SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
_____________________
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to sections 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 1999
OR
[ ] Transition report pursuant to sections 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _________ to ___________
Commission file number 333-33639
EVERCOM, INC.
(Exact name of Registrant as specified in its charter)
Delaware 75-2680266
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
______________
8201 Tristar Drive
Irving, Texas 75063
(972) 988-3737
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
______________
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of March 31, 1999, 15,933 shares of Class A common stock, par value
$0.01 per share, and 400 shares of Class B common stock, par value $0.01 per
share, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Exhibits to the following documents filed with the Securities and Exchange
Commission have been incorporated by reference in Part II of this Quarterly
Report on Form 10-Q:
1. Registration Statement on Form S-4 (File No. 333-33639); and
2. Quarterly Report on Form 10-Q, dated as of August 14, 1998.
EVERCOM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements....................................................................... 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................. 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 28
Item 2. Changes in Securities and Use of Proceeds.................................................. 28
Item 3. Defaults Upon Senior Securities............................................................ 28
Item 4. Submission of Matters to a Vote of Stockholders............................................ 28
Item 5. Other Information.......................................................................... 28
Item 6. Exhibits and Reports on Form 8-K........................................................... 29
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, MARCH 31,
1998 1999
---------------- ----------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................... $ 1,691,762 $ 254,531
Accounts receivable......................................................... 39,070,959 48,217,571
Refundable income taxes..................................................... 435,593 494,240
Inventories................................................................. 2,360,280 2,075,527
Prepaid expenses and other current assets................................... 392,448 450,222
Deferred income tax asset................................................... 1,442,122 1,636,824
--------------- ---------------
Total current assets.................................................... 45,393,164 53,128,915
PROPERTY AND EQUIPMENT......................................................... 29,485,944 28,814,067
INTANGIBLE AND OTHER ASSETS.................................................... 116,586,808 111,415,636
--------------- ---------------
TOTAL................................................................... $ 191,465,916 $ 193,358,618
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable............................................................ $ 21,856,484 $ 19,230,909
Accrued expenses............................................................ 23,798,055 25,318,491
Current portion of long-term debt........................................... 10,607,729 10,334,765
--------------- ---------------
Total current liabilities............................................... 56,262,268 54,884,165
LONG-TERM DEBT................................................................. 169,375,000 171,781,250
OTHER LONG-TERM LIABILITIES.................................................... 500,000 450,000
DEFERRED INCOME TAXES.......................................................... 1,442,122 1,636,824
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT:
Preferred stock, Senior and First Preferred Series A, $.01
par value; 6,000 and 5,000 shares authorized, 5,925 and 5,000
shares issued and outstanding, respectively (cumulative liquidation
value of $5,925,000 and $5,000,000, respectively) as of
March 31, 1999. Senior preferred stock, $.01 par value; 6,000
shares authorized, 5,925 shares issued and outstanding as of
December 31, 1998 (cumulative liquidation value of $5,925,000)........... 59 109
Common stock, $.01 par value; 50,000 shares authorized, 16,333 shares
issued and outstanding as of December 31, 1998 and March 31, 1999........ 163 163
Additional paid-in capital.................................................. 21,829,562 26,585,919
Accumulated deficit......................................................... (57,943,258) (61,979,812)
--------------- ---------------
Total stockholders' deficit............................................. (36,113,474) (35,393,621)
--------------- ---------------
TOTAL................................................................... $ 191,465,916 $ 193,358,618
=============== ===============
See notes to consolidated financial statements.
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EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTH
PERIOD ENDED
MARCH 31,
1998 1999
--------------- ----------------
OPERATING REVENUE........................................................ $ 49,224,614 $ 59,175,294
OPERATING EXPENSES:
Telecommunication costs................................................ 20,086,682 26,861,372
Facility commissions................................................... 15,773,247 18,027,716
Field operations and maintenance....................................... 2,032,553 1,637,775
Selling, general, and administrative................................... 4,082,828 4,321,855
Depreciation........................................................... 1,312,195 1,706,994
Amortization of intangibles............................................ 6,526,433 5,762,125
-------------- -------------
Total operating expense............................................. 49,813,938 58,317,837
-------------- -------------
OPERATING (LOSS) INCOME.................................................. (589,324) 857,457
OTHER EXPENSE (INCOME):
Interest expense, net.................................................. 4,720,088 4,880,164
Other (income), net.................................................... (146,555)
-------------- -------------
Total other (income) expense........................................ 4,573,533 4,880,164
-------------- -------------
LOSS BEFORE INCOME TAXES................................................. (5,162,857) (4,022,707)
INCOME TAX EXPENSE....................................................... 212,688 13,847
-------------- -------------
NET LOSS................................................................. $ (5,375,545) $ (4,036,554)
PREFERRED STOCK DIVIDENDS................................................ 118,500 138,930
-------------- -------------
NET LOSS APPLICABLE TO COMMON STOCK...................................... $ (5,494,045) $ (4,175,484)
============== =============
See notes to consolidated financial statements.
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EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTH
PERIOD ENDED
MARCH 31,
1998 1999
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................................................... $ (5,375,545) $ (4,036,554)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation.............................................................................. 1,312,195 1,706,994
Amortization of intangible assets, including deferred financing costs and
bond discount........................................................................... 6,749,954 6,003,647
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable..................................................................... (11,050,657) (9,146,612)
Inventories............................................................................. (569,917) 284,753
Prepaid expenses and other assets....................................................... 158,004 31,213
Accounts payable........................................................................ 3,420,965 (2,625,575)
Accrued expenses........................................................................ (859,125) 2,854,357
Income taxes............................................................................ 186,544 (58,647)
------------ -------------
Net cash used in operating activities.................................................. (6,027,582) (4,986,424)
------------ -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease in restricted cash................................................................ 1,919,312
Capital expenditures....................................................................... (3,046,298) (1,619,590)
Cash outflows for acquisitions............................................................. (7,718,935) (1,522,848)
------------ -------------
Net cash used in investing activities.................................................. (8,845,921) (3,142,438)
------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt, net of expenses........................................ 9,000,000 5,500,000
Payment of debt issuance costs............................................................. (336,992)
Repayment of debt.......................................................................... (11,189) (3,366,714)
Payment of preferred dividends............................................................. (474,000)
Proceeds from the issuance of preferred stock and warrants, net of expenses................ 4,895,337
------------ -------------
Net cash provided by financing activities.............................................. 8,514,811 6,691,631
------------ -------------
DECREASE IN CASH AND CASH EQUIVALENTS....................................................... (6,358,692) (1,437,231)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............................................. 7,777,996 1,691,762
------------ -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................................................... $ 1,419,304 $ 254,531
============ =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest..................................................................... $ 7,702,158 $ 1,480,481
============ =============
Cash paid for income taxes................................................................. $ 26,144 $ 72,494
============ =============
NONCASH TRANSACTIONS:
Dividends payable.......................................................................... $ 118,500 $ 138,930
============ =============
Issuance of debt for acquisition of assets................................................. $ 950,000 $ --
============ =============
See notes to consolidated financial statements.
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EVERCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements as of March 31, 1999 and for the
three-month periods ended March 31, 1998 and 1999 of Evercom, Inc. and its
subsidiaries (the "Company") have been prepared by the Company without audit.
As of January 1, 1999, the Company merged five of its wholly owned
subsidiaries (AmeriTel Pay Phones, Inc., Talton Telecommunications Corporation,
Talton Telecommunications of Carolina, Inc., Talton STC, Inc., and MOG
Communications, Inc.) into Talton Invision, Inc., another of the Company's
wholly owned subsidiaries. Concurrent with the merger, the Company amended
Talton Invision, Inc.'s Certificate of Incorporation to change its name to
Evercom Systems, Inc.
In the opinion of management, all necessary adjustments (which include only
normal recurring adjustments) to present fairly, in all material respects, the
consolidated financial position, results of operations, and cash flows as of and
for the respective periods, have been made. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with the
Company's 1998 consolidated financial statements contained in its Form 10-K as
filed with the Securities and Exchange Commission on March 29, 1999.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("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 net loss reported in the statements of
consolidated operations, since there were no other items of comprehensive income
for the periods presented.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
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 consolidated financial statements.
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2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
DECEMBER 31, MARCH 31,
1998 1999
---------------- ---------------
(UNAUDITED)
Trade accounts receivable, net of advance payments received of $141,460
and $137,574 at December 31, 1998 and March 31, 1999, respectively.......... $ 42,308,582 $ 50,003,761
Advance commissions receivable................................................. 2,020,020 1,917,470
Receivables related to acquisitions............................................ 141,044 141,044
Recoverable Universal Service Fund fees - current portion...................... 1,089,800 896,461
Receivables from joint venture partner......................................... 419,643
Employees and other............................................................ 329,749 207,162
-------------- -------------
46,308,838 53,165,898
Less allowance for unbillable and uncollectible chargebacks.................... (7,237,879) (4,948,327)
-------------- -------------
$ 39,070,959 $ 48,217,571
============== =============
At December 31, 1998 and March 31, 1999, the Company had advanced
commissions to certain inmate facilities of $2,495,558 and $2,302,320
(unaudited), which are recoverable from such facilities as a reduction of earned
commissions at specified monthly amounts. Amounts included in accounts
receivable represent the estimated recoverable amounts during the next fiscal
year with the remaining balance recorded in other assets.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31, MARCH 31,
1998 1999
---------------- ---------------
(UNAUDITED)
Leasehold improvements............................................. $ 834,051 $ 852,092
Telephone system equipment......................................... 33,776,168 34,783,492
Vehicles........................................................... 431,807 431,807
Office equipment................................................... 2,419,992 2,429,744
--------------- --------------
37,462,018 38,497,135
Less accumulated depreciation...................................... (7,976,074) (9,683,068)
--------------- --------------
$ 29,485,944 $ 28,814,067
=============== ==============
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4. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
DECEMBER 31, MARCH 31,
1998 1999
---------------- ----------------
(UNAUDITED)
Intangible assets:
Acquired telephone contracts.............................................. $ 63,835,844 $ 64,402,268
Noncompete agreements..................................................... 568,611 568,611
Deferred loan costs....................................................... 8,299,067 8,636,059
Goodwill.................................................................. 84,530,834 84,530,834
Other intangibles......................................................... 694,493 712,539
-------------- --------------
$ 157,928,849 $ 158,850,311
Less accumulated amortization.............................................. (42,640,007) (48,643,654)
-------------- --------------
Total intangible assets..................................................... 115,288,842 110,206,657
Deposits.................................................................... 400,540 409,615
Recoverable Universal Service Fund fees - noncurrent portion................ 421,888 414,514
Other assets - noncurrent portion of commission advances to facilities...... 475,538 384,850
-------------- --------------
$ 116,586,808 $ 111,415,636
============== ==============
-8-
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31, MARCH 31,
1998 1999
---------------- ----------------
(UNAUDITED)
Facility commissions............................................. $ 8,007,248 $ 7,516,244
Billing and collection fees...................................... 1,804,790 1,997,990
Uncollectible call chargebacks................................... 5,267,345 5,719,075
Accrued acquisition and financing costs.......................... 3,941,666 2,418,818
Accrued interest................................................. 218,646 3,376,807
Accrued excise taxes payable..................................... 2,072,856 1,933,960
Accrued dividends on preferred stock............................. 474,000 612,930
Accrued restructure costs........................................ 654,245 440,458
Accrued payroll and bonuses...................................... 778,633 333,033
Other............................................................ 578,626 969,176
-------------- --------------
$ 23,798,055 $ 25,318,491
============== ==============
The accrual for uncollectible call chargebacks represents a reserve for
amounts collected from the various local exchange carriers ("LECs") or third-
party billing services that are expected to be charged back to the Company in
future periods.
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.
Amounts Charged Amounts Amounts
to Earnings in Incurred in Incurred in
1998 1998 1999
Severance and related costs..................... $ 614,678 $ 252,885 $ 157,582
Leased facilities............................... 217,902 68,449 55,048
Legal and other costs........................... 379,685 236,685 1,158
------------ ----------- -----------
$ 1,212,265 $ 558,019 $ 213,788
============ =========== ===========
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6. LONG-TERM DEBT
The following is a summary of long-term debt:
DECEMBER 31, MARCH 31,
1998 1999
---------------- --------------
(UNAUDITED)
Senior Notes.......................................................... $ 115,000,000 $ $115,000,000
Senior Credit Facility:
Revolving loan facility............................................ 14,500,000 14,500,000
Term loan acquisition facility..................................... 49,500,000 47,093,750
Additional term loan facility...................................... 5,500,000
Note payable, with interest of 8.0%, due at maturity on
February 19, 1999 and subordinate to borrowings under
the Senior Notes and Senior Credit Facility......................... 950,000
Other................................................................. 32,729 22,265
-------------- --------------
179,982,729 182,116,015
Less current portion of long-term debt................................ (10,607,729) (10,334,765)
-------------- --------------
$ 169,375,000 $ 171,781,250
============== ==============
In March 1999 the Company amended its Senior Credit Facility (as defined),
as discussed further in footnote 7. Under the terms of the Senior Credit
Facility, the term loan acquisition facility is due in quarterly installments of
$2,406,250, 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.
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 revolving and term loan agreement (the "Senior
Credit Facility"). At March 31, 1999, the interest rate cap has an aggregate
notional amount of $30.0 million, which matures in June 2001, and caps interest
on the London Interbank Offering Rate ("LIBOR") portion of the term loan, up to
the aggregate notional amount, at 7.5%, plus the applicable LIBOR margin.
7. EQUITY OFFERING AND SENIOR CREDIT FACILITY AMENDMENT
In March 1999 the Company raised $5.0 million of equity from its existing
stockholders 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 warrants
will expire if not exercised before December 31, 2007. In determining the value
of the First Preferred Series A Stock and the warrants, the proceeds of the
issuance were allocated based on their relative fair values.
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. Dividends will be payable out of funds legally available
therefore, will be payable only when, as, and if declared by the Company's 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,
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
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ranks junior to the Company's Senior Preferred Stock (the "Senior Preferred
Stock") with respect to dividend rights and rights upon liquidation.
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.
As a result of the issuance of the First Preferred Series A Stock and
warrants discussed above, 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.
Also in March 1999, and in conjunction with the issuance of the First
Preferred Series A Stock and warrants, the Company amended 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. The Company
borrowed the additional $5.5 million in March 1999 and concurrently repaid $5.0
million under the revolving loan facility of the Senior Credit Facility.
The Senior Credit Facility, as amended in March 1999, includes a $55.0
million term loan acquisition facility, a $5.5 million additional term loan
facility, and a $25.0 million revolving loan facility (which includes a $5.0
million letter of credit facility). Scheduled principal payments under the term
loan facilities may not 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 loan facility expires on
December 31, 2002.
Amounts borrowed under the additional term loan facility bear interest, at
the option of the Company, at either (i) the Base Rate (as defined in the Senior
Credit Facility) plus 250 basis points or (ii) the LIBOR plus 350 basis points.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the financial
statements and the notes thereto contained elsewhere in this report. Certain
information contained in the discussion and analysis set forth below includes
forward-looking statements that involve risks and uncertainties. See "Special
Note Regarding Forward-Looking Information; Risk Factors."
OVERVIEW
The Company is 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.
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 regional bell operating company ("RBOC"), and began
processing call traffic under the 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,
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
-12-
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 consists 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.
Telecommunications 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 interexchange
carriers ("IXCs").
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, 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 services 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 as a percentage of revenue by
lower network charges, field maintenance, and SG&A expenses. The commission
rates paid by the Company have increased in each period, from 23.8% in 1995 to
30.5% for the quarter ended March 31, 1999. This 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 30.5% for
the quarter ended March 31, 1999 includes the effect of the validation, 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 expenses. These costs are also relatively small and more
constant components of operating expenses.
Effective December 1, 1996, the Company became the holding company for the
operations of AmeriTel Pay Phones, Inc. and Talton Telecommunications
Corporation and its subsidiary. The Company
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also acquired the operations of Tri-T, Inc. on April 4, 1997, Security Telecom
Corporation on June 27, 1997, Correctional Communications Corporation on July
31, 1997, the inmate payphone division of Communications Central, Inc. on
October 6, 1997, the inmate payphone division of North American InTeleCom on
December 1, 1997, the inmate payphone division of Peoples Telephone Company on
December 19, 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 Company, Inc. ("Saratoga") on July 1, 1998
(collectively, the "Acquisitions").
RESULTS OF OPERATIONS
The following table sets forth, for the three months ended March 31, 1998
and 1999, respectively, the results of operations of the Company.
THREE MONTH
PERIOD ENDED
MARCH 31,
1998 1999
------------------------ -------------------------
(DOLLARS IN THOUSANDS)
Operating revenues........................................... $ 49,225 100.0% $ 59,175 100.0%
Operating expenses:
Telecommunication costs..................................... 20,087 40.8 26,861 45.4
Facility commissions........................................ 15,773 32.0 18,028 30.5
Field operations and maintenance............................ 2,033 4.1 1,638 2.8
Selling, general, and administrative........................ 4,083 8.3 4,322 7.3
Depreciation................................................ 1,312 2.7 1,707 2.9
Amortization of intangibles................................. 6,526 13.3 5,762 9.7
--------- ------- --------- -------
Total operating expenses..................................... 49,814 101.2 58,318 98.6
--------- ------- --------- -------
Operating (loss) income...................................... (589) (1.2) 857 1.4
Other (income) expense:
Interest expense, net....................................... 4,720 9.6 4,880 8.2
Other, net.................................................. (146) (0.3)
--------- ------- --------- -------
Total other expense.......................................... 4,574 9.3 4,880 8.2
--------- ------- --------- -------
Loss before income taxes..................................... (5,163) (10.5) (4,023) (6.8)
Income tax expense........................................... 213 0.4 14 --
--------- ------- --------- -------
Net loss..................................................... $ (5,376) (10.9)% $ (4,037) (6.8)%
========= ======= ========= =======
EBITDA....................................................... $ 7,395 15.0% $ 8,326 14.1 %
========= ======= ========= =======
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31,
1998
Operating Revenues. The Company's operating revenues increased by $10.0
million, or 20.3%, from $49.2 million for the three months ended March 31, 1998
to $59.2 million for the three months ended March 31, 1999. The increase in
operating revenues was primarily due to the new services provided to a major
RBOC, the acquisition by the Company of MOG in the first quarter of 1998 and of
Saratoga in the third quarter of 1998, and new contract installations.
-14-
Operating Expenses. Total operating expenses increased $8.5 million, from
$49.8 million for the three months ended March 31, 1998 to $58.3 million for the
three months ended March 31, 1999. Operating expenses as a percentage of
operating revenues decreased 2.6% from 101.2% for the three months ended March
31, 1998 to 98.6% for the three months ended March 31, 1999. The decrease in
operating expenses as a percentage of revenues is primarily due to the factors
discussed below.
Telecommunication costs increased by $6.8 million, from $20.1 million for
the three months ended March 31, 1998 to $26.9 million for the three months
ended March 31, 1999. Telecommunication costs represented 40.8% of operating
revenues for the three months ended March 31, 1998 and 45.4% of operating
revenues for the three months ended March 31, 1999, an increase of 4.6%. The
dollar increase is primarily due to the Company's acquisitions of MOG and
Saratoga, new contract installations, and new services provided to a major RBOC
commencing in May 1998. The increase as a percentage of operating revenues is
primarily due to higher uncollectible account expense and billing and collection
costs associated with the new services provided to a major RBOC. As further
explained in the "Overview," the services provided to this RBOC exhibit higher
uncollectible account expense and billing and collection costs than the
Company's traditional inmate business. The increase as a percentage of operating
revenues is also due to higher uncollectible accounts caused by (i) an increase
in competitive local exchange carrier ("CLEC") activity and (ii) as a result of
the Company's recent acquisition and consolidation activities. In most cases
CLECs are unable to bill the Company's traffic, which limits the Company's
ability to collect receivables from CLEC customers. The Company is responding to
this problem by offering prepaid services to these customers. Higher
uncollectibles caused by the Company's acquisition and consolidation activities
were a result of some of the Company's systems not being fully integrated until
March 1999.
Facility commissions increased by $2.2 million, from $15.8 million for the
three months ended March 31, 1998 to $18.0 million for the three months ended
March 31, 1999. Facility commissions represented 32.0% of operating revenues for
the three months ended March 31, 1998 and 30.5% of operating revenues for the
three months ended March 31, 1999, a decrease of 1.5%. The decrease as a
percentage of operating revenues is primarily due to the effect of the new
services provided to a major RBOC, as further explained in the "Overview."
Commission rates are expected to gradually increase in the future due to
competition for larger facilities and increased commission rates on renewals.
Field operations and maintenance costs decreased by $0.4 million, from $2.0
million for the three months ended March 31, 1998 to $1.6 million for the three
months ended March 31, 1999. Field operations and maintenance costs represented
4.1% of operating revenues for the three months ended March 31, 1998 and 2.8% of
operating revenues for the three months ended March 31, 1999, a decrease of
1.3%. The decrease as a percentage of operating revenues is primarily due to the
savings associated with the consolidation of the Company's operations during
1998.
SG&A costs increased by $0.2 million, from $4.1 million for the three
months ended March 31, 1998 to $4.3 million for the three months ended March 31,
1999. SG&A represented 8.3% of operating revenues for the three months ended
March 31, 1998 and 7.3% of operating revenues for the three months ended March
31, 1999, a decrease of 1.0%. The decrease in SG&A as a percentage of operating
revenues is primarily due to the consolidation of the Company's operations
during 1998.
Depreciation and amortization costs decreased by $0.3 million, from $7.8
million for the three months ended March 31, 1998 to $7.5 million for the three
months ended March 31, 1999. Depreciation
-15-
and amortization costs represented 16.0% of operating revenues for the three
months ended March 31, 1998 and 12.6% of operating revenues for the three months
ended March 31, 1999, a decrease of 3.4%. The decrease as a percentage of
operating revenues is primarily due to amortization expense associated with the
acquisitions of inmate facility contracts by the Company. The Company amortizes
acquired inmate facility contracts over each contract's remaining term at the
acquisition date. As the contract terms expire, the acquired inmate facility
contracts become fully amortized and amortization expense declines.
Operating Income (Loss). The Company's operating income increased by $1.5
million, from a loss of $0.6 million for the three months ended March 31, 1998
to operating income of $0.9 million for the three months ended March 31, 1999,
substantially due to the decrease in amortization of intangibles and the other
factors described above. The Company's operating income margin increased from a
negative operating margin of 1.2% for the three months ended March 31, 1998 to a
positive operating margin of 1.4% for the three months ended March 31, 1999,
primarily as a result of the factors described above.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $0.3 million from $4.6 million for the three
months ended March 31, 1998 to $4.9 million for the three months ended March 31,
1999. The increase was primarily due to interest expense associated with
indebtedness incurred by the Company in connection with the Acquisitions.
Net Loss. The Company's net loss decreased by $1.4 million, from $5.4
million for the three months ended March 31, 1998 to $4.0 million for the three
months ended March 31, 1999, primarily as a result of the factors described
above.
EBITDA. Earnings before interest, taxes, depreciation, and amortization
("EBITDA") increased by $0.9 million, from $7.4 million for the three months
ended March 31, 1998 to $8.3 million for the three months ended March 31, 1999.
EBITDA as a percentage of operating revenues decreased from 15.0% for the three
months ended March 31, 1998 to 14.1% for the three months ended March 31, 1999,
primarily due to the factors described above. Although EBITDA is not a measure
of performance calculated in accordance with generally accepted accounting
principles, the Company has included information concerning EBITDA in this Form
10-Q because it is commonly used by certain investors and analysts as a measure
of a company's ability to service its debt obligations and is a component of the
Company's debt compliance ratios. EBITDA should not be used as an alternative
to, or be considered more meaningful than, operating income, net income, or cash
flows as an indicator of the Company's operating income. All of the Company's
subsidiaries are subject to state income taxes. Consequently, the Company
accrues income tax expense even in a loss period.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects that its principal sources of liquidity will be cash
flow from operations and borrowings under the revolving loan facility of the
Senior Credit Facility. The Company anticipates that its principal uses of
liquidity will be to provide working capital, finance future acquisitions, and
meet debt service requirements. Management expects that cash flow from
operations, along with additional borrowings under existing and future credit
facilities, will be sufficient to meet the Company's requirements for the
remainder of 1999. The Company currently anticipates that, under the terms of
the Senior Notes and the Senior Credit Facility, interest payments will be
required of approximately $18.5 million for fiscal year ending December 31, 1999
and the fiscal year ending December 31, 2000. As of March 31, 1999, the Company
has approximately $9.0 million of unused borrowing capacity under the Senior
Credit Facility. The Company anticipates that its primary capital expenditures
for the remainder of 1999 will be approximately $7.8 million for capital items
required to implement new contracts and contract renewals entered into by the
Company.
-16-
In March 1999 the Company raised $5.0 million of equity from its existing
stockholders 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. Dividends will be payable out of funds legally available
therefore, will be payable only when, as, and if declared by the Company's 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,
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 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 exercised before 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 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. Amounts
borrowed under the additional term loan facility bear interest, at the option of
the Company, at either (i) the Base Rate (as defined in the Senior Credit
Facility) plus 250 basis points or (ii) LIBOR plus 350 basis points. The Company
borrowed the additional $5.5 million in March 1999 and concurrently repaid $5.0
million under the revolving loan facility of the Senior Credit Facility.
Net cash used in operating activities was $5.0 million for the three months
ended March 31, 1999 as compared to $6.0 million for the three months ended
March 31, 1998, consisting primarily of $6.9 million of cash received on trade
receivables during the first week of April that normally would be received by
the end of March.
Cash used in investing activities was $3.1 million for the three months
ended March 31, 1999 as compared to $8.8 million for the three months ended
March 31, 1998, consisting primarily of both cash outflows for investments in
new business and customer contract renewals and the payment of $1.5 million of
acquisition costs relating to the Acquisitions.
Cash provided by financing activities was $6.7 million for the three months
ended March 31, 1999 as compared to $8.5 million for the three months ended
March 31, 1998, consisting primarily of the issuance $5.0 million of new equity,
$5.5 million of new borrowings under the Senior Credit Facility, and offset by
repayments of principal under the Senior Credit Facility and repayment of a $0.9
million note relating to the acquisition of MOG.
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
-17-
not be reborrowed. Amounts borrowed under the Senior Credit Facility bear
interest, at the option of the Company, at either (i) the Base Rate (as defined
in the Senior Credit Facility) 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 LIBOR 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 LIBOR loans, at least quarterly, in each case until maturity.
In addition, the Senior Credit Facility requires mandatory prepayments out of
the proceeds of certain equity or debt offerings, asset dispositions, receipt of
insurance proceeds not applied as provided in the Senior Credit Facility, and
receipts of funds from certain escrow accounts. Remaining scheduled principal
payments on the term loan facility are approximately $7.2 million, $12.4
million, $13.8 million, and $19.3 million during the years ending 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.
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 Senior Credit Facility. At March 31, 1999, the interest rate
cap has an aggregate notional amount of $30.0 million, which matures in June
2001, and caps interest on the LIBOR portion of the term loan, up to the
aggregate notional amount, at 7.5%, plus the applicable LIBOR margin.
As of May 4, 1999, the Company had $9.0 million of available borrowing
capacity under the Senior Credit Facility.
As of March 31, 1999, the Company had approximately $182.6 million of long-
term indebtedness outstanding including the current portion, a deficit in
stockholders' equity of $35.4 million, and $0.3 million of cash.
As of March 31, 1999, the Company's long-term indebtedness included (i)
$115.0 million principal amount of 11.0% Senior Notes due 2007 (the "Senior
Notes"), (ii) $67.1 million of indebtedness under the Senior Credit Facility,
and (iii) $0.5 million of other indebtedness.
The Company intends to evaluate additional acquisitions to expand its base
of installed inmate telephones and value added services and will continue to
evaluate possible acquisition opportunities. There can be no assurance that the
Company will have sufficient available capital resources to realize its
acquisition strategy. Such future acquisitions, depending on their size and the
form of consideration, may require the Company to seek additional debt or equity
financing.
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 net loss reported in the statements
of consolidated operations, since there were no other items of comprehensive
income for the periods presented.
-18-
CHANGES IN ACCOUNTING STANDARDS
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.
INFORMATION SYSTEMS AND THE YEAR 2000
The following statements and all other statements made in this Quarterly
Report on Form 10-Q with respect to the Company's Year 2000 processing
capabilities or readiness are "Year 2000 Readiness Disclosures" in conformance
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 senior
management. 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 March 31, 1999, the Discovery, Assessment, and Planning
phases were substantially complete for all program areas. The target completion
date for priority items by remaining steps are as follows: 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.
-19-
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 compliance 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. The Company is currently evaluating for purchase new
internal systems. Management believes that these systems, if purchased, will
enable the Company to resolve any potential Year 2000 Problems. In addition, the
purchase of new internal systems would also provide the Company with increased
functionability. The total cost to the Company of new internal systems is
estimated to be between $1.0 million and $1.5 million, most of which the Company
expects to incur in 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
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.
-20-
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.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION; RISK FACTORS
Certain statements in this Quarterly Report on Form 10-Q constitute
forward-looking statements. These forward-looking statements are all statements
that are not statements of historical fact or that might otherwise be considered
opinion, belief, or projection. These forward-looking statements involve known
and unknown risks, uncertainties, and other factors that may cause the actual
results, levels of activity, performance, or achievements of the Company, or
industry results, to be materially different from any future results, levels of
activity, performance, or achievements expressed or implied by such forward-
looking statements.
The risks described below are not the only risks facing the Company.
Additional risks that the Company does not yet know of or that the Company
thinks are not material may also have an adverse effect on the Company. If any
of those risks or any of the risks described below actually occur, the Company's
business, financial condition, results of operations, or prospects could be
materially adversely affected. 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.
This Quarterly Report on Form 10-Q contains or incorporates by reference
statements about our future that are not statements of historical fact. In some
cases, you can identify these statements by terminology such as "may," "will,"
"should," "expects," "plans," "anticipates," "believes," "estimates," "intends,"
"predicts," "potential," or "continue" or the negative of those terms and 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. These statements are only
predictions, and in evaluating those statements, you should specifically
consider the risks outlined below. Actual performance or results may differ
materially and adversely. All forward-looking statements included in this
Quarterly Report on Form 10-Q are based on information available to us on the
date hereof, and we are under no duty to update any of the forward-looking
statements after the date hereof.
-21-
COMPETITORS WITH GREATER RESOURCES
The inmate telecommunications industry is highly competitive. The Company
competes with numerous providers of inmate telephone services such as RBOCs,
LECs, IXCs, including major long distance carriers
such as AT&T Corp., MCI WorldCom, and Sprint Corporation, and independent public
pay telephone and inmate telephone companies. 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:
. rates of commissions paid to the correctional facilities;
. system features and functionality;
. system reliability and service;
. the ability to customize inmate call processing systems to the
specifications and needs of the particular correctional facility;
and
. relationships with correctional facilities.
As a result of these competitive factors, the Company may be required to pay
higher commissions to retain its existing contracts or obtain new contracts.
Historically, federal and state facilities, which are generally bid on a
system-wide basis, have been served by RBOCs, large LECs, and IXCs, which are
able to leverage their existing systems and infrastructure to serve these large,
high volume customers without the need for additional significant capital
expenditures. These providers have generally not, however, focused on the
smaller city and county correctional systems, which are typically negotiated on
a facility-by-facility basis. As a result, a significant portion of city and
county correctional facilities, which constitute a substantial majority of the
Company's customers, are served by independent inmate telephone and independent
public pay telephone companies. RBOCs, LECs, or IXCs could decide to pursue
actively contracts with city and county correctional facilities.
The Company's ability to offer competitive commission rates depends on
effectively controlling costs, which in turn necessitates capital expenditures
for software and systems. If RBOCs, LECs, and IXCs that have significantly
greater financial resources than the Company and are able to connect calls on
their owned networks for a negligible marginal cost were to focus on the inmate
telecommunications market, the Company could face substantial competition and
subsequent increases in commission rates or reduction in market share.
RISKS ASSOCIATED WITH UNCOLLECTIBLE ACCOUNTS
The Company is required to carry a reserve on its books for future charge-
backs from LECs and third party clearinghouses for uncollectible amounts when
such amounts exceed the reserves initially withheld by the LECs and
clearinghouses. The Company sets the reserves on its books using historical
data on charge-backs for each LEC or other billing service providers. The
setting of these reserves requires substantial use of estimation. Actual
expenses associated with uncollectible accounts could differ from the Company's
estimates. Factors that could cause actual expenses associated with
uncollectible accounts to vary from the Company's estimates include difficulties
in estimating reserves for acquired contracts and variations in expenses
associated with uncollectible accounts among LECs. These variations could
potentially lead to an increase in the Company's expenses associated with
uncollectible accounts.
-22-
DIFFICULTY OF EXECUTING ACQUISITION STRATEGY; RISKS ASSOCIATED WITH ANTICIPATED
GROWTH
The Company has experienced rapid growth, and intends to continue to grow
through further expansion of its existing operations and through acquisitions.
The Company intends to evaluate additional acquisitions to expand its base of
installed inmate telephones and value added services and will continue to
evaluate possible acquisition opportunities. The Company evaluates specific
acquisition opportunities based on market conditions and economic factors
existing at the time, and intends to pursue favorable opportunities as they
arise. The Company may encounter increased competition for acquisitions in the
future, which could result in higher prices for acquisition candidates. There
can be no assurance that the Company will find suitable acquisition candidates
at acceptable prices, have sufficient available capital resources to realize its
acquisition strategy, be successful in entering into definitive agreements for
desired acquisitions, or that any such acquisitions, if consummated, will prove
to be advantageous to the Company. 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.
The success of the Company's growth strategy is also dependent on the
ability of the Company to integrate acquired operations into existing
operations. In addition, the Company's success is dependent on the ability of
the Company to expand internal operations. The Company's ability to manage its
anticipated future growth will depend on a number of factors, including its
ability to evaluate new contract opportunities, monitor operations, control
costs, maintain effective quality control, obtain satisfactory and cost-
effective lease rights from and interconnection agreements with companies that
own transmission lines, and expand the Company's internal management, technical,
and accounting systems. The Company's rapid growth has placed, and its planned
future growth will continue to place, a significant strain on the Company's
financial, management, and operational resources. There can be no assurance that
the integration of acquired operations and continued expansion of internal
operations will not require the investment of capital or result in unforeseen
difficulties or absorb significant management resources at levels higher than
that anticipated by management, or that the Company will realize meaningful
economies of scale or operating efficiencies from its acquisitions. In addition,
acquisitions and the establishment of new operations will entail considerable
expenses in advance of anticipated revenues and may cause substantial
fluctuations in the Company's operating results.
The Company will need to integrate its acquired businesses with its
existing operations. This will entail, among other things, integration of
switching, transmission, technical, sales, marketing, billing, accounting,
quality control, management, payroll, personnel, regulatory compliance, and
other systems and operating hardware and software, some or all of which may be
incompatible with the Company's existing operations. In addition, the Company
has no prior experience in acquiring operations from RBOCs or LECs, and there
can be no assurance that the Company would be successful in consummating such
acquisitions or in integrating such operations. The Company's acquisition
strategy results in the amortization of acquired contracts over a relatively
short period of time, generally one to three years. As of March 31, 1999, the
Company had capitalized $27.1 million of acquired facility contracts and $75.7
million of goodwill, which could lead to operating losses.
SUBSTANTIAL LEVERAGE; RESTRICTIVE COVENANTS
The Company has significant debt and debt service obligations. The Senior
Credit Facility with CIBC as an agent for a syndicate of lenders consists of (a)
a $55.0 term loan acquisition facility, (b) a $5.5 million additional term loan
facility, and (c) a $25.0 revolving loan facility (which includes a $5.0 million
letter of credit facility). In addition, on June 27, 1997, the Company
consummated the offering of the Senior Notes. At March 31, 1999, the Company
had approximately $182.6 million of long-term indebtedness outstanding
(including the current portion).
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The significant leverage of the Company has several important consequences,
including, but not limited to, the following:
. the Company is required to dedicate a substantial portion of its
cash flow from operations to the payment of interest and principal
repayment obligations in connection with the Senior Notes, the
Senior Credit Facility, and other permitted indebtedness, thereby
reducing the funds available for its operations, capital
expenditures, and other purposes;
. the Company's leveraged position and the covenants contained in the
Senior Credit Facility and the Indenture governing the Senior Notes
limits the Company's ability to obtain additional financing, pay
dividends, repurchase stock, make investments, grant liens, and
take other actions that may be in the best interests of the
Company's stockholders; and
. the Company's substantial leverage may make it more vulnerable to
economic fluctuations, limit its ability to withstand competitive
pressures, and reduce its flexibility in responding to changing
business and economic conditions.
In addition, the Company's indebtedness under the Senior Credit Facility
bears interest at floating rates, which could adversely affect the Company's
ability to service its debt if interest rates rise.
There can be no assurance that the Company will be able to meet its debt
service obligations. If the Company is unable to generate sufficient cash flow
or otherwise obtain funds necessary to make required payments, or if the Company
otherwise fails to comply with the various covenants contained in its debt
obligations, it would be in default under the terms thereof, which would permit
the holders of such indebtedness to accelerate the maturity thereof and could
cause defaults under other indebtedness of the Company. The Company's ability
to repay or refinance its obligations with respect to its indebtedness will
depend on its future financial and operating results, which in turn, will be
subject to prevailing economic and competitive conditions and to certain
financial, business, and other factors, many of which are beyond the Company's
control.
LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT; ANTICIPATED LOSSES
The Company was founded in December 1996. Accordingly, the Company has a
limited operating history upon which an evaluation of the Company and its
prospects can be based. Because the Company anticipates that it will incur
operating losses for the foreseeable future, the Company believes that its
future success will depend on its ability to significantly increase revenues,
which cannot be assured. Additionally, the limited operating history of the
Company makes the accurate prediction of future operating results difficult or
impossible, and there can be no assurance that the Company's revenues will
increase or even continue at their current level or that the Company will
achieve or maintain profitability or generate cash from operations in future
periods. Since its inception, the Company has incurred losses and, as of March
31, 1999, had an accumulated deficit of approximately $62.0 million. The
Company expects to continue to incur significant losses on a quarterly and
annual basis for the foreseeable future.
DEPENDENCE ON TRANSMISSION FACILITIES-BASED CARRIERS
The Company does not own telecommunications transmission lines.
Accordingly, telephone calls made from correctional facilities are connected
through transmission lines that the Company leases under a variety of
arrangements with transmission facilities-based long distance carriers, some of
which are or may become competitors of the Company. The Company's calls are
transmitted via facilities leased on a per minute or monthly basis. Accordingly,
the Company is vulnerable to increases in its cost basis. If there is an
increase in demand for telecommunications services (for example, data services)
beyond the increase in supply of transmission facilities, the Company's costs
could increase.
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CHANGES IN REGULATION COULD ADVERSELY AFFECT THE COMPANY
The inmate telecommunications industry is regulated at both 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. There could be 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.
At the federal level, the industry is currently in a period of substantial
regulatory change in the aftermath of the Telecommunications Act of 1996 (the
"Telecom Act"), which, among other things, directed the FCC to restructure and
to change the regulatory framework of the pay telephone industry, including the
inmate telephone industry. Because the FCC is still in the process of
implementing its new regulations, and because several aspects of rule changes
proposed by the FCC are subject to requests for reconsideration, clarification,
and final resolution in related proceedings, the ultimate effect of regulatory
changes on the Company's business is uncertain. In particular, whether 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 in the future.
Historically, LECs that have operated in the inmate telephone industry have been
able to subsidize their inmate operations with revenue from regulated telephone
service in other sectors. The Telecom Act requires that this subsidization be
brought to an end. It is not clear how the FCC will effect this statutory
mandate. Similarly, because the rules issued under the Telecom Act have only
recently been adopted, it is too early to assess the LECs' competitive responses
to them.
In addition to adopting regulations implementing 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. 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. And, 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 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.
The Company charges relatively high rates for completing inmate collect,
debit, and prepaid calls. Many states have set maximum rates that can be
charged for inmate collect calls. Regulators could reduce the rates that may be
charged by the Company. From time to time, inmate telecommunications providers
are parties to proceedings initiated by consumer protection advocates or
individual called parties alleging that excessive rates are being charged with
respect to inmate collect calls. One such proceeding is currently pending in
the United States District Court in the State of Kentucky. Although the Company
has not been named in the proceeding, the plaintiffs in such proceeding are
seeking class action certification as to all inmate telecommunications providers
as defendants and all recipients of calls from inmate facilities as plaintiffs.
The proceeding is in its preliminary stages.
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RISKS ASSOCIATED WITH MARKET GROWTH STAGNATING OR DECLINING
The Company's future growth could be affected by negative trends in the
growth of the number of correctional facilities or the number of prisoners. If
the societal and political trends that have led to this growth rate abate, the
growth of the corrections industry could stagnate or decline. In particular, if
the drug laws or mandatory sentencing laws that have been enacted in the last
decade are repealed or reduced in scope, there could be an adverse effect on the
growth of the inmate population. In addition, state prison authorities in the
State of Texas have adopted policies severely restricting the making of
telephone calls by inmates in state correctional facilities. The adoption of
similar policies by other states could severely reduce the size of the inmate
telecommunications market.
RISK OF NEW BUSINESS AREAS
The Company is pursuing opportunities to market its specialized billing,
bad-debt and fraud management, and call validation services to RBOCs, LECs,
IXCs, and other inmate telecommunication 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.
The Company has assumed the risk of managing all billing and collections costs
related to this contract, with no recourse to the RBOC. The Company has limited
experience in obtaining contracts to provide, and in providing, such services to
third parties, and there can therefore be no assurance that the Company will be
successful in either of these endeavors.
LEASED LINE AND OTHER NETWORK COST REDUCTION STRATEGIES
The Company is currently pursuing a strategy of utilizing leased lines for
traffic in certain states to reduce its purchases of minutes of use. The Company
believes that this strategy will allow it to decrease operating expenses as a
percentage of revenue. There can, however, be no assurance that this strategy
will be implemented successfully or that, if the strategy is implemented
successfully, that such decrease in operating expenses as a percentage of
revenue will occur. In particular, the economic benefit to the Company of the
leased line strategy is substantially dependent upon the existence of a
sufficient level of traffic over the leased lines, and there can be no assurance
that sufficient traffic levels will be experienced by the Company. In addition,
the Company is pursuing additional alternative network solutions, including
purchasing lower per minute rates from second and third tier IXCs, carrying
voice traffic over frame relay facilities, and provisioning local lines through
CLECs rather than LECs. The Company could fail to successfully implement these
strategies, decrease operating expenses as a percentage of revenue through the
implementation of these strategies, or experience the traffic levels necessary
to obtain the economic benefits of the leased line strategy.
DIFFICULTY OF EXECUTING STRATEGY IF KEY PERSONNEL CANNOT BE RECRUITED AND
RETAINED
The Company's success is dependent on the efforts of certain of its of
officers, senior management, technical, and other personnel, and on its ability
to continue to attract, retain, and motivate qualified personnel, particularly
financial and accounting personnel. The competition for such employees is
intense, and the Company believes that it would be difficult to replace the
expertise and experience of such persons in the event that the services of one
or more such persons were to become unavailable. Accordingly, the loss of the
services of one or more of these individuals without adequate replacement could
have a material adverse effect on the Company and its ability to implement its
business strategy and to achieve its goals.
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LACK OF PATENTS AND POSSIBLE INFRINGEMENT
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.
GOVERNMENTAL ENTITIES AS CUSTOMERS
The Company's customers include state and local governmental entities
responsible for the administration and operation of correctional facilities. The
Company is subject, therefore, to the administrative policies and procedures
employed by, and the regulations that govern the activities of, these
governmental entities, including policies, procedures, and regulations
concerning the procurement and retention of contract rights and the provision of
services. There can be no assurance that the Company's operations will not be
adversely affected by the policies and procedures employed by, or the
regulations that govern the activities of, these governmental entities, or that
the Company will not be limited in its ability to secure additional customer
contracts, renew existing customer contracts, or consummate acquisitions as a
result of such policies, procedures, and regulations.
TECHNOLOGICAL CHANGE AND NEW SERVICES
The telecommunications industry has been characterized by rapid
technological advancements, frequent new service introductions, and evolving
industry standards. Management believes that the Company's future success will
depend on its ability to anticipate and respond to such changes and new
technology. There can be no assurance that the Company will not be materially
adversely affected by the introduction and acceptance of new technology. Some of
the Company's technology, such as its call processor technology, has not yet
been implemented in all of the facilities, which the Company services.
CONTROL BY PRINCIPAL SHAREHOLDERS
To the extent that certain of the Company's shareholders exercise their
voting rights in concert, they effectively have the ability to control the
election of all of the Company's Board of Directors, the outcome of most matters
submitted to a vote of the holders of Class A common stock, and generally are
able to direct the affairs of the Company. This could make it more difficult to
effect certain corporate actions, including replacing incumbent directors or
completing a merger, tender offer, or other takeover attempt.
ITEM 3. 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 issue 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
notional amount of $30.0 million, which matures in June 2001 and caps interest
on the LIBOR portion of the term portion of the Senior Credit Facility at 7.5%,
plus the LIBOR margin.
The following table presents the carrying and fair value of the Company's
debt along with average interest rates, as of December 31, 1998. Fair values are
calculated as the net present value of the expected cash flows of the financial
instrument.
Expected Maturity
Date............... 1999 2000 2001 2002 2003 Thereafter Total Fair 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%
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is from time to time a party to legal proceedings that arise in
the ordinary course of business. Management does not believe that the
resolution of any threatened or pending legal proceedings will have a material
adverse affect on the Company.
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In March 1999 the Company sold to certain of its existing stockholders and
warrant holders, and their affiliates, 5,000 investment units at a price of
$1,000 per unit. Each unit consists of one share of First Preferred Series A
Stock and a warrant to acquire one share of the Company's Class A common stock.
The warrants are exercisable at the holder's option for a strike price of $1,000
per unit. No underwriters were involved in the transaction, and the Company did
not pay any underwriting discounts or commissions. This issuance was exempt from
the registration requirements of the Securities Act of 1933, as amended,
pursuant to Section 4(2) thereof.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
During the period subject to this Quarterly Report on Form 10-Q, an
amendment to the Restated Certificate of Incorporation was adopted by the
written consent of the Company's stockholders, as permitted by the terms of the
Company's Restated Certificate of Incorporation. Such amendment (i) increased
the authorized shares of preferred stock, (ii) established the class of First
Preferred Series A Stock, and (iii) amended the dividend rights of the Senior
Preferred Stock.
Votes for: 13,778 Votes Against: 0 Did Not Vote: 2,155
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Description of Exhibit
- -------------- ------------------------------------------------------------
3.1 Certificate of Incorporation of the Company (filed as Exhibit
3.1 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
3.2 Bylaws of the Company (filed as Exhibit 3.2 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
3.3 Certificate of Amendment to Restated Certificate of
Incorporation of the Company, dated as of July 23, 1998 (filed
as Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q,
dated as of August 14, 1998 and incorporated herein by
reference).
3.4* Certificate of Amendment to Restated Certificate of
Incorporation of the Company, dated as February 11, 1999.
4.1* Form of Stock Certificate for the First Preferred Series A
Stock.
4.2* Form of Warrant Agreement.
10.1* Amendment No. 2 to Second Amended and Restated Credit
Agreement, dated as of March 3, 1999, by and among the Company,
Evercom Systems, Inc., Saratoga Telephone Company, Inc.,
Canadian Imperial Bank of Commerce as Administrative Agent for
the Lenders (as defined therein), and the Lenders (as defined
therein).
27.1* Financial Data Schedule
_______________
* Filed herewith.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the period subject to
this Quarterly Report on Form 10-Q.
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SIGNATURES
Pursuant to the requirement 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 WHIPPLE
-------------------
Dennis Whipple
Chief Executive Officer
By: /s/ JEFFREY D. CUSHMAN
-----------------------
Jeffrey D. Cushman
Chief Financial Officer
Date: May 12, 1999
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