an
aggregate national amount of $30.0 million, which matures in June 2001 and caps
interest on the LIBO rate portion of the term portion of the Senior Credit
Facility at 7.5%, plus the applicable LIBO rate margin.
The following table presents the carrying and fair value of the
Company's debt along with average interest rates. Fair values are calculated as
the net present value of the expected cash flows of the financial instrument.
Expected Maturity
Date............. Fair
1999 2000 2001 2002 2003 Thereafter Total Value
Variable Rate
Debt (1)........ $9,657,729 $12,375,000 $13,750,000 $28,250,000 $ 64,032,729 $ 64,032,729
Fixed Rate
Debt............. $ 950,000 $115,000,000 $115,950,000 $110,384,000
Average Interest
Rate............ 8%
_________________
(1) The average interest rate on variable debt is 9.74%
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Schedules
Page
----
Evercom, Inc.
Report of Independent Certified Public Accountants...................... 29
Consolidated Balance Sheets for December 31, 1997 and 1998.............. 30
Consolidated Statements of Operations for the one month
period ended December 31, 1996 and for each of the two
years ended December 31, 1998...................................... 31
Consolidated Statements of Stockholders' Equity (Deficit)
for the one month period ended December 31, 1996 and
for each of the two years ended December 31, 1998.................. 32
Consolidated Statements of Cash Flows for the one month
period ended December 31, 1996 and for each of the two
years ended December 31, 1998...................................... 33
Notes to Consolidated Financial Statements.............................. 34
Predecessors' Financial Statements
AmeriTel Pay Phones, Inc.
Report of Independent Certified Public Accountants...................... 55
Balance Sheet for November 30, 1996..................................... 56
Statement of Income for the eleven months ended November 30,
1996............................................................... 57
Statement of Stockholders' Equity for the eleven months
ended November 30, 1996............................................ 58
Statement of Cash Flows for the eleven months ended
November 30, 1996.................................................. 59
Notes to Financial Statements........................................... 60
27
Talton Telecommunications Corporation
Report of Independent Certified Public Accountants .............. 71
Consolidated Balance Sheet for November 30, 1996.................. 72
Consolidated Statement of Income for the eleven months
ended November 30, 1996...................................... 73
Consolidated Statement of Stockholders' Equity for the
eleven months ended November 30, 1996........................ 74
Consolidated Statement of Cash Flows for the eleven months
ended November 30, 1996...................................... 75
Notes to Consolidated Financial Statements........................ 76
SUPPLEMENTARY DATA:
- ------------------
Consolidated Valuation and Qualifying Accounts for the one
month period ended December 31, 1996 and for each of
the two years ended December 31, 1998........................ 83
28
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Stockholders of Evercom, Inc.:
We have audited the accompanying consolidated balance sheets of Evercom, Inc.
and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity (deficit)
and cash flows for each of the two years in the period ended December 31, 1998
and for the one-month period from December 1, 1996 (date of acquisition) to
December 31, 1996. Our audits also included the financial statement schedule
listed in the Index at Item 8. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the consolidated financial statements
and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company as of
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the two years in the period ended December 31, 1998 and the
one-month period ended December 31, 1996, in conformity with generally accepted
accounting principles. Also, in our opinion, such financial statement schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 25, 1999
29
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------------------------
ASSETS 1997 1998
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 7,777,996 $ 1,691,762
Accounts receivable 17,401,907 39,070,959
Refundable income taxes 600,388 435,593
Inventories 1,690,930 2,360,280
Prepaid expenses and other current assets 2,309,661 392,448
Deferred income tax assets 1,059,752 1,442,122
------------- -------------
Total current assets 30,840,634 45,393,164
PROPERTY AND EQUIPMENT 24,007,039 29,485,944
INTANGIBLE AND OTHER ASSETS 134,540,767 116,586,808
------------- -------------
TOTAL $ 189,388,440 $ 191,465,916
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 6,933,874 $ 21,856,484
Accrued expenses 24,678,158 23,798,055
Current portion of long-term debt 5,545,363 10,607,729
------------- -------------
Total current liabilities 37,157,395 56,262,268
LONG-TERM DEBT 160,040,938 169,375,000
OTHER LONG-TERM LIABILITIES 1,150,000 500,000
DEFERRED INCOME TAXES 1,059,752 1,442,122
COMMITMENTS AND CONTINGENCIES (See Notes)
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $.01 par value; 6,000 shares authorized; 5,925 shares issued and
outstanding (cumulative liquidation value of $5,925,000) 59 59
Common stock, $.01 par value; 50,000 shares authorized; 16,200 shares and
16,333 shares issued and outstanding as of December 31, 1997, and
December 31, 1998, respectively 162 163
Additional paid-in capital 22,036,963 21,829,562
Accumulated deficit (32,056,829) (57,943,258)
------------- -------------
Total stockholders' equity (deficit) (10,019,645) (36,113,474)
------------- -------------
TOTAL $ 189,388,440 $ 191,465,916
============= =============
See notes to consolidated financial statements.
30
EVERCOM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
One Month
Period Ended
December 31, Years Ended December 31,
------------ -------------------------------
1996 1997 1998
OPERATING REVENUE $ 5,506,110 $ 91,773,041 $ 225,292,986
OPERATING EXPENSES:
Telecommunication costs 2,298,712 37,871,217 99,842,779
Facility commissions 1,455,375 25,723,997 71,205,505
Field operations and maintenance 218,895 4,542,757 7,817,165
Selling, general and administrative 372,341 8,540,629 17,661,406
Depreciation and impairment 110,803 2,218,694 6,691,954
Amortization of intangibles 741,032 14,243,332 26,338,961
Restructure and other charges 399,817 1,743,290
------------- ------------- -------------
Total operating expenses 5,197,158 93,540,443 231,301,060
------------- ------------- -------------
OPERATING INCOME (LOSS) 308,952 (1,767,402) (6,008,074)
OTHER (INCOME) EXPENSE:
Interest expense, net 612,071 11,137,877 19,637,507
Other (income), net (20,490) (76,392) (235,623)
------------- ------------- -------------
Total other (income) expense 591,581 11,061,485 19,401,884
------------- ------------- -------------
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY LOSS (282,629) (12,828,887) (25,409,958)
INCOME TAX (BENEFIT) EXPENSE (22,502) (641,670) 476,471
------------- ------------- -------------
LOSS BEFORE EXTRAORDINARY ITEM (260,127) (12,187,217) (25,886,429)
EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENT 4,739,757
------------- ------------- -------------
NET LOSS (260,127) (16,926,974) (25,886,429)
PREFERRED STOCK DIVIDENDS 474,000 474,000
------------- ------------- -------------
NET LOSS APPLICABLE TO COMMON STOCK $ (260,127) $ (17,400,974) $ (26,360,429)
============= ============= =============
See notes to consolidated financial statements
31
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
PREFERRED STOCK COMMON STOCK ADDITIONAL
-------------------- ---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
------ ------ ------ ------------- ------------- -------------- --------------
Issuance of Preferred Stock 5,925 $59 $ 5,924,941 $ 5,925,000
Issuance of Common Stock 15,300 $153 15,686,031 15,686,184
Portion of Acquisition Cash
Payments to Continuing
Stockholders, Treated as a
Dividend $(14,869,728) (14,869,728)
Net Loss (260,127) (260,127)
------ ------ ------ ------------- ----------- ------------- ------------
BALANCE, JANUARY 1, 1997 5,925 59 15,300 153 $21,610,972 (15,129,855) 6,481,329
Preferred dividends (474,000) (474,000)
Issuance of common stock 900 9 899,991 900,000
Net loss (16,926,974) (16,926,974)
------ ------ ------ ------------- ------------ ------------- ------------
BALANCE, DECEMBER 31, 1997 5,925 59 16,200 162 22,036,963 (32,056,829) (10,019,645)
Preferred dividends (474,000) (474,000)
Issuance of common stock 133 1 266,599 266,600
(25,886,429) (25,886,429)
Net loss
------ ------ ------ ------------- ------------ ------------- -------------
BALANCE, DECEMBER 31, 1998 5,925 $59 16,333 $163 $21,829,562 $(57,943,258) $(36,113,474)
====== ====== ====== ============= =========== ============= ============
See notes to consolidated financial statements.
32
EVERCOM, INCEVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
ONE MONTH
PERIOD ENDED
DECEMBER 31, YEARS ENDED DECEMBER 31,
---------------- -------------------------------
1996 1997 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (260,127) $(16,926,974) $(25,886,429)
Adjustments to reconcile net loss to net
cash(used in) provided by operating activities:
Depreciation and impairment 110,803 2,218,694 6,691,954
Amortization of intangible assets, including deferred
financing costs and bond discount 803,023 14,804,641 27,482,445
Extraordinary loss on debt extinguishment 4,739,757
Deferred income taxes 160,512 (1,295,508)
Changes in operating assets and liabilities, net
of effects of acquisitions:
Accounts receivable 44,823 (6,974,425) (22,232,694)
Inventories 12,013 (723,013) (606,359)
Prepaid expenses and other assets (166,096) (87,536) 134,130
Accounts payable (1,010,795) 1,574,179 14,782,610
Accrued expenses (718,313) 9,694,953 3,728,009
Income taxes (394,963) (976,546) 164,795
------------ ------------- -------------
Net cash (used in) provided by operating activities (1,419,120) 6,048,222 4,258,461
------------ ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) Decrease in restricted cash (1,919,312) 1,919,312
Capital expenditures (268,801) (8,062,724) (13,591,974)
Cash outflows for acquisitions (46,983,442) (80,775,395) (11,711,061)
------------ ------------- -------------
Net cash used in investing activities (47,252,243) (90,757,431) (23,383,723)
------------ ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt 59,200,000 168,709,966 19,000,000
Repayment of advances (1,001,024)
Repayment of debt (15,912,706) (67,630,581) (5,553,572)
Payments of deferred financing costs (3,804,121) (7,885,650)
Payments of preferred dividends (474,000)
Proceeds from the issuance of common and
preferred stock, net of expenses 9,482,684 66,600
------------ ------------- -------------
Net cash provided by financing activities 48,965,857 92,192,711 13,039,028
------------ ------------- -------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 294,494 7,483,502 (6,086,234)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 294,494 7,777,996
------------ ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 294,494 $ 7,777,996 $ 1,691,762
============ ============= =============
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 640,035 $ 4,202,059 $ 25,102,184
============ ============= =============
Cash paid for income taxes $ 211,950 $ 1,552,973 $ 311,676
============ ============= =============
Noncash transactions:
Issuance of subordinate notes, preferred
stock and common stock for acquisitions $ 16,043,000 $ 900,000 $ 950,000
============ ============= =============
Dividends payable $ $ 474,000 $ 474,000
============ ============= =============
Amounts payable for acquisition costs $ $ 8,369,421 $
============ ============= =============
Amounts payable for deferred financing costs $ $ 757,493 $
============ ============= =============
Issuance of stock for forgiveness of
acquisition liability $ $ $ 200,000
============ ============= =============
Reduction of stockholders' equity to reflect
accrued continuing shareholder interests $ 14,869,728 $ $
============ ============= =============
See notes to consolidated financial statements.
33
EVERCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS - Evercom, Inc. (the "Company") owns, operates and maintains
telephone systems under contracts with correctional facilities in 43
states throughout the United States. The Company was incorporated on
November 20, 1996, and effective December 1, 1996, acquired all of the
outstanding equity interests of Talton Telecommunications Corporation and
AmeriTel Pay Phones, Inc. The Company has grown through numerous
subsequent acquisitions, as discussed in Note 2.
The Company accumulates call activity from its various installations and
bills its revenues related to this call activity through major local
exchange carriers ("LECs") or through third-party billing services for
smaller volume LECs, all of which are granted credit in the normal course
of business with terms of between 30 and 60 days. The Company also
provides validation, billing and collection services for the inmate calls
of a major regional bell operating company. The Company performs ongoing
credit evaluations of its customers and maintains allowances for
unbillable and uncollectible losses based on historical experience.
The Company operated in only one business segment as its operating
activities are related to the operation and processing of collect, prepaid
and debit calling services to local, county, state and private
correctional facilities in the United States.
PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions, such as estimates
of allowances and reserves for unbillable and uncollectible chargebacks
that affect the reported amounts of assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries, Talton Telecommunications Corporation, Talton
Telecommunications of Carolina, Inc., AmeriTel Pay Phones, Inc., Talton
STC Inc., Talton InVision, Inc., MOG Communications, Inc., Saratoga
Telephone Company, Inc., and One Source Telecommunications, Inc. All
significant intercompany balances and transactions are eliminated in
consolidation. Certain amounts have been reclassified to conform with the
current year presentation.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash on hand
and investments with a remaining maturity at date of purchase of three
months or less.
ACCOUNTS RECEIVABLE - Trade accounts receivable represent amounts billed
for calls placed through the Company's telephone systems to the various
LECs or third-party billing services, net of advance payments received,
and an allowance for unbillable and uncollectible calls, based on
historical experience, for estimated chargebacks to be made by the LECs.
Under account advance agreements with various third-party billing
services, advance payments equal to a percentage of the outstanding billed
receivables are remitted to the Company when calls are submitted to the
third-party billing service, and the Company grants a lien to the
third-party billing service on the related accounts
34
receivable for the advance. The remainder of the billed receivable is paid
to the Company, net of the advance amount, after the third-party billing
service has collected the amounts receivable from the respective LECs.
Interest is charged on the advance payment at varying rates.
INVENTORIES - Inventories are stated at the lower of cost, as determined
primarily using the weighted average cost method, or market. Inventory is
primarily composed of equipment for installation on new contracts and
supplies and parts for the telephone systems serviced by the Company.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation and amortization is provided on a straight-line basis over
the estimated useful lives of the related assets. The following is a
summary of useful lives for major categories of property and equipment.
ASSET USEFUL LIFE
Leasehold improvements Lesser of life or lease term
Telephone system equipment 3.5 to 7.5 years
Vehicles 3 years
Office equipment 3 to 7 years
Maintenance and repairs are expensed when incurred and major repairs that
extend an asset's useful life are capitalized. When items are retired or
disposed, the related carrying value and accumulated depreciation are
removed from the respective accounts, and the net difference less any
amount realized from the disposition is reflected in earnings.
INTANGIBLE AND OTHER ASSETS - Intangible and other assets primarily
include amounts allocated to acquired facility contracts, noncompete
agreements, goodwill and other intangible assets, which are stated at
cost, along with the long-term portion of customer advances, and the
long-term portion of recoverable Universal Service Fund fees. Amortization
of intangible assets is provided on a straight-line basis over the
estimated useful lives of the related assets. The following is a summary
of useful lives for major categories of intangible assets:
INTANGIBLE ASSET USEFUL LIFE
Acquired facility contracts Contract term
Noncompete agreements Agreement term
Deferred loan costs Loan term
Other assets and intangibles 2 to 5 years
Goodwill 20 years
Acquired facility contracts consist primarily of costs allocated to
locations acquired in acquisitions of facility contract rights from other
service providers, along with signing bonuses paid to the facilities under
new facility installations and other incremental direct costs paid to
obtain the facility contracts.
Other assets and intangibles include costs incurred to obtain direct
billing agreements with LECs, and licensing fees to obtain state licenses
to conduct business.
The Company periodically assesses the net realizable value of its
intangible assets, as well as all other long-term assets, by comparing the
expected future net operating
35
cash flow, undiscounted and without interest charges, to the carrying
amount of the underlying assets. The Company would evaluate a potential
impairment if the recorded value of these assets exceeded the associated
future net operating cash flows. Any potential impairment loss would be
measured as the amount by which the carrying value exceeds the fair value
of the asset. Fair value of assets would be measured by market value, if
an active market exists, or by a forecast of expected future net operating
cash flows, discounted at a rate commensurate with the risk involved. As
discussed in footnote 4, the Company recorded an impairment loss on a
portion of its telephone system equipment in 1998.
INCOME TAXES - The Company accounts for income taxes using the liability
method in accordance with the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
Under this method, deferred tax assets and liabilities are provided for
temporary differences between the financial statement and tax bases of the
assets and liabilities using current tax rates.
REVENUE RECOGNITION - Revenues related to collect, prepaid and debit
calling services are recognized during the period in which the calls are
made. In addition, during the same period, the Company accrues the related
telecommunication costs for validating, transmitting, billing and
collection, and line and long-distance charges, along with commissions
payable to the facilities and allowances for unbillable and uncollectible
calls, based on historical experience.
Revenues related to the validation, billing and collection services
provided to other entities are recognized in the period in which the calls
are processed through the Company's system. During the same period, the
Company accrues the related telecommunications costs for validating,
transmitting, and billing and collection costs, along with allowances for
unbillable and uncollectible calls, based on historical experience.
FACILITY COMMISSIONS - Under the terms of the Company's telephone system
contracts with correctional facilities, the Company pays commissions to
these facilities generally based on call volume revenues that are accrued
during the period the revenues are generated.
COMPREHENSIVE INCOME - SFAS No. 130, "Reporting Comprehensive Income"
became effective as of the first quarter of 1998. 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 the net loss reported in the statements of
consolidated operations for each of the two years in the period ended
December 31, 1998 and for the one-month period ended December 31, 1996,
since there were no other items of comprehensive income for the periods
presented.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," was issued in June 1998,
and requires recognition of all derivative financial instruments as either
assets or liabilities in consolidated balance sheets at fair value and
determines the method(s) of gain/loss recognition. SFAS No. 133 is
effective for fiscal years beginning after June 15, 1999. The Company is
currently evaluating the effect that the statement may have on the
Company's consolidated financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") released Statement of Position ("SOP") No. 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use."
SOP 98-1 requires the capitalization of certain expenditures for software
that is purchased or internally developed. SOP No. 98-1 is effective for
fiscal years beginning after
36
December 15, 1998. The Company believes that the adoption of this SOP will
have no material effect on the financial position, results of operations,
or cash flows of the Company.
In April 1998, the AICPA released SOP 98-5, "Reporting on the Costs of
Start-Up Activities." SOP 98-5 generally requires costs of start-up
activities to be expensed instead of being capitalized and amortized. SOP
98-5 is effective for fiscal years beginning after December 15, 1998. The
Company believes that the adoption of this SOP will have no material
effect on the financial position, results of operations or cash flows of
the Company.
2. ACQUISITIONS
Effective December 1, 1996, the Company acquired all of the outstanding
equity interests of Talton Telecommunications Corporation and AmeriTel Pay
Phones, Inc. The aggregate net purchase price was approximately $47.9
million, which was funded with the net proceeds from the issuance of
common and preferred stock and the proceeds from the issuance of long-term
debt.
Since certain of the stockholders of the Company held ownership interests
in Talton Telecommunications and AmeriTel Pay Phones, Inc., their
continuing ownership interest in the Company has been accounted for at
their prior historical basis, which has resulted in a reduction in
stockholders' deficit of approximately $14.9 million and a corresponding
reduction in the fair values assigned to tangible and identifiable
intangible assets, in accordance with the provisions of Emerging Issue
Task Force discussion No. 88-16, "Basis in Leveraged Buyout Transactions."
Effective April 4, 1997, the Company acquired substantially all of the net
assets of Tri-T, Inc. (d.b.a. Tataka) for cash of $0.8 million, which was
funded primarily by borrowings under the Senior Credit Facility.
Effective June 27, 1997, the Company acquired substantially all of the net
assets of Security Telecom Corporation for cash of $9.9 million and
issuance of 900 shares of the Company's Class A common stock. The Company
financed the acquisition with a portion of the proceeds from the Senior
Notes (as defined). Approximately $2.5 million of the purchase price was
withheld at closing, pending certain regulatory approvals and final
adjustments. In conjunction with the acquisition of Security Telecom
Corporation, the Company entered into an agreement with an employee of
Security Telecom Corporation giving the employee the right to receive cash
of $200,000 or to purchase up to 100 shares of the Company's Class A
common stock for $2,000 per share. The employee exercised this right in
September 1998.
Effective July 31, 1997, the Company acquired all of the net assets of
Correctional Communications Corporation for a cash purchase price of $10.3
million. Approximately $1.6 million of the purchase price is held in an
escrow account pending resolution to certain consents and indemnities. The
acquisition agreement also provides for contingent payment of up to $1.5
million if certain financial performance benchmarks are achieved in the
future. The $1.5 million contingency will be accounted for as an
adjustment to the purchase price when the contingency is resolved. The
Company financed the acquisition with a portion of the proceeds from the
Senior Notes.
Effective October 6, 1997, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate pay phone
division of Communications Central Inc. for $40 million in cash and
assumption of $2.0 million in liabilities subject to various adjustments
as defined in the agreement and subject to a provision for working capital
of approximately $1.2 million provided to the Company
37
pursuant to the purchase agreement. The Company financed the acquisition
with the remaining proceeds from the Senior Notes and borrowings under the
Senior Credit Facility.
Effective December 1, 1997, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate pay phone
division of North American InTeleCom, Inc. from TSC Communications for a
cash purchase price of $6.5 million in cash, a deferred payment of $1.7
million, and the assumption of certain liabilities approximating $0.7
million. The Company funded the acquisition with borrowings under the
Senior Credit Facility.
Effective December 19, 1997, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate pay phone
division of Peoples Telephone Company, Inc. for $10.6 million with the
assumption of certain liabilities. The acquisition agreement also provides
for additional contingent payments if certain financial results are
obtained in the future. The additional payments will be accounted for as
an adjustment to the purchase price when the contingency is resolved. The
Company funded the acquisition with borrowings under the Senior Credit
Facility.
Effective January 1, 1998, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate pay phone
division of ILD Teleservices, Inc. for a cash purchase price of $2.6
million. The acquisition was funded with borrowings under the Senior
Credit Facility.
Effective February 1, 1998, the Company entered into an agreement to
purchase MOG Communications, Inc. for a cash purchase price of $1.9
million and a note of $950,000. The acquisition was funded with borrowings
under the Senior Credit Facility.
Effective July 1, 1998, the Company entered into an agreement to purchase
Saratoga Telephone Company for a cash purchase price of $2.0 million. The
acquisition was funded with borrowings under the Senior Credit Facility.
The above acquisitions were accounted for using the purchase method of
accounting as of their respective acquisition dates and, accordingly, only
the results of operations of the acquired companies subsequent to their
respective acquisition dates are included in the consolidated financial
statements of the Company. At the acquisition date, the purchase price was
allocated to assets acquired, including identifiable intangibles and
liabilities assumed based on their fair market values. The excess of the
total purchase prices over the fair value of the net assets acquired
represents goodwill.
38
In connection with the acquisitions, assets were acquired and liabilities
were assumed as follows:
Purchase Prices 1997 1998
--------------- ------------ ------------
Net cash paid $ 80,775,395 $ 7,021,727
Amounts payable for acquisition costs 8,369,421
Subordinated notes, preferred stock and common stock
issued to sellers, net of expenses 900,000 950,000
------------ -----------
Total net purchase prices, including professional fees 90,044,816 7,971,727
Fair values of net assets acquired:
Fair values of assets acquired 53,131,563 3,828,315
Liabilities assumed (3,297,973) (416,780)
------------ -----------
Total net assets acquired 49,833,590 3,411,535
------------ -----------
Goodwill $ 40,211,226 $ 4,560,192
============ ===========
The following table presents unaudited pro forma results of operations of
the Company for the one month ended December 31, 1996 and for the years
ended December 31, 1997 and 1998, respectively, as if the acquisitions had
occurred at the beginning of each respective period:
ONE MONTH PERIOD
ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
------------------ -------------------------------------
1996 1997 1998
Operating revenues $ 15,613,199 $ 180,883,954 $ 226,779,019
Loss before extraordinary loss 2,082,154 27,304,983 26,572,457
Net loss 2,082,154 32,044,740 26,572,457
The unaudited pro forma results of operations are not necessarily
indicative of what the actual results of operations of the Company would
have been had the acquisitions occurred at the beginning of the periods
presented, nor do they purport to be indicative of the future results of
operations of the Company.
39
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
December 31,
--------------------------------------
1997 1998
Trade accounts receivable, net of advance payments
received of $187,647 and $141,460 at
December 31, 1997 and 1998, respectively $ 21,809,811 $ 42,308,582
Advance commissions receivable 272,921 2,020,020
Receivables related to acquisitions 456,875 141,044
Recoverable Universal Service Fund Fees - current portion 1,089,800
Receivables from joint venture partner 419,643
Employees and other 178,989 329,749
------------ ------------
22,718,596 46,308,838
Less allowance for unbillable and
uncollectible chargebacks (5,316,689) (7,237,879)
------------ ------------
$ 17,401,907 $ 39,070,959
============ ============
At December 31, 1997 and 1998, the Company had advanced commissions to
certain facilities of $1,290,732 and $2,495,558, respectively, 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.
At December 31, 1998, the Company had remitted $1,511,688 more federal
Universal Service Fund fees than it had collected from its
telecommunications customers. Based on the Company's current recovery
rate, $1,089,800 of this balance will be recovered in the next fiscal year
and is included in accounts receivable with the remaining balance recorded
in other assets.
40
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31,
------------------------------------
1997 1998
Leasehold improvements $ 493,836 $ 834,051
Telephone system equipment 24,480,777 33,776,168
Vehicles 249,868 431,807
Office equipment 1,075,751 2,419,992
------------ ------------
26,300,232 37,462,018
Less accumulated depreciation (2,293,193) (7,976,074)
------------ ------------
$ 24,007,039 $ 29,485,944
============ ============
DEPRECIATION AND IMPAIRMENT - Depreciation and impairment in 1997 and 1998
includes depreciation expense of $2,218,694 and $5,996,816, respectively.
Also included in depreciation and impairment in 1998 is an impairment loss
of $695,138, representing the net book value of telephone system equipment
that was removed from service.
5. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
December 31,
-------------------------------------------
1997 1998
Intangible and other assets:
Acquired telephone contracts $ 59,064,429 $ 63,835,844
Noncompete agreements 403,611 568,611
Deferred loan costs 8,299,067 8,299,067
Goodwill 79,970,642 84,530,834
Other intangibles 526,385 694,493
------------- -------------
148,264,134 157,928,849
Less accumulated amortization (15,157,562) (42,640,007)
------------- -------------
133,106,572 115,288,842
Deposits 416,384 400,540
Recoverable Universal Service Fund Fees - noncurrent portion 421,888
Other assets - noncurrent portion
of commission advances to facilities 1,017,811 475,538
------------- -------------
$ 134,540,767 $ 116,586,808
============= =============
41
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
December 31,
---------------------------------
1997 1998
Facility commissions $ 5,456,245 $ 8,007,248
Billing and collection fees 1,148,171 1,804,790
Uncollectible call chargebacks 990,135 5,267,345
Accrued acquisition and financing
costs 8,599,778 3,941,666
Accrued interest 6,557,651 218,646
Accrued excise taxes payable 1,166,003 2,072,856
Accrued dividends on preferred stock 474,000 474,000
Accrued restructure costs 654,245
Accrued payroll and bonuses 778,633
Other 286,175 578,626
----------- -----------
$24,678,158 $23,798,055
=========== ===========
The accrual for uncollectible call chargebacks represents a reserve for
amounts collected from LECs that are expected to be charged back to the
Company in future periods.
The amount payable for acquisitions and financing costs includes a $2.3
million holdback of the purchase price of Security Telecom Corporation
(see Note 2), which will be paid to the sellers after resolution of
certain indemnifications, and an $870,000 deferred payment relating to the
North American InTeleCom acquisition.
42
7. LONG-TERM DEBT
The following is a summary of long-term debt:
DECEMBER 31,
-------------------------------------
1997 1998
Senior Notes $ 115,000,000 $ 115,000,000
Senior Credit Facility
Revolving loan facility 2,000,000 14,500,000
Term loan facility 48,500,000 49,500,000
Note payable (see Note 2), with interest of 8.0%,
due at maturity on February 19, 1999, and
subordinate to borrowings of the Senior
Notes and Senior Credit Facility 950,000
Other 86,301 32,729
------------- -------------
165,586,301 179,982,729
Less current portion of long-term debt (5,545,363) (10,607,729)
------------- -------------
$ 160,040,938 $ 169,375,000
============= =============
SENIOR NOTES - On June 27, 1997, the Company issued $115.0 million of 11%
Senior Notes due 2007 (the "Senior Notes"). A portion of the proceeds of
the issuance was used to repay substantially all of the Company's previous
debt outstanding and to fund the purchase of Security Telecom Corporation.
As a result of the repayment of the outstanding debt, and amendment of the
Company's Senior Credit Facility, the Company incurred an extraordinary
loss of $4.7 million resulting from the write-off of the unamortized
deferred loan costs and the unamortized discount of the original senior
subordinated notes.
Interest on the Senior Notes is payable semiannually. All of the Company's
subsidiaries (the "Subsidiary Guarantors") are fully, unconditionally, and
jointly and severally liable for the Senior Notes. The Subsidiary
Guarantors are wholly owned and constitute all of the Company's direct and
indirect subsidiaries. The Company has not included separate financial
statements of its subsidiaries because (a) the aggregate assets,
liabilities, earnings and equity of such subsidiaries are substantially
equivalent to the assets, liabilities, earnings and equity of the Company
on a consolidated basis and (b) the Company believes that separate
financial statements and other disclosures concerning subsidiaries are not
material to investors.
43
The Senior Notes are redeemable at the Company's option on or after June
30, 2002. The Senior Notes are redeemable at the redemption prices
(expressed as percentages of principal amount) set forth below plus
accrued and unpaid interest:
YEAR PERCENTAGE
2002 105.500%
2003 103.667%
2004 101.833%
2005 and thereafter 100.000%
At any time on or prior to June 30, 2000, the Company may redeem up to 30%
of the Senior Notes originally issued at a redemption price of 111% of the
principal amount, plus accrued and unpaid interest, with the proceeds of
one or more Equity Offerings (as defined in the Senior Credit Facility).
SENIOR CREDIT FACILITY - The Company amended and restated its Senior
Credit Facility with a group of lenders in March 1999 in conjunction with
the issuance of First Preferred Series A stock and warrants, as discussed
in footnote 15. The amendment provides for an additional $5.5 million term
loan facility that will bear interest at similar rates to borrowings under
the Senior Credit Facility. The additional term loan facility matures on
December 31, 2002.
The Senior Credit Facility, as amended in March 1999, includes a $55
million term loan acquisition facility, a $5.5 million additional term
loan facility, and a $25.0 million revolving loan facility (which includes
a $5 million letter of credit facility). Scheduled principal payments
under the term loan facilities cannot be reborrowed. Under the terms of
the Senior Credit Facility, the term loan acquisition facility is
amortized on a quarterly basis over five years beginning September 30,
1998, the additional term loan facility matures on December 31, 2002, and
the revolving credit facility expires on December 31, 2002.
Amounts outstanding under the Senior Credit Facility bear interest at a
rate per annum equal to one of the following rates, at the Company's
option: (i) a base rate equal to the higher of the Federal Funds rate plus
50 basis points or the lead bank's reference rate plus a margin that
varies from 75 to 225 basis points, depending on the Company's Total Debt
to EBITDA Ratio (as defined in the Senior Credit Facility) or (ii) the
London Interbank Offering Rate ("LIBOR") plus a margin that varies from
200 to 350 basis points, based on the Company's Total Debt to EBITDA
Ratio. The Company pays a commitment fee on unused amounts of the Senior
Credit Facility at the rate of 50 basis points. The blended interest rate
in effect at December 31, 1998, on the Senior Credit Facility was 9.74%.
Interest is payable quarterly, and scheduled principal installments on the
term loan acquisition facility is due in quarterly installments of
$2,750,000 beginning September 30, 1998 through December 31, 1998,
decreasing to $2,406,250 on March 31, 1999, and increasing to $3,093,750
on March 31, 2000, and $3,437,500 on March 31, 2001, with the remaining
unpaid balance due on December 31, 2002. The additional term loan facility
is due on December 31, 2002. Both the revolving and the term loan
facilities are collateralized by substantially all of the assets of the
Company.
INTEREST RATE CAP AGREEMENT - On June 30, 1998, 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 Senior
Credit Facility. At December 31, 1998, the interest rate cap has an
44
aggregate notional amount of $30.0 million, which matures in June 2001,
and caps interest on the LIBOR portion of the term loan at 7.5%, plus the
applicable LIBOR margin.
COVENANTS AND OTHER - The Senior Notes and the Senior Credit Facility
contain financial and operating covenants requiring, among other items,
the maintenance of certain financial ratios, including total debt to free
cash flow (as defined in the Senior Credit Facility), senior secured debt
to free cash flow and various other ratios of free cash flow to specified
minimums. In addition, the Senior Credit Facility contains various
covenants, which, among other things, limit the Company's ability to incur
additional indebtedness, restrict the Company's ability to invest in and
divest of assets, and restrict the Company's ability to pay dividends. As
of December 31, 1998, the Company was not in compliance with one of its
financial covenant ratios under the Senior Credit Facility and was
consequently required to obtain a waiver of default letter from its group
of lenders. The financial covenant ratio, the fixed charge coverage ratio,
which is a measure of the Company's debt service, capital expenditures,
and income tax obligations to its free cash flow, was subsequently
modified in the March 1999 amendment to the Senior Credit Facility. Based
on this modification, the Company is in compliance with its debt covenants
and would have been in compliance as of December 31, 1998. In the event
the Company fails to comply with the covenants and other restrictions, as
specified, it could be in default under the Senior Notes and the Senior
Credit Facility and substantially all of the Company's long-term
maturities could be accelerated.
As a result of the issuance of the First Preferred Series A Stock and
warrants discussed in Note 15, the Company was required to obtain a waiver
from its Senior Credit Facility group of lenders that waives the lenders'
rights to the proceeds raised by the Company from the equity offering.
At December 31, 1998, the scheduled maturities of long-term debt were as
follows:
1999 $ 10,607,729
2000 12,375,000
2001 13,750,000
2002 28,250,000
2003 0
Thereafter 115,000,000
------------
$179,982,729
============
45
8. INCOME TAXES
A summary of the income tax expense (benefit) is as follows:
One-Month
Period Ended
December 31, Years Ended December 31,
-------------------- -------------------------------
1996 1997 1998
Current income tax provision:
Federal $ (73,837) $ 228,461 $ (135,134)
State (10,260) 425,377 611,605
Deferred income taxes 61,595 (1,295,508)
----------- ----------- -----------
$ (22,502) $ (641,670) $ 476,471
=========== =========== ===========
The income tax expense (benefit) differs from statutory rates primarily
because of permanent differences related to a valuation allowance on
deferred tax assets, nondeductible write-off of debt discount expense and
nondeductible goodwill amortization. The following is a reconciliation of
the income tax benefit reported in the statement of operations:
One-Month
Period Ended
December 31, December 31,
---------------- ------------------------------
1996 1997 1998
Tax benefit at statutory rates $ (96,094) $ (5,973,339) $ (8,639,386)
Effect of state income taxes (13,284) (301,595) (521,679)
Effect of nondeductible goodwill amortization 86,876 675,910 759,953
Nondeductible write-off of debt discount 332,163
Valuation allowance on deferred tax assets 4,674,920 8,588,395
Other (49,729) 289,188
------------- ------------ ------------
$ (22,502) $ (641,670) $ 476,471
============= ============ ============
46
The tax effects of temporary differences giving rise to deferred income
tax assets and liabilities were:
DECEMBER 31,
----------------------------------------
1997 1998
Deferred income tax assets:
Reserves for unbillable and uncollectible chargebacks $ 1,486,129 $ 3,214,286
Other reserves 166,368 689,786
Amortization of intangibles 2,210,171 8,191,148
Net operating loss carryforward 1,872,004 2,610,217
Valuation allowance (4,674,920) (13,263,315)
------------ ------------
1,059,752 1,442,122
Deferred income tax liability:
Depreciation and amortization (1,059,752) (1,442,122)
------------ ------------
Net deferred income tax asset (liability) $ - $ -
============ ============
This net deferred income tax liability is classified in the consolidated
balance sheet as follows:
December 31,
-------------------------------------
1997 1997
Current asset $ 1,059,752 $ 1,442,122
Noncurrent liability (1,059,752) (1,442,122)
------------- ------------
$ - $ -
============= ============
The Company has established a valuation allowance for deferred tax assets
primarily as a result of operating and extraordinary losses. The Company
was unable to determine that it is more likely than not that the deferred
tax assets will be realized. The Company has accumulated a federal income
tax net operating loss carryforward of approximately $7.7 million through
December 31, 1998 of which $317,000 and $7.4 million will expire in 2017
and 2018, respectively.
9. STOCKHOLDERS' EQUITY
COMMON STOCK - The authorized common stock of the Company includes 49,600
shares of Class A common stock and 400 shares of Class B common stock.
Holders of the shares of the Company's Class A and the Company's Class B
common stock have identical rights and privileges except that holders of
the Company's Class B common stock are entitled to four votes a share as
compared to one vote per share for holders of the Company's Class A common
stock.
In September 1998, an employee exercised his option, received in
connection with a previous acquisition, to purchase 100 shares of the
Company's Class A common stock for $2,000 per share. Additionally, in
November 1998, a former employee exercised options to purchase 33 shares
of the Company's Class A common stock for $2,000 per share.
47
Issued and outstanding shares of Class A common stock as of December 31,
1997 and 1998, were 15,800 shares and 15,933 shares, respectively. Issued
and outstanding shares of Class B common stock as of December 31, 1997 and
1998, were 400 shares. The Class B common stock is convertible into four
shares of Class A common stock upon the occurrence of a major event, as
defined.
SENIOR PREFERRED STOCK - In connection with the acquisitions of Talton
Telecommunications Corporation and AmeriTel Pay Phones, Inc. as discussed
in Note 2, the Company issued 5,925 shares of senior preferred stock to
former stockholders of the acquired companies. The preferred stockholders
have no voting rights and are entitled to receive cumulative dividends at
the rate of $80 per share per annum, payable quarterly, when declared by
the Board of Directors. In the event of any liquidation, dissolution or
winding up of the Company (voluntary or involuntary), the holders of the
preferred stock shall be entitled to receive a preference over common
stockholders in any distribution of assets of the Company, equal to $1,000
per share plus cumulative unpaid dividends. Upon the occurrence of a major
event, which includes (i) a sale of all or substantially all the assets of
the Company or (ii) a registered public offering of equity interests with
gross proceeds of at least $20.0 million under the Securities Act of 1933,
as amended, the Company is required to redeem the outstanding shares of
preferred stock at a price equal to $1,000 a share plus cumulative unpaid
dividends. Each holder of preferred stock is entitled to convert each
preferred share into 0.08505 shares of Class A common stock, at the option
of the holder, at any time after the date of issuance and on or prior to
the occurrence of a major event, as defined.
In addition to the senior preferred stock discussed above, the Company is
authorized to issue up to 44,000 shares of junior preferred stock, of
which no shares had been issued as of December 31, 1998.
In March 1999, the Company issued 5,000 shares of newly authorized First
Preferred Series A Stock as discussed in footnote 15.
WARRANTS - At the acquisition date, the Company entered into a warrant
agreement with certain of its senior subordinated note holders, which
granted the note holders the right to purchase 1,085 shares of Class A
common stock at an exercise price of $.01 a share, which was below the
market value of the underlying shares at that date. Accordingly, as of
December 31, 1996, approximately $1,085,500 of the proceeds of the senior
subordinated note borrowings were allocated to these warrants and were
recorded as additional paid-in capital. The $1,085,500, net of accumulated
amortization, was written off in 1997 as part of the extraordinary loss on
debt extinguishment upon the issuance of the Senior Notes and the related
repayment of the outstanding balances under the previous Senior Credit
Facility.
At the acquisition date, the Company also entered into various warrant
agreements with its other subordinated lenders along with its Class B
common stockholders that granted such holders the right to purchase 6,230
shares of Class A common stock of the Company upon terms established by
the Board of Directors. In conjunction with the issuance of the Senior
Notes, 1,059 of these warrants were terminated. The remaining 5,171
warrants are exercisable in whole or part, at various dates through
December 27, 2006, at warrant prices ranging from $1,000 to $3,000 a
share.
In March 1999, the Company issued 5,000 warrants giving the holders of
each warrant the right to acquire one share of the Company's Class A
common stock for $1,000 per share, as discussed in footnote 15.
OPTIONS - In connection with certain employment agreements in 1997 and
1998, the Company granted 691 and 896, respectively, options to acquire
common stock at an exercise price equal to the fair market
48
value of such shares at the date of grant. The options vest ratably over
the term of the employment agreements and expire ten years from the date
of grant.
On May 26, 1998, the Company's Board of Directors approved the Evercom,
Inc. 1998 Stock Option Plan (the "Plan"). The Plan provides for the grant
of options to purchase shares of Class A common stock to certain officers
and employees. The Company granted 56 options to employees on June 30,
1998. These options have a term of ten years, an exercise price equal to
the fair market value of such shares at the date of grant and vest over
five years.
The following information summarize the shares subject to options:
Number of Shares Weighted Average Exercise
Price Per Share
1997 1998 1997 1998
---- ---- ---- ----
Options outstanding, beginning of year 691 $2,000
Granted 691 952 2,000 2,000
Exercised (33) 2,000
Cancelled (55) 2,000
--------- ---------
Options outstanding, end of year 691 1,555 $2,000 $2,000
=== =====
Options exercisable, end of year 106 291
== ===
The following table summarizes information about options outstanding at
December 31, 1998:
WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE EXERCISE
RANGE OF EXERCISE PRICE NUMBER OUTSTANDING CONTRACTUAL LIFE PRICE
$2,000 1,555 9.92 $2,000
The Company applies the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its options. Accordingly, no
compensation cost has been recognized for such option grants. Had
compensation cost for the
49
Company's options been determined based upon the fair value at the grant
dates for awards consistent with the method prescribed by the SFAS No.
123, "Accounting for Stock-Based Compensation," the Company's pro forma
net loss would have been as follows:
YEARS ENDED DECEBER 31,
-----------------------------------
1997 1998
COMPENSATION COST DISCLOSURE
Compensation Cost $ 207,000 $ 344,000
Net Loss:
As reported (16,926,974) (25,886,429)
Pro forma (17,133,974) (26,230,429)
Stock option share data:
Stock options granted during the period 691 952
Weighted average option fair value (a) $ 900 $ 720
________________
(a) Calculated in accordance with the Black-Scholes option pricing
model, using the following assumptions: expected volitility of 0%;
expected dividend yield of 0%; expected option term of ten years and
risk-free rate of return of 6.09% and 4.5% for the options granted in
1997 and 1998, respectively.
10. RELATED-PARTY TRANSACTIONS
One of the Company's subsidiaries leased office space from a stockholder
under a month-to-month lease with monthly rentals of $3,000. This lease
expired on December 31, 1996. Subsequently, the Company entered into a new
lease agreement with the stockholder, with monthly payments in 1997 and
1998 of $9,083 and $9,812, respectively. The lease term extends through
December 31, 2001, at which time the Company has an option to extend the
lease for an additional five years.
A stockholder of the Company earns a commission based on the net operating
income, as defined by the commission agreement, generated from one of the
Company's contracts. The Company paid $300,000 to this stockholder in
accordance with this commission agreement during the year ended December
31, 1998.
In conjunction with the formation of the Company in 1996 and the
consummation and original financing of the acquisitions of Talton
Telecommunications Corporation and AmeriTel Pay Phones, Inc., the Company
paid transaction fees and expenses of $1,670,000 to three companies
affiliated with certain stockholders that have been capitalized in the
acquisitions.
50
The Company entered into a management services and consulting agreement
with a company affiliated with certain stockholders, along with separate
consulting agreements with four stockholders who are former employees of
the acquired companies. These agreements require the payment of aggregate
minimum annual consulting fees over the agreement life in the following
amounts:
1999 $500,000
2000 200,000
2001 200,000
2002 100,000
These agreements also provide for the reimbursement of direct expenses
along with future payments for transaction consulting services. One of the
agreements entitles an affiliate of certain stockholders to a 1% fee based
on the gross acquisition price for any asset or stock acquisitions by the
Company. This agreement, which expires in December 1999, limits the
cumulative acquisition fees paid to this consultant to an amount not to
exceed $1,250,000 over the life of the agreement. In 1997 and 1998, the
Company paid $187,000 and $666,000, respectively, under the terms of this
agreement and $591,250 and $0 were recorded as a liability at December 31,
1997 and 1998, respectively. This agreement also provides for an
additional payment upon the refinancing of certain senior subordinated
notes outstanding. In conjunction with the offering of the Senior Notes,
the Company paid $200,000 under the terms of this agreement.
The management services and consulting agreement has a three-year term and
is cancelable at either party's discretion, with all consulting fees under
the remaining term of the agreement to be paid upon the date of
termination. The remaining consulting agreements are cancelable only at
the option of the consultants and expire over one- to five-year terms. In
connection with these agreements, the Company paid $478,000 and $300,000
during the years ended December 31, 1997 and 1998, respectively.
11. BENEFIT PLAN
The Company's subsidiaries sponsor 401(k) savings plans for the benefit of
eligible full-time employees, which are qualified benefit plans in
accordance with the Employee Retirement Income Security Act ("ERISA").
Employees participating in the plan can generally make contributions to
the plan of up to 15% of their compensation. The plans provide for
discretionary matching contributions by the Company of up to 50% of an
eligible employee's contribution. Total plan expenses were $3,517 for the
one-month ended December 31, 1996, and $5,115 and $5,490 for the years
ended December 31, 1997 and 1998, respectively.
51
12. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - The Company leases office furniture, office space and
vehicles under various operating lease agreements. Rent expense under
these operating lease agreements was $19,900 during the one-month ended
December 31, 1996, and $496,967 and $919,085 during the year ended
December 31, 1997 and 1998, respectively. Minimum future rental payments
under noncancelable operating leases for each of the next five years and
thereafter and in the aggregate are:
Year ending December 31:
1999 $ 652,353
2000 458,571
2001 431,203
2002 329,238
2003 311,350
Thereafter 1,317,250
------------
$ 3,499,965
============
MINIMUM COMMISSIONS - In the normal course of business, the Company pays
commissions to correctional facilities generally based on call volume
revenues. In certain situations, the Company will enter into a minimum
commission guarantee with the correctional facility. The minimum guarantee
is developed based on, among other things, an expected base level of call
traffic. The Company's three-year contract with one of its customers
provides for minimum annual commissions of approximately $10 million per
year. Call traffic, and therefore revenues generated from the contract in
the initial period of operation were substantially below initial
projections. As a result of the shortfall, the Company and its customer
have agreed to review the results for the initial period of operation,
review the causes for the shortfall and negotiate the guaranteed
commission amount. The Company has recorded a liability for the minimum
commission based on its estimate of the most likely outcome of the
negotiations. The maximum potential payment required under the original
minimum commission guarantee at December 31, 1998 was approximately $2.9
million. Under the terms of the contract, any minimum guarantee payment
due is not required to be made until the year 2000. Management of the
Company believes that the Company has adequately accrued for the
commission liability as of December 31, 1998 and that the final negotiated
commission payment will not have a material adverse effect on the
consolidated financial position, results of operations, or cash flows of
the Company.
EMPLOYMENT AGREEMENTS - As of December 31, 1998, the Company had entered
into employment agreements with certain key management personnel, which
provided for minimum compensation levels and incentive bonuses along with
provisions for termination of benefits in certain circumstances and for
certain severance payments in the event of a change in control (as
defined).
LITIGATION - The Company is subject to various legal proceedings and
claims that arise in the ordinary course of business operations. In the
opinion of management, the amount of liability, if any, with respect to
these actions would not materially affect the financial statements of the
Company.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to SFAS No. 107, "Disclosure About Fair Value of Financial
Instruments," the Company is required to disclose an estimate of the fair
value of the Company's financial instruments. The Company believes that
the carrying amounts of cash and cash equivalents, accounts receivable
and accounts
52
payable are a reasonable estimate of their fair value because of the short-
term maturities of such instruments. In addition, because the interest rates
on the amounts borrowed under the Senior Credit Facility are variable, their
fair values approximate their carrying values.
The fair value of the Senior Notes is based on their quoted market value. The
following is a summary of the carrying value of the Company's debt
instruments:
DECEMBER 31, 1997 DECEMBER 31, 1998
--------------------------------------------- ------------------------------------------
HISTORICAL HISTORICAL
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
Senior Notes $115,000,000 $123,912,500 $115,000,000 $109,434,000
Senior Credit Agreement 50,500,000 50,500,000 64,000,000 64,000,000
14. RESTRUCTURING AND OTHER COSTS
RESTRUCTURING COSTS - During 1998, management authorized and committed to a
plan of restructure. The plan provides for the consolidation of certain
operations, including the closing of a number of office locations and
reducing the workforce by approximately 21 employees and certain management
positions. Based on the finalization of estimates included within the plan
and the actual undertaking of certain actions in accordance with the plan,
management made revisions to the original estimates during the fourth
quarter. The revisions primarily relate to the final determination of the
number of employees terminated, which resulted in 19 terminations, the
unexpected subletting of certain facilities, and a refinement of expected
legal and other costs. Although certain specific actions of the plan were
modified, the overall plan for restructuring the Company is expected to be
completed at a total cost of approximately $200,000 less than the original
provision.
Original restructuring reserves were established totaling $1.4 million, of
which $200,000 was reversed in the fourth quarter. Of the adjusted amount,
$600,000 was reserved for severance and related costs, $200,000 for the
office leases and $400,000 for legal and other costs.
Major categories of the restructuring reserve and the amounts incurred are
summarized below:
Amounts
Charged to Amounts
Earnings in Incurred in
1998 1998
---------------- --------------
Severance and related costs $ 614,678 $252,885
Leased facilities 217,902 68,449
Legal and other costs 379,685 236,685
---------- --------
$1,212,265 $558,019
========== ========
OFFERING COSTS - During 1998, the Company incurred $531,025 of external costs
associated with a potential offering of equity securities. Due to the
postponement of the equity offering, these costs were expensed in 1998.
53
FEDERAL BID COSTS - During 1997, the Company incurred $399,817 of external
costs associated with a bid for the Federal Bureau of Prisons contract. The
Company was unsuccessful in obtaining the contract. The contract award has
been appealed; however, the Company has expensed all costs associated with
the bid.
EXTRAORDINARY LOSS- During 1997, as a result of the repayment of outstanding
indebtedness and amendments of the Senior Credit Facility, the Company
expensed approximately $4.7 million of debt issuance, legal and other costs
associated with the extinguishment of the prior credit facilities. These
amounts have been classified as an extraordinary loss in accordance with the
provisions of SFAS No. 4, "Reporting Gains and Losses From the Extinguishment
of Debt."
15. SUBSEQUENT EVENTS
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 $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 the Company's Class A common stock for $1,000 per share.
The First Preferred Series A Stock will be entitled to receive dividends at
the applicable First Preferred Series A Rate, payable quarterly commencing on
April 1, 1999. Such dividends will be payable out of funds legally available
therefor, will be payable only when, as, and if declared by the Board of
Directors, shall be 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 eight percent per annum through March
31, 2001, will be ten percent per annum from April 1, 2001 through June 30,
2001 and thereafter will increase by 0.5% for each additional three month
period up to a maximum of 16% per annum. The First Preferred Series A Stock
ranks senior to all classes of common stock but ranks junior to the Senior
Preferred Stock of the Company 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.
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, in conjunction with the issuance of the First Preferred
Series A Stock and warrants, the Company amended and restated its Senior
Credit Facility, as discussed further in footnote 7. The amendment increased
the Company's borrowing capacity under the term loan facility of the Senior
Credit Facility by $5.5 million.
******
54
INDEPENDENT AUDITORS' REPORT
To the Stockholders of
AmeriTel Pay Phones, Inc.:
We have audited the accompanying balance sheet of AmeriTel Pay Phones, Inc. (the
"Company") as of November 30, 1996, and the related statement of income,
stockholder's equity and cash flows for the eleven months then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of AmeriTel Pay Phones, Inc. as of November 30,
1996, and the results of its income and its cash flows for the eleven months
then ended, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Dallas, Texas
April 4, 1997
55
AMERITEL PAY PHONES, INC.
BALANCE SHEET
NOVEMBER 30,
ASSETS 1996
----------------------
CURRENT ASSETS:
Cash and cash equivalents $ 80,664
Accounts receivable 5,546,304
Stock subscriptions receivable 1,061,384
Refundable income taxes 342,986
Inventories 785,438
Prepaid expenses 34,646
Deferred tax asset 396,752
-----------
Total current assets 8,248,174
PROPERTY AND EQUIPMENT 4,521,521
INTANGIBLE AND OTHER ASSETS 14,114,958
-----------
TOTAL $26,884,653
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,429,916
Accrued expenses 3,289,957
Current maturities of long-term debt 1,824,907
-----------
Total current liabilities 6,544,780
LONG-TERM DEBT 13,019,811
DEFERRED INCOME TAXES 425,689
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 500,000 shares authorized;
244,800 shares issued and outstanding (liquidation value of
$1,534,157 at November 30, 1996) 2,448
Common stock, $.01 par value, 10,000,000 shares authorized;
3,519,315 shares issued and outstanding as of
November 30, 1996 35,193
Additional paid-in capital 3,704,863
Retained earnings 3,151,869
-----------
Total stockholders' equity 6,894,373
-----------
TOTAL $26,884,653
===========
See notes to financial statements.
56
AMERITEL PAY PHONES, INC.
STATEMENT OF INCOME
ELEVEN MONTHS
ENDED
NOVEMBER 30,
1996
------------------------
OPERATING REVENUE $29,305,641
OPERATING EXPENSES:
Telecommunication costs 13,728,316
Facility commissions 6,086,469
Field operations and maintenance 1,166,063
Selling, general and administrative 2,281,177
Depreciation 536,264
Amortization of intangibles 1,624,017
Nonrecurring expenses 684,320
-----------
Total operating expenses 26,106,626
-----------
OPERATING INCOME 3,199,015
OTHER (INCOME) EXPENSE:
Interest income (20,816)
Interest expense 1,375,701
Other, net 38,881
-----------
Total other (income) expense 1,393,766
-----------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY LOSS 1,805,249
INCOME TAXES 693,001
-----------
INCOME BEFORE EXTRAORDINARY LOSS 1,112,248
EXTRAORDINARY LOSS FROM EARLY
EXTINGUISHMENT OF DEBT 52,353
-----------
NET INCOME $ 1,059,895
===========
See notes to financial statements.
57
AMERITEL PAY PHONES, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
PREFERRED COMMON STOCK ADDITIONAL
---------------------- PAID-IN RETAINED
STOCK SHARES AMOUNT CAPITAL EARNINGS TOTAL
--------- ------------ -------- ----------- ----------- -----------
BALANCE, JANUARY 1, 1996 $2,448 3,233,854 32,338 2,292,548 2,209,682 4,537,016
Issuance of common stock 285,461 2,855 1,412,315 1,415,170
Preferred stock dividends ($0.48 per share) (117,708) (117,708)
Net income 1,059,895 1,059,895
--------- ------------ -------- ----------- ----------- -----------
BALANCE, NOVEMBER 30, 1996 $2,448 3,519,315 $35,193 $3,704,863 $3,151,869 $6,894,373
========= ============ ======== =========== =========== ===========
See notes to financial statements.
58
AMERITEL PAY PHONES, INC.
STATEMENT OF CASH FLOWS
ELEVEN
MONTHS
ENDED
NOVEMBER 30,
1996
----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,059,895
Adjustments to reconcile net income to net cash provided by operating activities:
Extraordinary loss 52,353
Depreciation and amortization 2,160,281
Deferred income taxes (35,524)
Changes in operating assets and liabilities:
Accounts receivable (3,803,925)
Inventory 271,286
Prepaid expenses 44,880
Accounts payable 1,092,431
Accrued expenses 1,460,005
Income taxes 266,149
-----------
Net cash provided by operating activities 2,567,831
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,516,236)
Cash outflows for acquisition of facility contracts (4,698,468)
-----------
Net cash used in investing activities (6,214,704)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt borrowings 5,600,000
Proceeds from issuance of common stock 19,501
Payments of long-term debt (2,645,282)
Dividends paid on common and preferred stock (137,708)
-----------
Net cash provided by financing activities 2,836,511
-----------
DECREASE IN CASH AND CASH EQUIVALENTS (810,362)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 891,026
-----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 80,664
===========
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 1,489,076
===========
Cash paid for income tax $ 462,380
===========
Noncash transactions:
Issuance of common stock upon exercise of stock options in exchange
for stock subscriptions receivable, along with the related tax benefit $ 1,395,669
===========
Amounts payable for acquisitions $ 310,000
===========
See notes to financial statements.
59
AMERITEL PAY PHONES, INC.
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS - AmeriTel Pay Phones, Inc. (the "Company"), which was incorporated
on June 6, 1991, owns, operates and maintains telephone systems under
contracts with correctional facilities in 30 states, with the majority of its
installations in Missouri, Kansas, Iowa, Indiana, Minnesota and Nebraska.
The Company accumulates call activity from its various installations and
bills its revenues related to this call activity through major local exchange
carriers ("LECs") or through third-party billing services, all of which are
granted credit in the normal course of business with terms of between 30 and
60 days. The Company performs ongoing credit evaluations of its customers and
maintains allowances for unbillable and uncollectible losses based on
historical experience.
PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions, such as estimates of allowances
for unbillable and uncollectible chargebacks, that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS - For purposes of the statement of cash flows, cash
and cash equivalents include cash on hand and cash investments with a
remaining maturity at the date of purchase of three months or less.
ACCOUNTS RECEIVABLE - Trade accounts receivable represent amounts billed for
calls placed through the Company's telephone systems to the various LECs or
third-party billing services, net of advance payments received, and an
allowance for unbillable and uncollectible calls based on historical
experience for estimated chargebacks to be made by the LECs. Under account
advance agreements with various third-party billing services, advance
payments equal to a percentage of the outstanding billed receivables are
remitted to the Company when calls are submitted to the third-party billing
service, and the Company grants a lien to the third-party billing service on
the related accounts receivable for the advance. The remainder of the billed
receivable is paid to the Company, net of the advance amount, after the
third-party billing service has collected the amounts receivable from the
respective LECs. Interest is charged on the advance payment at varying rates.
INVENTORIES - Inventories are stated at the lower of cost, as determined
using the weighted average cost method, or market. Inventory is primarily
composed of equipment available for installation on new contracts and
supplies and parts for the telephone systems serviced by the Company.
60
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation and amortization is provided on a straight-line basis over the
estimated useful lives of the related assets. The following is a summary of
useful lives for major categories of property and equipment:
ASSET USEFUL LIFE
Leasehold improvements Term of lease
Telephone system equipment 7.5 to 10 years
Vehicles 5 years
Office equipment 3 to 7 years
Maintenance and repairs are expensed when incurred, and major repairs that
extend an asset's useful life are capitalized. When items are retired or
disposed of, the related carrying value and accumulated depreciation are
removed from the respective accounts, and the net difference less any amount
realized from the disposition is reflected in earnings.
INTANGIBLE AND OTHER ASSETS - Intangible and other assets primarily include
amounts allocated to acquired facility contracts, noncompete agreements,
goodwill and other intangible assets, which are stated at cost, along with
the long-term portion of customer advances. Amortization of intangible assets
is provided on a straight-line basis over the estimated useful lives of the
related assets. The following is a summary of useful lives for major
categories of intangible assets:
INTANGIBLE ASSET USEFUL LIFE
Acquired facility contracts 7.5 years
Noncompete agreements Agreement term
Deferred loan costs Loan term
Other intangibles 5 to 20 years
Goodwill 15 years
Acquired facility contracts consist primarily of costs allocated to locations
acquired in acquisitions of facility contract rights from other service
providers, along with signing bonuses paid to the facilities under new
facility installations and other incremental direct costs paid to obtain the
facility contracts.
Other intangibles include organizational costs and licensing fees to obtain
state licenses to conduct business.
The Company began in 1996 to periodically assess the net realizable value of
its intangible assets, as well as all other assets, by comparing the expected
future net operating cash flow, undiscounted and without interest charges, to
the carrying amount of the underlying assets. The Company would evaluate a
potential impairment if the recorded value of these assets exceeded the
associated future net operating cash flows. Any potential impairment loss
would be measured as the amount by which the carrying value exceeds the fair
value of the asset. Fair value of assets would be measured by market value,
if an active market exists, or by a forecast of expected future net operating
cash flows, discounted at a rate commensurate with the risk involved.
INCOME TAXES - The Company accounts for income taxes using the liability
method in accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under this method,
deferred tax assets and liabilities are provided for temporary
61
differences between the financial statement and tax bases of the assets and
liabilities using current tax rates.
REVENUE RECOGNITION - Revenues are recognized during the period the calls are
made. In addition, during the same period, the Company accrues the related
telecommunication costs for validating, transmitting, billing and collection,
and line and long distance charges, along with commissions payable to the
facilities and allowances for unbillable and uncollectible calls, based on
historical experience.
FACILITY COMMISSIONS - Under the terms of the Company's telephone system
contracts with correctional facilities, the Company pays commissions to these
facilities generally based on call volume revenues, which are accrued during
the period the revenues are generated.
FINANCIAL INSTRUMENTS - The Company's financial instruments under SFAS No.
107, "Disclosures About Fair Value of Financial Instruments," include cash
and cash equivalents, accounts receivable, accounts payable and long-term
debt. The Company believes that the carrying amounts of cash and cash
equivalents, accounts receivable, accounts payable and long-term debt are a
reasonable estimate of their fair value because of the short-term maturities
of such instruments or, in the case of the revolving credit facility
borrowings, because of the floating interest rates on such borrowings. In the
case of the subordinated promissory notes to related parties, which bear a
fixed interest rate, the Company believes that the current interest rates on
these notes approximate the rates that could be currently negotiated with
such related parties.
2. ACQUISITIONS
During the eleven months ended November 30, 1996, the Company acquired
facility contracts and the related facility equipment from various other
independent inmate phone operators for purchase prices aggregating $5.0
million.
These acquisitions were each accounted for using the purchase method of
accounting as of their respective acquisition dates, and accordingly, only
the results of the operations of these facilities subsequent to their
respective acquisition dates are included in the financial statements of the
Company. At the acquisition dates, the purchase prices were allocated to the
assets acquired, including telephone system equipment, facility contracts and
other identifiable intangibles based on their fair market values.
62
The excess of the total purchase prices over the fair values of the assets
acquired represented goodwill. In connection with the acquisitions, assets
were acquired, and liabilities were assumed as follows:
ELEVEN MONTHS
ENDED
NOVEMBER 30,
1996
---------------
Purchase prices:
Net cash paid $4,698,468
Amounts payable to sellers 310,000
----------
Total purchase price 5,008,468
Estimated fair values of tangible and
identifiable intangible assets acquired 4,121,809
----------
Goodwill $ 886,659
==========
The following table presents unaudited pro forma results of operations of the
Company for the eleven months ended November 30, 1996, as if the 1996
acquisitions had occurred at the beginning of 1996:
1996
----
(UNAUDITED)
Net sales $31,929,045
===========
Income before extraordinary loss $ 1,308,344
===========
Net income $ 1,255,991
===========
The unaudited pro forma results of operations are not necessarily indicative
of what the actual results of operations of the Company would have been had
the acquisitions occurred at the beginning of the year, nor do they purport
to be indicative of the future results of operations of the Company.
In connection with two of the acquisitions in 1996, the Company recorded
amounts payable to the sellers of $310,000, the payment of which was
contingent upon the fulfillment of certain stipulations that the Company
believed were probable of being met. In the event that the stipulations were
not met and the full balance was not paid by the Company, intangible assets
previously recorded on these acquisitions would be reduced.
63
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
NOVEMBER 30,
1996
----
Trade accounts receivable $6,895,904
Advance commissions receivable 353,378
Employees and other 50,670
----------
7,299,952
Less advances on receivables (719,093)
Less allowance for unbillable and uncollectible chargebacks (1,034,555)
----------
$5,546,304
==========
At November 30, 1996, the Company had advanced commissions to certain
facilities of $843,378, 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.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
NOVEMBER 30,
1996
----
Leasehold improvements $ 59,145
Telephone system equipment 5,159,020
Vehicles 138,914
Office equipment 334,543
----------
5,691,622
Less accumulated depreciation and amortization (1,170,101)
----------
$4,521,521
==========
Substantially all of the Company's property and equipment is collateral for
the Company's long-term debt.
64
5. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
NOVEMBER 30,
1996
----
Intangible assets:
Acquired facility contracts $11,432,435
Noncompete agreements 375,000
Goodwill 5,088,960
Other intangibles 100,945
-----------
16,997,340
Less accumulated amortization (3,372,382)
-----------
Total intangible assets 13,624,958
Other assets - noncurrent portion of commission
advances to facilities 490,000
-----------
$14,114,958
===========
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
NOVEMBER 30,
1996
----
Billing and collection fees $ 420,338
Facility commissions 722,769
Long-distance charges 1,399,180
Recurring and special bonuses 521,875
Other 225,795
----------
$3,289,957
==========
65
7. LONG-TERM DEBT
Long-term debt consists of the following:
NOVEMBER 30,
1996
-----------------
Revolving credit facility advances $12,600,000
Subordinated promissory note payable to a related party, with
interest at 10%, due on December 31, 2001 800,000
Subordinated promissory notes payable to a related party, with
interest of 10%, payable in quarterly installments of
$106,472 until maturity on March 31, 2001, collateralized by
a security interest in certain facility equipment and contracts 1,244,718
Amount payable in connection with a facility contract
acquisition, due in February 1999 200,000
-----------
14,844,718
Less current maturities of long-term debt (1,824,907)
-----------
$13,019,811
===========
The revolving credit facility is a $20,000,000 revolving credit facility with
United Missouri Bank, N.A. and NBD Bank, with interest at a floating rate
based on either prime or LIBOR options plus applicable basis points based on
the Company's applicable coverage ratios. The outstanding balance at
September 30, 1996, was converted into an installment note at that date, with
the remaining balance of the revolving credit facility available until
September 30, 1998. The installment note is payable in quarterly installments
of $378,000 in 1997, increasing on an annual basis thereafter through
September 30, 2001. The Company pays a commitment and facility fee of 0.5% on
the average daily unused portion of the revolving credit facility. The
revolving credit facility is collateralized by substantially all assets of
the Company.
Scheduled principal maturities on long-term debt for the five years
subsequent to December 31, 1996, are as follows:
1997 $ 1,824,907
1998 2,374,490
1999 3,194,374
2000 3,122,947
2001 4,328,000
-----------
$14,844,718
===========
In conjunction with the sale of the Company, as discussed in Note 14, all of
the outstanding debt was repaid.
66
8. INCOME TAXES
The provision for income taxes for the eleven months ended November 30, 1996,
is as follows:
1996
---------------
Current taxes payable:
Federal $609,228
State 119,297
Deferred income taxes (35,524)
--------
$693,001
========
The provision for income taxes differs from statutory rates primarily as a
result of state income taxes and permanent differences. The following is a
reconciliation of income taxes reported in the statement of operations:
1996
---------------
Tax at statutory rates $613,785
Effect of state income taxes 102,487
Other (23,271)
--------
$693,001
========
The tax effects of temporary differences giving rise to deferred income tax
asset and liabilities were:
ELEVEN MONTHS
ENDED
NOVEMBER 30,
1996
----------------
Deferred tax asset:
Allowance for unbillable and uncollectible chargebacks $ 396,752
Deferred tax liabilities:
Depreciation and amortization (402,892)
Other (22,797)
---------
(425,689)
---------
Net deferred income tax liability $ (28,937)
=========
67
This net deferred income tax liability is classified in the balance sheet as
follows:
ELEVEN MONTHS
ENDED
NOVEMBER 30,
1996
----------------
Current asset $ 396,752
Noncurrent liability (425,689)
---------
$ (28,937)
=========
9. STOCKHOLDERS' EQUITY
STOCK OPTIONS - On May 1, 1994, the Board of Directors of the Company adopted
a stock option agreement for certain employees and consultants of the
Company. On the same date, the Board of Directors granted options for 233,335
shares of common stock at $.765 per share, the then-estimated fair market
value per share of common stock of the Company that were exercisable at any
time for a period of up to ten years from the date of grant.
On December 19, 1994, the Board of Directors of the Company adopted the 1995
Stock Option Plan (the "Plan") for the directors, officers and other key
employees of the Company, effective for fiscal year 1995. The maximum number
of shares that could be granted under the Plan was amended from 653,600
shares to 446,248 shares on April 28, 1995. Under the provisions of the Plan,
options were to be granted at an exercise price per share not less than the
fair market value at the date of grant, as determined by the Compensation
Committee (the "Committee"), and were to be exercisable on the date of grant.
The Committee was also assigned responsibility for determining the term of
each option, which in no event could exceed ten years from the date of grant.
A total of 225,492 options were granted under the Plan during 1995 at a price
of $4.59 per share, the then estimated fair market value per share of common
stock of the Company.
During 1996, no additional stock options were granted to employees, and
employees exercised all remaining unexercised options prior to the sale of
the Company, as discussed in Note 14. The following is a summary of changes
in stock options during 1996:
EXERCISE
WEIGHTED
AVERAGE
NUMBER OF PRICE
SHARES PER SHARE
Outstanding at January 1, 1996 285,461 3.790
Exercised during 1996 (285,461) 3.790
----------
Outstanding at November 30, 1996 -
==========
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock option plans, and accordingly, no compensation has
been recognized since stock options granted under these plans were at
exercise prices, which approximated market value at the grant date. Had the
Company
68
implemented SFAS No. 123, "Accounting for Stock-Based Compensation" the
implementation would not have affected the net income of the Company for the
eleven months ending November 30, 1996, because no options were granted
during the period and because options granted prior to 1996 were fully
vested.
In connection with the issuance of shares of the Company's common stock for
exercised options in 1996, the Company recognized, as increases in common
stock and additional paid-in capital, the aggregate exercise price of
$1,080,885, along with the tax benefits related to such options of $334,285.
At November 30, 1996, the Company had recorded stock subscriptions receivable
of $1,061,384 from certain employees for unpaid exercise proceeds, which were
subsequently collected by the Company in December 1996.
PREFERRED STOCK - The preferred stock accrues dividends at 8% for the one-
year period ending on the first anniversary of the original issue date, 10%
until the second anniversary date and 12% thereafter. The preferred stock is
convertible any time into 244,800 shares of common stock on an after-stock-
conversion basis. During 1996, $137,708 of the cash dividends were paid on
the preferred stock.
In conjunction with the sale of the Company, as discussed in Note 14, all
outstanding shares of preferred stock were redeemed.
10. RELATED PARTY TRANSACTIONS
In addition to the related party notes payable discussed in Note 7 and the
stock subscription receivables related to exercised stock options discussed
in Note 9, during the eleven months ended November 30, 1996, the Company paid
an affiliate of its majority stockholders a consulting fee of $37,500 and
incurred certain legal costs on behalf of its stockholders, which are
recorded as accounts receivable from such stockholders.
11. BENEFIT PLAN
The Company sponsors a 401(k) savings plan for the benefit of eligible full-
time employees; this is a qualified benefit plan in accordance with the
Employee Retirement Income Security Act ("ERISA"). The employees
participating in the plan can generally make contributions to the plan of up
to 15% of their compensation. The plan provides for discretionary matching
contributions by the Company of up to 50% of an eligible employee's
contribution. No significant contributions to this plan were made by the
Company during 1996.
12. OTHER COSTS
NONRECURRING COSTS - During 1996, the Company incurred costs of $250,000
related to the settlement of a lawsuit related to a prior acquisition, along
with special bonuses of $434,320 paid to key management at the date of the
sale of the Company, as discussed in Note 14. These special bonuses were
payable to key management upon the closing of the sale of the Company
pursuant to a transaction bonus agreement with such employees, due and
payable only upon the closing of the sale, a portion of which was
attributable to the buyout of existing employment contracts with such
employees.
69
EXTRAORDINARY LOSS - In connection with the sale of the Company, all
outstanding long-term debt was repaid, resulting in the expensing of existing
unamortized debt issue costs of $52,353 (net of income tax benefit of
$32,573). This loss has been classified as an extraordinary loss in
accordance with the provisions of SFAS No. 4, "Reporting Gains and Losses
From the Early Extinguishment of Debt."
13. COMMITMENTS AND CONTINGENCIES
OPERATING LEASE - The Company leases office space under an operating lease
agreement that expires on July 31, 1999. Rent expense under this and prior
operating lease agreements was $61,050 during fiscal year 1996. The total
remaining future minimum lease payments for the Company under the operating
lease agreement are as follows:
1997 $ 66,600
1998 66,600
1999 38,850
--------
$172,050
========
CONTINGENCIES - The Company is subject to various legal proceedings and
claims that arise in the ordinary course of business operations. In the
opinion of management, the amount of liability, if any, with respect to these
actions would not materially affect the financial position of the Company or
its results of operations.
14. SUBSEQUENT SALE OF COMPANY
On December 27, 1996, Talton Holdings, Inc. acquired all of the outstanding
common stock of the Company in a purchase business combination effective
December 1, 1996. In conjunction with this transaction, all of the
outstanding debt of the Company was repaid and all of the outstanding
preferred stock was redeemed.
******
70
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Stockholders of Talton Telecommunications Corporation:
We have audited the accompanying consolidated balance sheet of Talton
Telecommunications Corporation and subsidiary (the "Company") as of November 30,
1996, and the related consolidated statements of income, stockholders' equity
and cash flows for the eleven months then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Talton
Telecommunications Corporation and subsidiary as of November 30, 1996, and the
results of their income and their cash flows for the eleven months then ended,
in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Dallas, Texas
April 4, 1997
71
TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
NOVEMBER 30,
ASSETS 1996
----------------
CURRENT ASSETS:
Cash and cash equivalents $ 449,904
Accounts receivable 2,388,958
Refundable income taxes
Inventories 168,395
Prepaid expenses 55,788
Deferred income tax asset 54,400
----------
Total current assets 3,117,445
PROPERTY AND EQUIPMENT 4,119,147
INTANGIBLE AND OTHER ASSETS 586,656
----------
TOTAL $7,823,248
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 950,576
Accrued expenses 3,205,027
Income taxes payable 892,000
----------
Total current liabilities 5,047,603
DEFERRED INCOME TAXES 308,605
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $1.00 par value; 5,000 shares authorized,
issued and outstanding 5,000
Retained earnings 2,462,040
----------
Total stockholders' equity 2,467,040
----------
TOTAL $7,823,248
==========
See notes to consolidated financial statements.
72
TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
ELEVEN MONTHS
ENDED
NOVEMBER 30,
1996
----
OPERATING REVENUE $24,357,473
OPERATING EXPENSES:
Telecommunication costs 9,588,482
Facility commissions 7,875,455
Field operations and maintenance 649,739
Selling, general and administrative 1,639,827
Depreciation 1,001,982
Amortization of intangibles 122,180
-----------
Total operating expenses 20,877,665
-----------
OPERATING INCOME 3,479,808
OTHER (INCOME) EXPENSE:
Interest income (55,268)
Interest expense 169,789
Other, net (12,321)
-----------
Total other (income) expense 102,200
-----------
INCOME BEFORE INCOME TAXES 3,377,608
INCOME TAXES 1,223,989
-----------
NET INCOME $ 2,153,619
===========
See notes to consolidated financial statements.
73
TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
COMMON STOCK
----------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------- ----------- -----------
BALANCE, JANUARY 1, 1996 5,000 $5,000 $ 308,421 $ 313,421
Net income for the eleven months ended November 30, 1996 2,153,619 2,153,619
------ ------- ---------- ----------
BALANCE, NOVEMBER 30, 1996 5,000 $5,000 $2,462,040 $2,467,040
====== ======= ========== ==========
See notes to consolidated financial statements.
74
TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
ELEVEN MONTHS
ENDED
NOVEMBER 30,
1996
----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,153,619
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 1,124,162
Deferred income taxes 250,989
Changes in operating assets and liabilities:
Accounts receivable (180,563)
Inventories 142,233
Prepaid expenses (55,788)
Accounts payable 14,007
Accrued expenses (97,672)
Income taxes payable 1,381,652
-----------
Net cash provided by operating activities 4,732,639
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,287,703)
Payments for intangible and other (12,975)
-----------
Net cash used in investing activities (1,300,678)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt (3,383,794)
-----------
Net cash used in financing activities (3,383,794)
-----------
INCREASE IN CASH AND CASH EQUIVALENTS 48,167
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 401,737
-----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 449,904
===========
SUPPLEMENTAL INFORMATION:
Interest paid $ 172,578
===========
Income taxes refunded $ (408,652)
===========
See notes to consolidated financial statements.
75
TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS - Talton Telecommunications Corporation (the "Company"), which was
incorporated in 1973, owns, operates and maintains telephone systems under
contracts with correctional facilities in Alabama, Mississippi, North
Carolina and South Carolina. The Company also operates and maintains public
pay telephone systems at various third-party property locations. The Company
accumulates call activity from its various installations and bills its
revenues related to this call activity through major local exchange carriers
("LECs") or through third-party billing services for smaller volume LECs, all
of which are granted credit in the normal course of business with terms of
between 30 and 60 days. The Company performs ongoing credit evaluations of
its customers and maintains allowances for unbillable and uncollectible
losses based on historical experience.
PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions, such as estimates of allowances
and reserves for unbillable and uncollectible chargebacks, that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiary, Talton
Telecommunications of Carolina, Inc. All significant intercompany balances
and transactions are eliminated in consolidation.
CASH AND CASH EQUIVALENTS - For purposes of the statement of cash flows, cash
and cash equivalents includes cash on hand and cash investments with a
remaining maturity at the date of purchase of three months or less.
ACCOUNTS RECEIVABLE - Trade accounts receivable represents amounts billed for
calls placed through the Company's telephone systems to the various LECs or
third-party billing services, net of an allowance for unbillable and
uncollectible calls, based on historical experience, for estimated
chargebacks to be made by the LECs.
INVENTORIES - Inventories are stated at the lower of cost, as determined
using the first-in, first-out ("FIFO") method of valuation or market.
Inventory is primarily composed of equipment available for installation on
new contracts and supplies and parts for the telephone systems serviced by
the Company.
76
PROPERTY AND EQUIPMENT - Property and equipment is stated at cost.
Depreciation and amortization is provided on a straight-line basis over the
estimated useful lives of the related assets. The following is a summary of
useful lives for major categories of property and equipment:
ASSET USEFUL LIFE
Leasehold improvements 15 to 39 years
Telephone system equipment 5 to 6 years
Vehicles 5 years
Office equipment 5 to 7 years
Maintenance and repairs are expensed when incurred, and major repairs that
extend an asset's useful life are capitalized. When items are retired or
disposed of, the related carrying value and accumulated depreciation are
removed from the respective accounts, and the net difference less any amount
realized from the disposition is reflected in earnings.
INTANGIBLE AND OTHER ASSETS - Intangible and other assets include amounts
allocated to acquired facility contracts, noncompete agreements, goodwill and
other intangible assets, which are stated at cost. Amortization of intangible
assets is provided on a straight-line basis over the estimated useful lives
of the related assets. The following is a summary of useful lives for major
categories of intangible assets:
INTANGIBLE ASSET USEFUL LIFE
Acquired facility contracts Contract term
Noncompete agreements Agreement term
Goodwill 15 years
Acquired facility contracts consist primarily of costs allocated to locations
acquired in acquisitions of facility contract rights from other service
providers, along with other incremental direct costs paid to obtain the
facility contracts.
The Company periodically assesses the net realizable value of its intangible
assets, as well as all other assets, by comparing the expected future net
operating cash flows, undiscounted and without interest charges, to the
carrying amount of the underlying assets. The Company would evaluate a
potential impairment if the recorded value of these assets exceeded the
associated future net operating cash flows. Any potential impairment loss
would be measured as the amount by which the carrying value exceeds the fair
value of the asset. Fair value of assets would be measured by market value,
if an active market exists, or by a forecast of expected future net operating
cash flows, discounted at a rate commensurate with the risk involved.
INCOME TAXES - The Company accounts for income taxes using the liability
method in accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under this method,
deferred tax assets and liabilities are provided for temporary differences
between the financial statement and tax bases of the assets and liabilities
using current tax rates.
REVENUE RECOGNITION - Revenues are recognized during the period the calls are
made. In addition, during the same period, the Company accrues the related
telecommunication costs for validating, transmitting, billing and collection,
and line and long distance charges, along with commissions payable to the
facilities and allowances for unbillable and uncollectible calls, based on
historical experience.
77
FACILITY COMMISSIONS - Under the terms of the Company's telephone system
contracts with correctional facilities, the Company pays commissions to these
facilities generally based on call volume revenues that are accrued during
the period the revenues are generated.
FINANCIAL INSTRUMENTS - The Company's financial instruments under SFAS No.
107, "Disclosures About Fair Value of Financial Instruments," include cash
and cash equivalents, accounts receivable, accounts payable and long-term
debt. The Company believes that the carrying amounts of cash and cash
equivalents, accounts receivable, accounts payable and long-term debt are a
reasonable estimate of their fair value because of the short-term maturities
of such instruments or, in the case of long-term debt, because of the
floating interest rates on such long-term debt.
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
NOVEMBER 30,
1996
----------------
Trade accounts receivable $2,390,864
Amounts due from shareholders 154,894
Other 3,200
----------
2,548,958
Less allowance for unbillable and uncollectible
chargebacks (160,000)
----------
$2,388,958
==========
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
NOVEMBER 30,
1996
-----------------
Leasehold improvements $ 449,116
Telephone system equipment 7,425,582
Vehicles 246,611
Office equipment 319,167
-----------
8,440,476
Less accumulated depreciation and
amortization (4,321,329)
-----------
$ 4,119,147
===========
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4. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
NOVEMBER 30,
1996
----------------
Acquired facility contracts $ 1,562,906
Noncompete agreement 250,000
Goodwill 455,704
Other 66,375
-----------
2,334,985
Less accumulated amortization (1,748,329)
-----------
$ 586,656
===========
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
NOVEMBER 30,
1996
---------------
Facility commissions $1,317,000
Uncollectible call chargebacks 840,000
Sales and excise taxes 702,838
Payroll and benefits 145,295
Other 199,894
----------
$3,205,027
==========
The accrual for uncollectible call chargebacks represents a reserve for
amounts collected from the various LECs or third-party billing services
that are expected to be charged back to the Company in future periods.
79
6. LONG-TERM DEBT
All of the outstanding debt was repaid by the Company during 1996, there are
no outstanding balances at November 30, 1996.
The Company has a $750,000 line of credit arrangement with The Peoples Bank
and Trust Company. The line had no outstanding balance at November 30, 1996.
The line of credit bears interest at the prime rate, and is personally
guaranteed by the majority stockholder.
7. INCOME TAXES
The provision for income taxes for the eleven months ended November 30, 1996,
are as follows:
1996
---------------
Current taxes payable:
Federal $ 901,000
State 72,000
Deferred income taxes 250,989
----------
$1,223,989
==========
The Company has provided income tax expense during the nine months ended
September 30, 1996, using the effective tax rates for each of its taxing
jurisdictions that have been allocated between current income taxes payable
and deferred income taxes based on 1996 anticipated temporary differences.
The provision for income taxes differs from statutory rates primarily as a
result of state income taxes and permanent differences. The following is a
reconciliation of income taxes reported in the consolidated statement of
income:
NOVEMBER 30,
1996
----------------
Tax at statutory rates $1,148,387
Effect of state income taxes 97,951
Tax penalties and other (22,349)
----------
$1,223,989
==========
80
The tax effects of temporary differences giving rise to deferred income tax
asset and liabilities were:
NOVEMBER 30,
1996
----------------
Deferred income tax assets:
Allowance for unbillable and uncollectible revenues $ 54,400
---------
54,400
Deferred income tax liabilities:
Depreciation and amortization (307,557)
Other (1,048)
---------
(308,605)
---------
Net deferred income tax liability $(254,205)
=========
This net deferred income tax liability is classified in the consolidated
balance sheet as follows:
NOVEMBER 30,
1996
----------------
Current asset $ 54,400
Noncurrent liability (308,605)
---------
$(254,205)
=========
8. BENEFIT PLAN
The Company sponsors a 401(k) savings plan for the benefit of eligible full-
time employees that is a qualified benefit plan in accordance with the
Employee Retirement Income Security Act ("ERISA"). The employees
participating in the plan can generally make contributions to the plan of
between 5% and 10% of their compensation. The plan provides for discretionary
matching contributions by the Company of up to 50% of an eligible employee's
contribution. Total plan expense was $32,820 for the eleven months ended
November 30, 1996.
9. COMMITMENTS AND CONTINGENCIES
The Company leases certain property and equipment used in its operations
under operating lease agreements. Such leases, which are primarily for
office furniture, office space and vehicles, have lease terms ranging from
one to four years.
81
Future minimum lease payments for years ending December 31 under
noncancelable operating leases are summarized below:
1996 (one month) $ 10,848
1997 63,209
1998 30,187
1999 960
2000 720
--------
$105,924
========
Rent expense in connection with these leases totaled $107,158 for the eleven
months ended November 30, 1996.
10. RELATED PARTY TRANSACTIONS
The Company's majority and president has personally guaranteed three of the
Company's operating leases, which have expiration dates ranging from March
1997 to September 1998. Total payments under the guaranteed leases for the
eleven months ended November 30, 1996, totaled $79,239.
During 1996, the Company's stockholders incurred $154,894 of legal expenses,
which were paid by the Company and are recorded as amounts due from
stockholders in accounts receivable at November 30, 1996, pending
reimbursement from such stockholders.
11. SUBSEQUENT SALE OF COMPANY
On December 27, 1996, Talton Holdings, Inc. acquired all of the outstanding
common stock of the Company in a purchase business combination effective
December 1, 1996.
******
82
EVERCOM, INC.
SCHEDULE II
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
One Month Ended December 31, 1996 and
Years Ended December 31, 1997 and 1998
(In thousands)
Additions
Charged to
Beginning Costs and Ending
Description Balance Expense Deductions Balance
--------------------------------------- --------------------------------------------------------------------
1996
Allowance for doubtful accounts 1,195 653 (723) 1,125
1997
Allowance for doubtful accounts 1,125 17,257 (13,065) 5,317
1998
Allowance for doubtful accounts 5,317 35,670 (33,749) 7,238
83
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
84
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages, and positions of each of the
directors and officers of the Company as of December 31, 1998.
Name Age Position
---- -------- --------
Dennis L. Whipple.................................. 55 Chief Executive Officer, Chairman, and Director
Donald B. Vaello................................... 52 Chief Operating Officer
Jeffrey D. Cushman................................. 37 Chief Financial Officer, Vice President, Secretary, and
Treasurer
Keith S. Kelson.................................... 32 Vice President of Finance, Assistant Secretary, and
Assistant Treasurer
Todd W. Follmer (1)................................ 39 Director
Gregg L. Engles.................................... 41 Director
Richard H. Hochman (1)(3).......................... 53 Director
Jay R. Levine (2)(3)............................... 42 Director
Nina E. McLemore (2)............................... 53 Director
Bruce I. Raben (1)................................. 45 Director
David A. Sachs (2)................................. 39 Director
Roger K. Sallee (3)................................ 50 Director
Julius E. Talton, Sr. (2).......................... 70 Director
Joseph P. Urso..................................... 44 Director
_______________
(1) Member of the Executive Committee.
(2) Member of the Audit and Finance Committee
(3) Member of the Compensation Committee
Dennis L. Whipple. Mr. Whipple became Chief Executive Officer, Vice
Chairman and a Director of the Company in September 1998. In November 1998, Mr.
Whipple became Chairman of the Company's Board of Directors. From June 1995
until March 1998, Mr. Whipple served as President of ALLTEL Communications, Inc.
Mr. Whipple served as Chief Executive Officer and President of Contel Cellular,
Inc. from 1991 through June 1995. Prior to joining Contel Cellular, Inc., Mr.
Whipple held various positions with GTE from 1971 through 1991, most recently as
Corporate Vice President of Marketing and Business Development.
Donald B. Vaello. Mr. Vaello became Chief Operating Officer of the Company
in June 1998. From August 1994 until June 1998 Mr. Vaello served as Chairman
and Chief Operating Officer of North American Intelcom, a public communications
company that he formed in 1983 and sold in 1989 to Diamond Shamrock Refining and
Marketing, Inc. After the sale to Diamond Shamrock Refining and Marketing,
Inc., Mr. Vaello served in various capacities with Diamond North American
Intelcom, most recently as President and Chief Operating Officer.
Jeffrey D. Cushman. Mr. Cushman became Chief Financial Officer of the
Company in November 1997. In addition, in December 1997 Mr. Cushman was named
Vice President, Secretary, and Treasurer. From 1985 until October 1997, Mr.
Cushman served in various capacities with Electronic Data Systems Corporation
("EDS"), most recently as director of Business Development for EDS' Customer
Solutions Unit.
Keith S. Kelson. Mr. Kelson became Vice President of Finance of the
Company in April 1998 and became Assistant Secretary and Assistant Treasurer of
the Company in May 1998. From January 1995 until April 1998, Mr. Kelson served
in the accounting and auditing services division of Deloitte & Touche, LLP. From
May 1991 until January 1995, Mr. Kelson served as Accounting Manager for Viata
Corporation, a credit card processing company. Mr. Kelson is a certified public
accountant.
Todd W. Follmer. Mr. Follmer was elected to the Company's Board of
Directors in December 1996. Mr. Follmer served as the Chairman of the Company's
Board of Directors from June 1998 until November 1998, and as the Company's
Chief Executive Officer and President from June 1998 until September 1998. From
November 1997 until June 1998, Mr. Follmer served as Acting Chief Executive
Officer, and from December 1996 until June 1998, Mr. Follmer served as Vice
President, Assistant Secretary, and Assistant Treasurer. Mr. Follmer has been a
principal of EUFCC since January 1996. From January 1993 until December 1995,
Mr. Follmer
85
served as President of Gulf Capital Partners Inc., a merchant banking firm.
Gregg L. Engles. Mr. Engles was elected to the Company's Board of
Directors in December 1996. Mr. Engles has served as Chairman and has been a
principal of EUFCC since January 1996. Mr. Engles has served as Chairman of the
Board and Chief Executive Officer of Suiza Foods Corporation since October 1994.
Mr. Engles has also served in various senior management positions with certain
subsidiaries of Suiza Foods since 1988. In addition, Mr. Engles has served as
President of Kaminski Engles Capital Corporation ("KECC") since May 1988 and as
President of Engles Management Corporation ("EMC") since February 1993. KECC and
EMC are investment banking and consulting firms. Mr. Engles is a director of
Columbus Realty Trust.
Richard H. Hochman. Mr. Hochman was elected to the Company's Board of
Directors in December 1996. Mr. Hochman has served as the Chairman of Regent
Capital Management Corp., a private investment firm, since January 1995. From
1990 to December 1994, Mr. Hochman was a Managing Director of PaineWebber, Inc.,
an investment banking firm. Mr. Hochman is a director of Cablevision Systems
Corporation and RABCO Enterprises.
Jay R. Levine. Mr. Levine was elected to the Company's Board of Directors
in December 1996. Since April 1997, Mr. Levine has served as a Managing Director
of CIBC Oppenheimer, an investment banking firm, and since May 1997 has managed
the CIBC Oppenheimer High Yield Merchant Banking Funds. From September 1996 to
May 1997, Mr. Levine served as President of PPMJ, Inc., a private consulting
firm. From 1990 until June 1996, Mr. Levine served as a senior executive in the
Morningside and Springfield Group, a private investment company. Mr. Levine is a
director of Aircraft Service International Group, Inc., Consolidated Advisers
Limited, L.L.C., Global Crossing, Ltd., and Heating Oil Partners, L.P.
Nina E. McLemore. Ms. McLemore was elected to the Company's Board of
Directors in December 1996. Ms. McLemore has been the President of Regent
Capital Management Corp. since January 1995. From 1990 until 1993, Ms. McLemore
served in various capacities with Liz Claiborne Accessories.
Bruce I. Raben. Mr. Raben was elected to the Company's Board of Directors
in December 1996. Since February 1996, Mr. Raben has served as a Managing
Director of CIBC Wood Gundy Securities Corp., an investment banking firm. From
March 1990 to February 1996, Mr. Raben served as a Managing Director of
Jefferies & Co., an investment banking firm. Mr. Raben is a director of GT
Parent Holdings, L.D.C., Terex Corporation, Optical Security, Inc., and Equity
Marketing, Inc.
David A. Sachs. Mr. Sachs was elected to the Company's Board of Directors
in December 1996. Since July 1994, Mr. Sachs has been a principal of Onyx
Partners, Inc., a merchant banking firm, and since October 1997 Mr. Sachs has
been a Managing Director of Ares Management, L.P., an investment management
firm. From October 1990 until June 1994, Mr. Sachs was employed at TMT-FW, Inc.,
an affiliate of Taylor & Co., a private investment management firm. Mr. Sachs is
a director of Terex Corporation.
Roger K. Sallee. Mr. Sallee was elected to the Company's Board of
Directors in December 1996. Mr. Sallee founded AmeriTel and served as its
President and Chief Executive Officer from July 1991 until December 1996.
Joseph P. Urso. Mr. Urso was elected to the Company's Board of Directors
in December 1996. Mr. Urso has served as President and has been a principal of
EUFCC since January 1996. Since March 1996, Mr. Urso has served as Chairman of
Interstate Engineering, a manufacturing firm located in California. Mr. Urso was
a shareholder of Stutzman & Bromberg, P.C. from January 1992 until June 1995.
Julius E. Talton, Sr. Mr. Talton was elected to the Company's Board in
December 1996. From December 1996 until June 1998, Mr. Talton served as
Chairman of the Board and President of the Company. Mr. Talton founded Talton
Telecommunications and served as its Chairman of the Board, President, and Chief
Executive Officer from 1973 until December 1996. Mr. Talton served as President
of Talton Outdoor Advertising from 1976 until November 1996. Mr. Talton is a
director of the People's Bank and Trust Company in Alabama.
The Company's Certificate of Incorporation divides the Board of Directors
into two classes, the "Class A/B Directors" and the "Class B Directors," with
each class serving a one-year term. The size of the Board of Directors depends
on the aggregate percentage ownership of all outstanding Common Stock held by
Gregg L. Engles, Joseph P. Urso, Todd W. Follmer,
86
and their respective affiliates (the "EUF Holders") and Onyx Talton Partners,
L.P. and Sachs Investment Partners and their respective affiliates (the "Onyx
Holders").
The size of the Company's Board of Directors is currently eleven (11)
members, with the holders of Common Stock and Class B Common Stock entitled to
elect six Class A/B Directors and the holders of Class B Common Stock entitled
exclusively to elect five Class B Directors. The Class A/B Directors are Richard
H. Hochman, Jay R. Levine, Nina E. McLemore, Bruce I. Raben, Dennis L. Whipple,
and Julius E. Talton. The Class B Directors are Gregg L. Engles, Todd W.
Follmer, David A. Sachs, Roger K. Sallee, and Joseph P. Urso.
Each Class A/B Director is entitled, at all times, to one vote on any
matter voted on by the Board of Directors. The number of votes that each Class B
Director is entitled to on any matter voted on by the Board of Directors depends
on the aggregate percentage ownership of all outstanding Common Stock held by
the EUF Holders and the Onyx Holders. Each Class B Director is currently
entitled to a 0.6 director vote on any matter voted on by the Board of
Directors, resulting in the Class B Directors having an aggregate of three (3)
director votes as a class. As the EUF Holders' and the Onyx Holders' ownership
of the outstanding Common Stock decreases, the number of Class B Directors that
the EUF Holders have the right to designate, the aggregate number of votes held
by the remaining Class B Directors, and the size of the Company's Board of
Directors decrease (and the number of Class A/B Directors increases), all as set
forth in the Company's Certificate of Incorporation and the Shareholders
Agreement (as defined). Under the terms of the Certificate of Incorporation and
the Shareholders Agreement, the total number of votes on the Board of Directors
will remain at nine.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth annual cash compensation paid or accrued by
the Company to the Company's Chief Executive Officer and its other Executive
Officers receiving total salary and bonus in excess of $100,000 for the fiscal
years ended December 31, 1998, 1997, and 1996.
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
OTHER ANNUAL SHARES ALL OTHER
COMPENSATION UNDERLYING COMPENSATION
Name and Principal Position YEAR SALARY($) BONUS($) ($)(1) OPTIONS (#) ($)
- ---------------------------
Dennis L. Whipple (2)
Chief Executive Officer............ 1998 95,577 75,000 0 500 0
1997 ___ ___ ___ ___ ___
1996 ___ ___ ___ ___ ___
Todd W. Follmer (3)................. 1998 0 0 0 0 0
1997 0 0 0 0 0
1996 0 0 0 0 0
Donald B. Vaello (4)
Chief Operating Officer............ 1998 106,153 80,000 18,749(5) 200 0
1997 ___ ___ ___ ___ ___
1996 ___ ___ ___ ___ ___
Jeffrey D. Cushman (6)
Chief Financial Officer, Vice
President, Secretary, and
Treasurer.......................... 1998 143,500 85,000 0 125 0
1997 17,500 35,000 0 0 0
1996 ___ ___ ___ ___ ___
87
Keith S. Kelson (7)
Vice President of Finance,
Assistant Treasurer, and
Assistant Secretary................ 1998 68,205 40,000 0 50 0
1997 ___ ___ ___ ___ ___
1996 ___ ___ ___ ___ ___
(1) Unless otherwise indicated, the aggregate value of perquisites and other
personal benefits does not exceed the lesser of $50,000 or 10% of the
total annual salary and bonus report for the named executive officer.
(2) Appointed effective September 7, 1998.
(3) Mr. Follmer served as Chief Executive Officer of the Company from June 1998
until September 1998.
(4) Appointed effective June 26, 1998.
(5) Consisted of payment of closing costs on sale of residence.
(6) Appointed effective November 15, 1997.
(7) Appointed effective April 27, 1998.
Option Grants
During 1998, options to purchase an aggregate of 1,555 shares of Common
Stock at an exercise price of $2,000 per share were granted. The following table
provides information regarding stock options granted during 1998 to the Named
Executive Officers.
Option Grants During 1998
Individual Grants
% of Total Potential Realizable
Number of Options Value at Assumed
Securities Granted to Annual Rates of Stock
Underlying Options Employees Exercise Price Appreciation for
Granted (#) During Price Expiration Option Term (1)
Name 1998 ($/Share) Date 5% 10%
Dennis L. Whipple.............. 500 32.15% $2,000 9/10/2008 628,895 1,593,742
Donald B. Vaello............... 200 12.86% $2,000 1/1/2008 251,558 637,497
Todd W. Follmer................ 0 -- -- -- -- --
Jeffrey D. Cushman............. 125 8.04% $2,000 1/1/2008 157,224 398,436
Keith S. Kelson................ 50 3.22% $2,000 1/1/2008 62,889 159,374
_____________
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the rules of the Securities and Exchange Commission. The
actual value, if any, that an executive officer may realize will depend on
the excess of the stock price over the exercise price on the date the
option is exercised. There is no assurance the value realized by an
executive officer will be at or near the assumed 5% or 10% levels.
Aggregated Option Exercises in 1998 and Year-End Option Values
During 1998, none of the Named Executive Officers exercised any options.
Employment Agreements and Other Arrangements
Dennis L. Whipple joined the Company as Chief Executive Officer in
September 1998. The Company entered into a written employment agreement with Mr.
Whipple that has an initial term expiring on December 31, 2001, with successive
one-year renewals thereafter unless notice is given by either party not less
than 90 days immediately preceding the commencement of the renewal period. Mr.
Whipple receives an annual base salary of $300,000, and received a guaranteed
bonus of $75,000 for 1998. Mr. Whipple's target annual bonus is 100% of his base
salary and is earned upon the achievement of pre-determined performance
objectives. This bonus may actually be in excess of such amount, up to a maximum
of 200% of Mr. Whipple's base salary, in the event such objectives are exceeded.
Mr. Whipple is guaranteed a bonus in 1999 of at least $150,000. In addition, Mr.
Whipple received options to purchase 500 shares of Common Stock at a per share
price of $2,000. If Mr. Whipple is terminated by the Company without cause, the
employment agreement provides for a severance pay equal to the
88
cash compensation paid by the Company to Mr. Whipple in the year prior to the
year in which his employment is terminated or not extended. The employment
agreement contains non-competition provisions that cover the Company's existing
markets and expansion markets and that apply during the term of the agreement
and for a period of one year after the expiration or earlier termination of the
agreement.
Donald B. Vaello joined the Company as Chief Operating Officer in June
1998. The Company entered into a written employment agreement with Mr. Vaello
that has an initial term expiring on June 30, 2001, with successive one-year
renewals thereafter unless notice is given by either party not less than 90 days
immediately preceding the commencement of the renewal period. Mr. Vaello
receives an annual base salary of $200,000, and a one-time guaranteed bonus of
$30,000, which was paid on or before December 31, 1998. Mr. Vaello is also
eligible for an annual bonus generally equal to an additional amount up to 50%
of his base salary based upon achieving pre-determined performance objectives.
This bonus may be in excess of such amount in the event such objectives are
exceeded. In addition, Mr. Vaello received options to purchase 200 shares of
Common Stock at a price of $2,000 per share. The employment agreement provides
for a severance payment equal to one year's base salary if Mr. Vaello is
terminated by the Company without cause. The employment agreement also contains
non-competition provisions that cover the Company's existing markets and
expansion markets that apply during the term of the agreement and for a period
of one year after the expiration or earlier termination of the agreement.
Jeffrey D. Cushman joined the Company as Chief Financial Officer in
November 1997. The Company entered into a written employment agreement with Mr.
Cushman that was amended in November 1998. The agreement has an initial term
expiring on December 31, 1999, with successive one-year renewals thereafter
unless notice is given by either party not later than 90 days immediately
preceding the commencement of the renewal period. Mr. Cushman receives an
annual base salary of $168,000 and a one-time guaranteed bonus of $85,000,
$35,000 of which was paid in June 1998, and the remaining $50,000 of which was
paid in February 1999. Mr. Cushman's target annual bonus is 50% of his base
salary and is earned upon the achievement of pre-determined performance
objectives. This bonus may actually be in excess of such amount, up to a maximum
of 100% of Mr. Cushman's base salary, in the event such objectives are exceeded.
In addition, Mr. Cushman received options to purchase 125 shares of Common
Stock at a price of $2,000 per share. If Mr. Cushman is terminated by the
Company without cause, the employment agreement provides for a severance payment
equal to the cash compensation paid by the Company to Mr. Cushman in the
calendar year prior to the calendar year in which his employment is terminated
or not extended. The employment agreement also contains non-competition
provisions that cover the Company's existing markets and expansion markets that
apply during the term of the agreement and for a period of one year after the
expiration or earlier termination of the agreement, provided that the one year
period shall be extended for an additional year in the event that Mr. Cushman,
rather than the Company, terminates the employment agreement.
Keith S. Kelson joined the Company as Vice President of Finance in April
1998. Mr. Kelson's offer letter specifies that Mr. Kelson receives a base
salary of $100,000 per year. Mr. Kelson is eligible for an annual bonus
generally equal to an additional amount up to 40% of his base salary based upon
pre-determined performance objectives. This bonus may actually be in excess of
such amount in the event such objectives are exceeded. In addition, Mr. Kelson
received options to purchase 50 shares of Common Stock at an exercise price of
$2,000 per share. The offer letter provides for a severance payment equal to one
year's base salary if Mr. Kelson is terminated by the Company without cause.
Stock Option Plans
The Company's 1998 Stock Option Plan (the "Stock Option Plan") has been
established to provide the officers and employees of the Company a strong
incentive to contribute to the success of the Company by granting them options
to acquire Common Stock. The Stock Option Plan is administered by the
Compensation Committee for the Board of Directors. The Compensation Committee
has the authority to determine the persons employed by the Company who are to be
granted options under the Stock Option Plan, the number of shares subject to
each option, the date of the grant of each option, the option exercise price,
whether the option granted is to be treated as an incentive stock option or a
non-statutory stock option, the vesting period, and such other determinations as
may be appropriate or necessary for the administration of the Stock Option Plan.
Only employees of the Company may be granted options under the Stock Option
Plan. The option exercise price of each option granted under the Stock Option
Plan may not be less than 100% of the fair market value of the Common Stock on
the date of grant. In the event of a Change of Control (as defined in the Stock
Option Plan), options issued pursuant to the Stock Option Plan become
immediately exercisable for a period of 30 days following such event. Any
options not exercised
89
during the 30 day period are treated as if no Change in Control had occurred and
will be governed by the terms of their original grant.
The Stock Option Plan may be abandoned or terminated by the Board of
Directors at any time. Such abandonment or termination, however, will not alter
or impair any rights under any options granted prior to termination or
abandonment. Unless previously terminated, the Stock Option Plan will expire on
January 1, 2008.
The Company has reserved 2,000 shares of Common Stock for issuance pursuant
to the Stock Option Plan. As of December 31, 1998, options to acquire 1,055
shares had been granted to the Company's employees. The option exercise price
for each of these options is $2,000 per share. These options generally provide
for a ratable vesting over a three to five year period commencing upon the
employee's initial employment with the Company. The options generally expire,
if not previously exercised, upon the earlier of ten years following their date
of grant or three months following the option holder's termination of employment
with the Company. If any options terminate or expire without having been
exercised, the shares not purchased under such options again are available for
issuance under the Stock Option Plan.
Limitation of Liability and Indemnification
The Company's Certificate of Incorporation provides, consistent with the
provisions of the Delaware General Corporation Law ("DGCL"), that no director of
the Company will be personally liable to the Company or any of its stockholders
for monetary damages arising from the director's breach of fiduciary duty as a
director. This does not apply, however, with respect to any action for unlawful
payments of dividends, stock purchases, or redemptions, nor does it apply if the
director: (i) has breached his or her duty of loyalty to the Company and its
stockholders; (ii) does not act or, in failing to act, has not acted in good
faith; (iii) has acted in a manner involving intentional misconduct or a knowing
violation of law or, in failing to act, has acted in a manner involving
intentional misconduct or a knowing violation of law; or (iv) has derived an
improper personal benefit. The provisions of the Certificate of Incorporation
eliminating liability of directors for monetary damages do not affect the
standard of conduct to which directors must adhere, nor do such provisions
affect the availability of equitable relief. In addition, such limitations on
personal liability do not affect the availability of monetary damages under
claims based on federal law.
The Company's bylaws provide for indemnification of its officers and
directors to the fullest extent permitted by the DGCL.
90
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of the Company's
capital stock as of December 31, 1998 by (i) each stockholder known by the
Company to beneficially own more than 5% of any class of the Company's
outstanding capital stock; (ii) each director of the Company; (iii) each
executive officer named in the Summary Compensation Table; and (iv) all
executive officers and directors as a group.
SHARES BENEFICIALLY OWNED
--------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
SHARES OF SHARES OF PERCENT SHARES OF
CLASS A CLASS B OF TOTAL SENIOR
COMMON PERCENT COMMON PERCENT OF VOTING REFERRED PERCENT
NAME OF BENEFICIAL OWNER STOCK OF CLASS STOCK CLASS POWER(1) STOCK OF CLASS(2)
- ------------------------ -------- --------- --------- ----------- ----------- --------- -----------
Dennis L. Whipple -- -- -- -- -- -- --
Julius E. Talton(3).............................. 2,062.5 12.94% -- -- % 11.8% 2,500.0 42.2%
Jeffrey D. Cushman............................... -- -- -- -- -- -- --
Todd W. Follmer(4)............................... -- -- 100.0 25.0 2.3 -- --
Gregg L. Engles(4)............................... 150.0 * 100.0 25.0 3.1 -- --
Richard H. Hochman(5)............................ 2,000.0 12.6 -- -- 11.4 -- --
Jay R. Levine(6)................................. 5,935.5 -- -- -- -- -- --
Nina E. McLemore(7).............................. 2,000.0 12.6 -- -- 11.4 -- --
Bruce I. Raben(6)................................ 5,935.5 -- -- -- -- -- --
David A. Sachs(8)................................ 250.0 1.6 31.5 7.9 2.1 -- --
Roger K. Sallee.................................. 22.0 * -- -- * 61.7 1.04
Joseph P. Urso(4)................................ -- -- 100.0 25.0 2.3 -- --
CIBC (9)......................................... 5,935.5 37.2 -- -- 33.8 -- --
Regent Capital Partners, L.P.(10)................ 2,000.0 12.6 -- -- 11.4 -- --
Onyx Talton Partners, L.P.(11)................... -- -- 100.0 25.0 2.3 -- --
Richard C. Green, Jr............................. 250.0 1.6 -- -- 1.4 310.8 5.25
Robert K. Green.................................. 250.0 1.6 -- -- 1.4 310.8 5.25
William M. Ohland(12)............................ 900.0 5.6 -- -- 5.1 -- --
Donald B. Vaello................................. -- -- -- -- -- -- --
Keith S. Kelson.................................. -- -- -- -- -- -- --
All executive officers and directors as a group
(14 persons).................................... 6,484.5 40.7 331.5 82.9 44.55 2,561.7 43.23
________________
* Less than 1.0%
(l) In calculating the percent of total voting power, the voting power of
shares of Common Stock (one vote per share) and Class B Common Stock (four
votes per share) is aggregated. This calculation also assumes that no
shares of Senior Preferred Stock are converted into shares of Common Stock.
(2) Such percentages have been calculated in accordance with Section 13(d)(4)
of the Securities Exchange Act of 1934, as amended.
(3) The address for each of these stockholders is 720 Alabama Avenue, Selma,
Alabama 36701.
(4) The address for each of these stockholders is 3811 Turtle Creek Blvd.,
Suite 1300, Dallas, Texas 75219
(5) Includes 2,000 shares of Common Stock held by Regent Capital Partners. Mr.
Hochman, who is the chairman of Regent Capital Management Corp., an
affiliate of Regent Capital Partners, exercises voting and investment power
with respect to such shares. Mr. Hochman's address is 505 Park Avenue, 17th
Floor, New York, New York 10022.
(6) Includes shares of Common Stock and warrants to acquire shares of Common
Stock held by CIBC. Messrs. Levine and Raben are employees of an affiliate
of CIBC. Such persons' address is 425 Lexington Ave., New York, New York
10017. Messrs. Levine and Raben disclaim beneficial ownership of such
shares.
(7) Includes 2,000 shares of Common Stock held by Regent Capital Partners. Ms.
McLemore, who is the president of Regent Capital Management Corp., an
affiliate of Regent Capital Partners, exercises voting and investment power
with respect to such shares. Ms. McLemore's address is 505 Park Avenue,
17th Floor, New York, New York 10022.
(8) Consists of 250 shares of Common Stock held by Sachs Investment Partners
and 31.5 shares of Class B Common Stock held by Onyx Talton Partners, L.P.
Mr. Sachs is a general partner of Sachs Investment Partners and a principal
shareholder of Onyx Partners, Inc., the general partner of Onyx Talton
Partners L.P. Mr. Sachs is a general partner of Sachs Partners, L.P. and
exercises voting and investment power with respect to such shares. Mr.
Sachs disclaims beneficial ownership of an additional 68.5 shares of Class
B Common Stock held by Onyx Talton Partners, L.P. Mr. Sachs is a general
partner of Sachs Investment Partners, L.P., and exercises voting and
investment power with respect to such shares. Mr. Sachs disclaims
beneficial ownership of an additional 68.5 shares of Class B Common Stock
held by Onyx Talton Partners, L.P. Mr. Sachs address is 1999 Avenue of the
Stars, Suite 1900, Los Angeles, California 90067.
91
(9) Includes 1,085.5 shares of Common Stock subject to a warrant that is
exercisable within 60 days. CIBC's address is 161 Bay Street, P.P. Box 500,
M51258, Toronto, Canada. Jay R. Bloom, Andrew R. Heyes, and Dean C. Kehler,
employees of an affiliate of CIBC, have the power to vote and dispose of
the listed securities.
(10) Includes 500 shares of Common Stock held by Regent Capital Equity Partners,
L.P., an affiliate of Regent Capital Partners. Regent Capital Partners'
address is 505 Park Avenue, 17th Floor, New York, New York 10022.
(11) Onyx Talton Partners, L.P.'s address is 9595 Wilshire Blvd., Suite 700,
Beverly Hills, California 90212.
(12) Consists of shares issued to STC as part of the purchase price in the STC
Acquisition. Mr. Ohland owns all of the outstanding capital stock of STC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain Relationships and Related Transactions
Consulting and Strategic Services Agreement
In connection with the acquisitions of AmeriTel and Talton
Telecommunications, the Company entered into a Consulting and Strategic Services
Agreement with EUF Talton, a limited partnership controlled by Messrs. Engles,
Urso, and Follmer, pursuant to which the Company will pay to EUF Talton an
annual consulting fee of $300,000 for an initial term of three years ending
December 27, 1999. Pursuant to this agreement, EUF Talton will provide
management consulting services relating to strategic and financial matters,
including acquisitions, business strategies, and financial planning. In
addition, the Company has agreed to pay to EUF Talton an acquisition fee of 1%
of the gross acquisition price of any acquisitions of assets or stock by the
Company, up to an aggregate maximum of $1.25 million.
Consulting and Employment Agreements
In connection with the acquisitions of AmeriTel and Talton
Telecommunications, the Company entered into the agreements described below.
Each of the named persons was a former stockholder of AmeriTel or Talton
Telecommunications.
The consulting agreement of Julius E. Talton (the "Talton Consulting
Agreement") provided that Mr. Talton would serve as a director of the Company
and perform such duties related to the business conducted by the Company as the
Board of Directors designated from time to time. The Talton Consulting Agreement
had an initial term of two years, with successive one-year renewal periods
thereafter unless earlier terminated by the Company or Mr. Talton. In addition
to an aggregate of $10,000 payable in equal monthly installments to Mr. Talton
over the first twelve months of the agreement, the agreement provided that Mr.
Talton would receive payments of $86,000 and $96,000 for the first and second
years of the initial term, respectively, and $120,000 for each year thereafter
that the agreement remained in effect. The Talton Consulting Agreement
contained a non-competition provision that applied during the term of the
agreement and applies for a period of two years after the expiration or earlier
termination of the agreement. Mr. Talton ceased working for the Company
effective as of June 30, 1998 and the Talton Consulting Agreement was terminated
as of that date. All fees due under the Talton Consulting Agreement were paid
on a prorated basis through June 30, 1998. See "--Talton Agreement."
Julius E. Talton, Jr.'s employment agreement (the "Talton Employment
Agreement") provided that Mr. Talton, Jr. would serve as an executive of the
Company, performing such duties and holding such positions as the Board of
Directors or senior management of the Company directed. The Talton Employment
Agreement had an initial term of one year, with successive one-year renewal
periods thereafter unless earlier terminated by the Company or Mr. Talton, Jr.
In addition to an aggregate of $25,000 payable in equal monthly installments to
Mr. Talton, Jr. over the first twelve months of the agreement, the agreement
provided that Mr. Talton, Jr. would receive an annual base salary of $100,000, a
guaranteed bonus of $25,000 which was paid, in accordance with the agreement,
upon closing of the Notes Placement, and an incentive cash bonus of up to 37.5%
of base salary if certain performance goals established by the Board of
Directors were achieved. The Talton Employment Agreement contained a non-
competition provision that will apply until June 2000. Mr. Talton, Jr. also
received an option to purchase up to 247.5 shares of Common Stock at an exercise
price of $2,000 per share. Mr. Talton, Jr. ceased working for the Company
effective as of June 30, 1998 and the Talton Employment Agreement was terminated
as of that date. All fees due under the Talton Employment Agreement were paid
on a prorated basis through June 30, 1998. See "--Talton Agreement."
The consulting agreement of James E. Lumpkin (the "Lumpkin Consulting
Agreement") provided that Mr. Lumpkin would serve, if requested, as a director
of the Company and would perform such duties related to the business conducted
by the Company as the chief executive officer or the Board of Directors
designated from time to time. The Lumpkin Consulting Agreement has an initial
term of two years, with successive one-year renewal periods thereafter unless
earlier terminated by the
92
Company or Mr. Lumpkin. In addition to an aggregate of $10,000 payable in equal
monthly installments to Mr. Lumpkin over the first twelve months of the
agreement, the agreement provided that Mr. Lumpkin would receive $62,000 and
$72,000 for the first and second years of the initial term, respectively. Mr.
Lumpkin's consulting agreement contained a non-competition provision that will
apply until June 2000. Mr. Lumpkin ceased working for the Company effective as
of June 30, 1998 and the Lumpkin Consulting Agreement was terminated as of that
date. All fees due under such the Lumpkin Consulting Agreement were paid on a
prorated basis through June 30, 1998. See "--Talton Agreement."
The consulting agreement of Roger K. Sallee provides that Mr. Sallee will
serve as a director of the Company and will perform such duties related to the
business conducted by the Company as the chief executive officer or the Board of
Directors may designate from time to time. The consulting agreement had an
initial term of one year, with successive one-year renewal periods thereafter
unless earlier terminated by the Company or Mr. Sallee. In addition to a lump
sum payment of $5,000 paid on the effective date of the agreement, Mr. Sallee
will receive an annual consulting fee of $30,000 for each year that the
agreement remains in effect. Mr. Sallee's consulting agreement contains non-
competition provisions covering the Company's existing markets and expansion
markets that apply during the term of the agreement and for a period of three
years and two years, respectively, after the expiration or earlier termination
of the agreement.
Talton Agreement
On July 1, 1998, the Company entered into an agreement with Julius E.
Talton, Julius E. Talton, Jr. and James Lumpkin (the "Talton Agreement"). The
Talton Agreement provided that each of the Talton Consulting Agreement, the
Talton Employment Agreement, and the Lumpkin Consulting Agreement was terminated
effective as of June 30, 1998. In accordance with the terms of the Talton
Agreement, Mr. Talton, Mr. Talton, Jr., and Mr. Lumpkin will provide consulting
services to the Company in relation to the Company's contract with a major RBOC.
The Talton Agreement has a term of one year, ending on June 30, 1999. Under the
terms of the Talton Agreement, Mr. Talton, Mr. Talton, Jr., and Mr. Lumpkin will
be paid 10% of the Profits (as defined in the Talton Agreement) between July 1,
1998 and December 31, 1998 and 5% of the Profits between January 1, 1999 and
June 30, 1999 from the Company's contract with a major RBOC.
Lease Agreement
In December 1996, Talton Telecommunications entered in a lease agreement
(the "Talton Lease") with Mr. Talton for office space located in Selma, Alabama.
The Talton Lease has a five-year term commencing January 1, 1997, with an option
to renew for an additional five-year term. Under the Talton Lease, Talton
Telecommunications will pay fixed annual rent of approximately $109,000,
$112,000, $90,000, $93,000, and $96,000, respectively, for the five years of the
initial term.
93
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (2) The response to this portion of Item 14 is submitted as a
separate section of this report commencing on page 27.
(a) (3) Exhibits.
Exhibit
No. Description of Exhibit
--- ----------------------
2.1 Asset Purchase Agreement, dated as of August 21, 1997, among the Company, InVision Telecom, Inc., and
Communications Central, Inc. (filed as Exhibit 2.1 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
2.2 Contribution Agreement, dated as of December 20, 1996, among the Company, Richard C. Green, Jr., Robert K.
Green, T.R. Thompson, Roger K. Sallee, and certain other stockholders, and AmeriTel Pay Phones, Inc. (filed as
Exhibit 2.2 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
2.3 Contribution Agreement, dated as of December 20, 1996, among the Company, Julius E. Talton, Julius E. Talton,
Jr., and James E. Lumpkin (filed as Exhibit 2.3 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
2.4 Stock Acquisition Agreement, dated as of December 20, 1996, among the Company, Richard C. Green, Jr., Robert
K. Green, T. R. Thompson, Roger K. Sallee, and certain other stockholders, and AmeriTel Pay Phones, Inc.
(filed as Exhibit 2.4 to the Company's Registration Statement No. 333-33639 and incorporated herein by
reference).
2.5 Stock Acquisition Agreement, dated as of December 20, 1996, among the Company, Julius E. Talton, Julius E.
Talton, Jr., James E. Lumpkin, Carrie T. Glover, Talton Telecommunications Corporation, and Talton
Telecommunications of Carolina, Inc. (filed as Exhibit 2.5 to the Company's Registration Statement No.
333-33639 and incorporated herein by reference).
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).
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, 1996, 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).
94
4.6 Shareholders Agreement, dated as of December 27, 1996, by and 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).
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).
10.1 Purchase Agreement dated as of June 27, 1997, between the Company and CIBC Wood Gundy Securities Corp. (filed
as Exhibit 10.1 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
10.2 Amended and Restated Credit Agreement, dated as of July 30, 1997, among the Company, Canadian Imperial Bank of
Commerce, CIBC Inc., and First Source Financial LLP (filed as Exhibit 10.2 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
10.3 Asset Purchase Agreement, dated as of May 9, 1997, among the Company, Security Telecom Corporation, and
95
William H. Ohland (filed as Exhibit 10.3 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
10.4 First Amendment to Asset Purchase Agreement, dated as of June 21, 1997, among the Company, Security Telecom
Corporation, and William H. Ohland (filed as Exhibit 10.4 to the Company's Registration Statement No.
333-33639 and incorporated herein by reference).
10.5 Consulting Agreement, dated as of December 27, 1966, between the Company and James E. Lumpkin (filed as
Exhibit 10.6 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
10.6 Consulting Agreement, dated as of December 27, 1996, between the Company and Julius E. Talton (filed as
Exhibit 10.7 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
10.7 Consulting and Strategic Services Agreement, dated as of December 27, 1996, between the Company and EUF
Talton, L.P. (filed as Exhibit 10.8 to the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
10.8 Employment Agreement, dated as of December 27, 1996, between the Company and Julius E. Talton, Jr. (filed as
Exhibit 10.9 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
10.9 Employment Agreement, dated as of November 17, 1997, between the Company and Jeffrey D. Cushman (filed as
Exhibit 10.12 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
10.10* Employment Agreement, dated as of June 26, 1998, between the Company and Donald B. Vaello.
10.11 Letter Agreement, dated as of April 17, 1998, between the Company and Keith S. Kelson (filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 and incorporated
herein by reference).
10.12* Employment Agreement, dated as of September 7, 1998, between the Company and Dennis L. Whipple.
10.13* First Amendment to Employment Agreement, dated as of October 21, 1998, between the Company and Jeffrey D.
Cushman.
10.14 Talton Agreement, dated as of July 1, 1998, among the Company, Talton Network Services, Inc., Julius E. Talton
Sr., Julius E. Talton Jr., and James E. Lumpkin (filed as Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q/A for the quarter ended September 30, 1998 and incorporated herein by reference).
10.15* Agreement, dated as of April 15, 1998, between the Company (doing business as Correctional Billing Services)
and [Confidential information set forth here has been filed separately with the Securities and Exchange
Commission under Rule 24b-2 under the Securities Exchange Act of 1934].
12.1* Computation of Ratio of Earnings to Fixed Charges.
21.1* Subsidiaries of the Company.
27.1* Financial Data Schedule
96
__________________
* Filed herewith.
(b) Reports on Form 8-K.
(1) On December 7, 1998, the Company filed a Form 8-K (pursuant to
Item 5 of Form 8-K) regarding the Company's Board of Directors
naming Dennis L. Whipple as Chief Executive Officer, Director,
and Chairman of the Board.
(c) Exhibits -- The response to this portion of Item 14 is submitted as
separate section of this report commencing on page 94.
(d) Financial Statement Schedules -- The response to this portion of Item
14 is submitted as a separate section of this report on page 83.
The agreements set forth above described the contents of certain exhibits
thereunto that are not included. Such exhibits will be furnished to the
Commission upon request.
97
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ Dennis L. Whipple
----------------------
Dennis L. Whipple
Chief Executive Officer,
Chairman, and Director
Date: March 26, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated.
Signature Title Date
--------- ----- ----
/s/ Dennis L. Whipple Chief Executive Officer, Chairman, March 26, 1999
- --------------------------------------------------------------- and Director
Dennis L. Whipple
/s/ Richard H. Hochman Director March 26, 1999
- ---------------------------------------------------------------
Richard H. Hochman
Director
- ---------------------------------------------------------------
Nina E. McLemore
/s/ Julius E. Talton, Sr. Director March 26, 1999
- ---------------------------------------------------------------
Julius E. Talton, Sr.
/s/ David A. Sachs Director March 26, 1999
- ---------------------------------------------------------------
David A. Sachs
/s/ Todd W. Follmer Director March 26, 1999
- ---------------------------------------------------------------
Todd W. Follmer
/s/ Bruce I. Raben Director March 26, 1999
- ---------------------------------------------------------------
Bruce I. Raben
/s/ Roger K. Sallee Director March 26, 1999
- ---------------------------------------------------------------
Roger K. Sallee
/s/ Joseph P. Urso Director March 26, 1999
- ---------------------------------------------------------------
Joseph P. Urso
/s/ Jay R. Levine Director March 26, 1999
- ---------------------------------------------------------------
Jay R. Levine
/s/ Gregg L. Engles Director March 26, 1999
- ---------------------------------------------------------------
Gregg L. Engles
/s/ Jeffrey D. Cushman Chief Financial Officer, Vice March 26, 1999
- --------------------------------------------------------------- President, Secretary and Treasurer
Jeffrey D. Cushman
98