FORM 10-Q/A
AMENDMENT NO. 2
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended: June 30, 1998 Commission File Number: 0-22610
DAVEL COMMUNICATIONS GROUP, INC.
--------------------------------
(Exact name of registrant as specified in its charter)
ILLINOIS 37-1064777
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) I.D. No.)
1429 MASSARO BOULEVARD, TAMPA, FLORIDA 33619
--------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant`s telephone number: (813) 623-3545
________________________
Indicate by check mark whether the Registrant has (1) 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. X Yes No
----- -----
As of August 13, 1998, the number of shares outstanding of the Registrant`s
Common Stock was 5,772,209.
DAVEL COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands, except per share and share data)
June 30 December 31
ASSETS 1998 1997
---- ----
CURRENT ASSETS
Cash and cash equivalents $ 7,435 $ 2,567
Trade accounts receivable, net of allowance
for doubtful accounts of $5,344 and $185,
respectively 24,164 9,105
Note receivable 2,347 2,536
Other current assets 3,713 702
--------- ---------
Total current assets
37,659 14,910
PROPERTY AND EQUIPMENT 82,112 34,528
OTHER ASSETS 65,506 3,520
--------- ---------
Total assets $ 185,277 $ 52,958
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 16,667 $ 1,501
Accounts payable 3,067 1,257
Accrued liabilities 10,428 1,832
--------- ---------
Total current liabilities 30,162 4,590
LONG-TERM DEBT 80,330 6,801
DEFERRED INCOME TAXES 10,267 3,597
SHAREHOLDERS' EQUITY
Preferred stock - $.01 par value, 1,000,000 shares
authorized but unissued - -
Common stock - $.01 par value, 10,000,000 shares
authorized, 5,772,209 and 4,629,323 shares issued
and outstanding, respectively 58 46
Additional paid-in capital 49,191 20,685
Retained earnings 15,269 17,239
--------- ---------
Total shareholders' equity 64,518 37,970
--------- ---------
Total liabilities and shareholders' equity $ 185,277 $ 52,958
========= =========
The accompanying notes are an integral part of these balance sheets.
2
DAVEL COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED JUNE 30
(In thousands, except per share and share data)
1998 1997
---- ----
Revenues
Coin calls
Non-coin calls $ 14,896 $ 6,086
9,811 5,795
---------- ----------
Total revenues 24,707 11,881
Costs and expenses
Telephone charges 5,363 2,318
Commissions 3,777 1,551
Service, maintenance and network costs 4,908 2,368
Selling, general and administrative 9,375 3,055
---------- ----------
Total operating costs and expenses 23,423 9,292
---------- ----------
Operating profit 1,284 2,589
Interest expense (2,562) (83)
Other 180 96
---------- ----------
Income (loss) from operations before income taxes (1,098) 2,602
Provision for income taxes (462) 989
========== ==========
Net income (loss) $ (636) $ 1,613
========== ==========
Basic earnings (loss) per share $ (.14) $ .35
========== ==========
Diluted earnings (loss) per share $ (.14) $ .35
========== ==========
Weighted average shares outstanding 4,672,774 4,581,269
========== ==========
The accompanying notes are an integral part of these statements.
3
DAVEL COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE SIX MONTHS ENDING JUNE 30
(In thousands, except per share and share data)
1998 1997
---- ----
Revenues
Coin calls $26,432 $11,457
Non-coin calls 17,578 11,104
------ ------
Total revenues 44,010 22,561
Costs and expenses
Telephone charges 9,876 4,569
Commissions 6,969 2,928
Service, maintenance and network costs 9,002 4,598
Restructuring costs 825 -
Selling, general and administrative 16,898 6,064
------ -----
Total operating costs and expenses 43,570 18,159
------ ------
Operating profit 440 4,402
Interest expense (4,209) (161)
Other 343 169
--- ---
Income (loss) from operations before income taxes (3,426) 4,410
Provision for income taxes (1,456) 1,674
------ ------
Net income (loss) $(1,970) $2,736
======= ======
Basic earnings (loss) per share
$(.42) $.60
===== ====
Diluted earnings (loss) per share $(.42) $.59
===== ====
Weighted average shares outstanding 4,657,265 4,581,269
========= =========
The accompanying notes are an integral part of these statements.
DAVEL COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE SIX MONTHS ENDED JUNE 30
(In thousands)
1998 1997
---- ----
Cash flows from operating activities
Net income (loss) $(1,970) $2,736
Adjustments to reconcile net income (loss) to cash flows
from operating activities:
Gain on sale of property and equipment (36) (6)
Depreciation and amortization 7,456 1,896
Deferred income taxes 270 413
Restructuring charge 825 -
Changes in assets and liabilities, net of
effects from acquisitions
Accounts receivable (9,172) (3,197)
Note receivable 189 -
Other assets (2,687) 211
Accounts payable 1,147 175
Accrued liabilities 3,546 260
----- ---
Net cash flows from operating activities (432) 2,488
Cash flows from investing activities
Capital expenditures (3,805) (2,480)
Proceeds from sale of property and equipment 51 19
Decrease in net assets of discontinued operations - 599
(Increase) decrease in cash value of life insurance - (2)
Increase in other investing assets (1,597) (237)
Purchase of pay telephones (215) (6,160)
Purchase of Communications Central Inc., net of cash acquired (103,946) -
-------- -------
Net cash flows from investing activities (109,512) (8,261)
Cash flows from financing activities
Long-term debt financing 120,700 6,160
Payments on long-term debt (34,405) (3,115)
Proceeds of sale of common stock 28,517 -
------ ------
Net cash flows from financing activities 114,812 3,045
------- -----
Net (decrease) increase in cash
and cash equivalents 4,868 (2,728)
Cash and cash equivalents, beginning of period 2,567 4,630
----- -----
Cash and cash equivalents, end of period
$7,435 $1,902
====== ======
The accompanying notes are an integral part of these statements.
5
DAVEL COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
The accompanying unaudited consolidated financial statements have been prepared
by the Company and include the accounts of its subsidiaries. These statements
reflect all adjustments, consisting of only normal recurring adjustments which
are, in the opinion of management, necessary for a fair presentation of
financial results for the three- and six-month periods ended June 30, 1998 and
1997, in accordance with generally accepted accounting principles for interim
financial reporting. Certain information and footnote disclosures normally
included in audited financial statements have been omitted pursuant to such
rules and regulations. These interim consolidated financial statements should be
read in conjunction with the Company's audited consolidated financial statements
and the notes thereto for the years ended December 31, 1997 and 1996 and
Management's Discussion and Analysis of Financial Condition and Results of
Operations appearing elsewhere in this Form 10-Q and in the Company's Form 10-K
for the year ended December 31, 1997. The results of operations for the six
month periods ended June 30, 1998 and 1997 are not necessarily indicative of the
results for the full year.
1. DESCRIPTION OF BUSINESS
-----------------------
Davel Communications Group, Inc. and its subsidiaries taken as a whole (the
"Company") owns and operates a network of approximately 40,000 payphones in 36
states and the District of Columbia and provides operator services to these
payphones through its long-distance switching equipment and through contractual
relationships with various long-distance companies. The Company's payphones can
accept coins as payment for local and long-distance calls and process non-coin
calls, including calling card, credit card and third-party billed calls. The
Company's payphones are located at convenience stores, truck stops, service
stations, grocery stores and other locations which typically have a high demand
for payphone service.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
Cash and Cash Equivalents
- -------------------------
The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
Earnings Per Share
- ------------------
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128 (SFAS 128) during the period ended December 31, 1997, and all
prior period earnings per share data has been presented on this basis.
6
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Although these estimates are based on management's knowledge of current events
and actions it may undertake in the future, they may ultimately differ from
actual results.
Reclassification
- ----------------
Certain reclassifications have been made to conform to the 1997 presentation.
3. ACQUISITION
-----------
On February 3, 1998, the Company completed its acquisition of Communications
Central, Inc. (the "CCI Acquisition) at a price of $10.50 per share in cash, or
approximately $70.2 million in the aggregate, assumed CCI's outstanding debt of
$36.7 million and incurred $6.9 million in transaction costs. The CCI
Acquisition has been accounted for by the purchase method, and accordingly the
results of operations are included in the Company's consolidated statement of
operations from the date of acquisition. Goodwill associated with the
acquisition will be amortized over fifteen years using straight-line
amortization. The following summarizes unaudited pro forma consolidated results
of operations for the six months ended June 30, 1997 assuming the CCI
Acquisition occurred at the beginning of 1997. These pro forma results are
provided for comparative purposes only and do not purport to be indicative of
the results which would have been obtained if this acquisition had been effected
on the dates indicated or which may be obtained in the future.
Six Months Ended June 30, 1997:
Total revenues $51,561
=======
Income from continuing operations 3,066
=======
Basic Income from continuing operations
per share 0.67
=======
Diluted Income from continuing operations
per share 0.65
=======
7
The allocation of the purchase price of the CCI Acquisition is
summarized as follows:
Working capital $ 7,955
Property and equipment, net 48,578
Goodwill 45,700
Identifiable intangible assets 11,583
--------
$113,816
========
4. LINE-OF-CREDIT
--------------
In connection with the CCI Acquisition on February 3, 1998, the Company entered
into a credit agreement dated as of February 3, 1998, with NationsBank, N.A., as
Administrative Agent, SunTrust Bank, Tampa Bay, as Documentation Agent, LaSalle
National Bank, as Co-Agent, and other lenders (the "Lenders"), pursuant to which
the Lenders made available to the Company an initial revolving loan commitment
(the "Revolving Credit Facility") of $15 million, including a $5.0 million
sublimit available for the issuance of letters of credit, and a term commitment
(the "Term Loan Facility") of $110 million (the "1998 Credit Agreement"). The
balance outstanding of $8.7 million outstanding on a 1996 credit agreement was
refinanced simultaneously with the signing of the 1998 Credit Agreement and is
included as part of the balances outstanding on the 1998 Credit Agreement.
The loans outstanding under the Term Loan Facility and the Revolving Credit
Facility bear interest, at the Company's option, equal to (i) the Base Rate (as
defined in the 1998 Credit Agreement ) plus a margin of 1.25% or (ii) LIBOR (as
defined in the 1998 Credit Agreement), based on one, two, three or six month
periods, plus a margin of 2.75%, with the applicable margins for the Term Loan
Facility and the Revolving Credit Facility being subject to reductions based on
the Company's ratio of Funded Debt (as defined in the 1998 Credit Agreement) to
EBITDA (as defined in the 1998 Credit Agreement) at given times. As of August
13, 1998, the interest rates on the balance of $80.2 million outstanding under
the Term Loan Facility and on a $1.0 million and an $8.0 million note
outstanding under the Revolving Credit Facility were 8.44%, 8.50% and 8.44%,
respectively.
Amounts outstanding under the Term Loan Facility are required to be repaid in
consecutive quarterly installments, the first was paid on June 30, 1998 and the
next two installments (each in the aggregate principal amount of approximately
$3.33 million) are due on the last day of each of the two calendar quarters
commencing with the quarter ending September 30, 1998. The next 20 installments
in the aggregate principal amount of $5.0 million each will be due on the last
day of each calendar quarter commencing with the quarter ending March 31, 1999.
The final installment under the Term Loan Facility will be payable on February
3, 2004. The Revolving Credit Facility will mature
8
on February 3, 2004. As of August 13, 1998, $80.2 million in outstanding
principal amount had been borrowed under the Term Loan Facility and $9.0 million
in outstanding principal amount had been borrowed under the Revolving Credit
Facility.
Loans under the Term Loan Facility and the Revolving Credit Facility may be
prepaid at any time and are subject to certain mandatory prepayments in an
amount equal to (i) 100% of the net proceeds in excess of $1.0 million received
from the issuance of equity by the Company or its subsidiaries, (ii) 100% of the
net proceeds from certain asset sales in excess of $0.5 million in any calendar
year and (iii) 50% (75% for the Company's 1998 fiscal year) of the Company's
Excess Cash Flow (as defined in the 1998 Credit Agreement) if the ratio of its
Funded Debt to EBITDA as of the last day of the fiscal year is less than 2.5 to
1.0. Prepayments under the Revolving Loan Facility will be applied first to
reduce Base Rate loans until they are reduced to zero and then to reduce LIBOR
loans. On June 30, 1998, pursuant to the terms of the 1998 Credit Agreement, the
Company reduced the principal amounts outstanding under the Term Loan Facility
by $24.3 million, and by $5.5 million on August 6, 1998.
The Term Loan Facility and the Revolving Credit Facility are guaranteed, on a
joint and several basis, by the Company and certain of the direct and indirect
subsidiaries of the Company. The 1998 Credit Agreement contains representations
and warranties, affirmative and negative covenants and events of default
customary for similar financings.
On June 30, 1998, the Company and the Lenders agreed to the third amendment to
the 1998 Credit Agreement which revised the definition of the borrowing base to
include the entire amount of the Revolving Loan Facility through November 30,
1998. As of June 30, 1998, the company was in violation of the covenant
contained in the 1998 Credit Agreement which required the ratio of funded debt
to EBITDA for the trailing twelve month period to be at or below 4.25 to 1. The
Company and the Lenders have agreed to waive this requirement by entering into
the fourth amendment to the 1998 Credit Agreement to increase the maximum
allowable ratio of funded debt to EBITDA to 5.00 to 1.00 for each of the fiscal
quarters ended June 30, 1998 and September 30, 1998. The fourth amendment also
increases the amount of capital expenditures allowed from $6.0 million in the
fiscal year ended December 31, 1998, to $10.0 million to allow the Company to
pursue additional payphone acquisitions.
5. RESTRUCTURING COSTS
-------------------
In connection with the CCI Acquisition, the Company plans to close the Atlanta
office of CCI and close field offices where CCI and the Company have duplicate
facilities. The office closings are expected to be completed by the end of the
third quarter of 1998. In connection with this, the Company recognized
restructuring costs of $825. These costs are composed of payments incurred in
connection with early lease terminations, facility closing costs and employee
termination benefits for 53 excess field operations and
9
administrative personnel. Costs of $298 were incurred in the six months ended
June 30, 1998 and taken against the reserve.
6. SUPPLEMENTAL CASH FLOW INFORMATION
----------------------------------
Cash paid for interest and income taxes for the six month periods ended June 30,
1998 and 1997 was as follows:
1998 1997
---- ----
Interest $3,408,522 $160,694
Income taxes $ 192,399 $ 1,865
7. PROVISION FOR DIAL-AROUND COMPENSATION
--------------------------------------
On September 20, 1996, the Federal Communications Commission (FCC) adopted rules
in a docket entitled In the Matter of Implementation of the Payphone
Reclassification and Compensation Provisions of the Telecommunications Act of
1996, FCC 96-388 (the 1996 Payphone Order), implementing the payphone provisions
of Section 276 of the Telecommunications Act of 1996 (the Telcom Act). The 1996
Payphone Order, which became effective November 7, 1996, initially mandated
dial-around compensation for both access code calls and 800 subscriber calls at
a flat rate of $45.85 per payphone per month (131 calls multiplied by $0.35 per
call). Commencing October 7, 1997 and ending October 6, 1998, the $45.85 per
payphone per month rate was to transition to a per-call system at the rate of
$0.35 per call. Several parties filed petitions for judicial review of certain
of the FCC regulations including the dial-around compensation rate. On July 1,
1997, the U.S. Court of Appeals for the District of Columbia Circuit (the Court)
responded to appeals related to the 1996 Payphone Order by remanding certain
issues to the FCC for reconsideration. These issues included, among other
things, the manner in which the FCC established the dial-around compensation for
800 subscriber and access code calls, the manner in which the FCC established
the interim dial-around compensation plan and the basis upon which interexchange
carriers (IXCs) would be required to compensate payphone service providers
(PSPs). The Court remanded the issue to the FCC for further consideration, and
clarified on September 16, 1997, that it had vacated certain portions of the
FCC's 1996 Payphone Order, including the dial-around compensation rate.
Specifically, the Court determined that the FCC did not adequately justify (i)
the per-call compensation rate for 800 subscriber and access code calls at the
deregulated local coin rate of $0.35, because it did not sufficiently justify
its conclusion that the costs of local coin calls are similar to those of 800
subscriber and access code calls; and (ii) the allocation of the payment
obligation among the IXCs for the period from November 7, 1996 through October
6, 1997.
In accordance with the Court's mandate, on October 9, 1997, the FCC adopted and
released its Second Report and Order in the same docket, FCC 97-371 (the 1997
Payphone Order). This order addressed the per-call compensation rate for 800
subscriber
10
and access code calls that originate from payphones in light of the decision of
the Court which vacated and remanded certain portions of the FCC's 1996 Payphone
Order. The FCC concluded that the rate for per-call compensation for 800
subscriber and access code calls from payphones is the deregulated local coin
rate adjusted for certain cost differences. Accordingly, the FCC established a
rate of $0.284 ($0.35 -$0.066) per call for the first two years of per-call
compensation (October 7, 1997, through October 6, 1999). The IXCs are required
to pay this per-call amount to PSPs, including the Company, beginning October 7,
1997. After the first two years of per-call compensation, the market-based local
coin rate, adjusted for certain costs defined by the FCC as $0.066 per call, is
the surrogate for the per-call rate for 800 subscriber and access code calls.
These new rule provisions were made effective as of October 7, 1997. For the
period October 7, 1997 through June 30, 1998, the Company has recorded dial-
around compensation at a rate of $0.284 multiplied by 131 calls or $37.20 per
payphone per month. In addition, the 1997 Payphone Order tentatively concluded
that the same $0.284 per-call rate adopted on a going-forward basis should also
govern compensation obligations during the period from November 7, 1996, through
October 6, 1997, and that PSPs are entitled to compensation for all access code
and 800 subscriber calls during the period. The FCC stated that the manner in
which the payment obligation of the IXCs for the period from November 7, 1996
through October 6, 1997, will be allocated among the IXCs will be addressed in a
subsequent order.
Based on the FCC's tentative conclusion in the 1997 Payphone Order, the Company
has adjusted the amounts of dial-around compensation previously recorded related
to the period from November 7, 1996 through June 30, 1997, from the initial
$45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). Beginning on
July 1, 1997, the Company has recorded dial-around compensation at the rate of
$37.20 per payphone per month.
The Company recorded dial-around compensation revenue of approximately $4.2
million, $7.9 million, $2.3 million and $4.8 million for the three month and six
month periods ended June 30, 1998 and 1997, respectively.
The Company's counsel, Rammelkamp, Bradney, Kuster, Fritsche & Lindsay, P.C., is
of the opinion that the Company is legally entitled to fair compensation under
the Telcom Act for dial-around calls the Company delivered to any carrier during
the period from November 7, 1996, through October 6, 1997. Based on the
information available, the Company believes that the minimum amount it is
entitled to as fair compensation under the Telcom Act for the period from
November 7, 1996 through October 6, 1997 is $37.20 per payphone per month and
the Company, based on the information available to it, does not believe that it
is reasonably possible that the amount will be materially less than $37.20 per
payphone per month.
While the amount of $0.284 per call constitutes the Company's position of the
appropriate level of fair compensation, certain IXCs have asserted in the past,
are asserting and are expected to assert in the future that the appropriate
level of fair
11
compensation should be lower than $0.284 per call. Various parties have appealed
certain aspects of the 1997 payphone Order to the Court of Appeals for the
District of Columbia. The issues being appealed include, but are not limited to,
the costs included or excluded in the FCC's determination of the appropriate
per-call dial-around compensation rate.
On May 15, 1998, the Court remanded the per-call compensation rate to the FCC
for further explanation without vacating the $0.284 per call rate. The Court
stated that any resulting overpayment would be subject to refund and directed
the FCC to conclude its proceedings within a six-month period from the effective
date of the Court's decision. The Company believes that the FCC will issue its
ruling in the current proceeding within the six-month period established by the
court. Based on the information available to it, the Company does not believe
that it is reasonably possible that the amount of compensation for dial-around
calls will be materially reduced from the amount recorded as dial-around
compensation. While the amount of $0.284 per call constitutes the Company's
position on the minimum appropriate level of fair compensation, certain IXCs
have challenged this rate level, asserting that the appropriate level of fair
compensation should be lower than $0.284 per call, such determination could have
a material adverse impact on the Company's results of operations and financial
position.
On April 3, 1998, the FCC issued a Memorandum Opinion and Order (the "1998
Payphone Order") which was made immediately effective. The 1998 Payphone Order
granted IXCs a waiver of dial-around compensation requirements to enable them to
pay per-phone compensation in lieu of per-call payments for dial-around calls
when payphone-specific coding digits are not available to track the calls as
being generated from a payphone. Payphones that are capable of providing such
digits were determined to receive compensation at a rate of $0.284 per call. For
payphones that cannot provide specific coding digits, the FCC stated that a
flat-rate, per-phone payment must be made by calculating the average monthly
number of dial-around calls received from Regional Bell Operating Company
("RBOC") payphones that can provide the coding digits. The average number of
RBOC payphones providing coding digits as of the first of each month will be
added together for the months of October 1997 through March 1998 and divided by
six to calculate an average number of RBOC payphones. The average number of
calls per month is then divided by the average number of phones per month to
arrive at an average call volume from RBOC payphones. This average multiplied by
$0.284 determines the amount of monthly flat-rate, per-phone compensation for
payphones that cannot supply payphone-specific coding digits. A six-month
average will be used to calculate such compensation amounts for the fourth
quarter of 1997 and first quarter 1998 payments. Beginning in the second quarter
of 1998, the individual monthly average will be used for the month in which
compensation is payable.
The FCC further determined that this weighted call average for per-phone
compensation was too high for payphones in non-equal access areas or small to
mid-sized LEC territories where payphone-specific coding digits are not
currently available and the LEC is precluded recovery of the upgrade cost. In
these areas, payers were ordered to compensate PSPs based on the weighted
average of call volumes submitted on the record.
12
Based on data from only two companies, the FCC found that 16 calls per payphone
per month was the appropriate compensation level. However, the FCC invited
parties to submit additional information to enable it to further evaluate its
tentative conclusions.
At this time, the Company is not able to quantify either the amount of per-phone
compensation where digits are not provided, the number of its payphones served
by non-equal access switches, or the number of equal access switches in small
and mid-sized LEC territories. Under the 1998 Payphone Order, for each such
payphone served by a non-equal access switch or in a small or mid-sized LEC
territory, the Company could experience a reduction in dial-around compensation.
Based on currently available information, the Company believes that the number
of such payphones is less than 3% of its payphone base and any related reduction
would not have a material adverse effect on its financial condition and results
of operations. Further, upon the FCC's review of additional data and
reconsideration of the 1998 Payphone Order, the compensation methodologies
described above could be revised.
The FCC provided that the 1998 Payphone Order was applicable only to the period
beginning October 7, 1997 and not to the period November 6, 1996 to October 6,
1997. The FCC indicated that issues related to this period would be addressed in
a subsequent order.
8. COMPREHENSIVE INCOME
--------------------
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
which establishes standards for reporting and disclosure of comprehensive income
and its components. For the periods ended June 30, 1998 and 1997, comprehensive
income equals net income.
9. EARNINGS PER SHARE:
-------------------
In accordance with SFAS 128, the following tables reconcile net income and
weighted average shares outstanding to the amounts used to calculate the basic
and diluted earnings per share for the three month and six month periods ended
June 30, 1998 and 1997.
Three months ended June 30,
1998 1997
---- ----
Weighted average shares outstanding 4,672,774 4,581,269
Assumed exercise of options and warrants
(treasury stock method) 128,029 88,432
--------- ---------
Diluted shares outstanding 4,800,803 4,669,701
========= =========
13
Six months ended June 30,
1998 1997
---- ----
Weighted average shares outstanding 4,657,265 4,581,269
Assumed exercise of options and warrants
(treasury stock method) 128,029 88,432
--------- ---------
Diluted shares outstanding 4,785,294 4,669,701
========= =========
10. OTHER EVENTS
------------
On June 12, 1998, the Company announced the signing of a definitive agreement to
merge with PhoneTel Technologies, Inc, ("PhoneTel"), based in Cleveland, Ohio.
Under the terms of the agreement, shareholders of PhoneTel will receive Company
common stock equal to $3.08 per share based on the Company's average closing
price for the 30 consecutive trading days ending on the second trading day prior
to shareholders' approval; provided, however, that, in no event, will PhoneTel
shareholders receive greater than 0.13765 shares of Company common stock for
each share of PhoneTel stock. The transaction, which is expected to close in the
fall of 1998, is subject to the approval of the shareholders of both companies
and receipt of required regulatory approvals. The transaction is also subject to
other conditions, including PhoneTel's redemption of its 14% PIK Preferred Stock
and consummation of a cash tender offer for its 12% Senior Notes due 2006 at a
price not exceeding 101% of the principal amount of the notes, pursuant to which
a minimum of 80% of the aggregate outstanding principal amount of $125 million
shall have been tendered. The refinancing of the combined companies'
indebtedness will be achieved through a combination of high yield debt and a
senior credit facility. The Company expects to account for the merger as a
pooling of interests. PhoneTel owns a network of approximately 45,000 payphones
in 42 states.
On June 30, 1998, the Company announced the closing of an investment by an
affiliate of Equity Group Investments, Inc., a privately-held investment company
controlled by Sam Zell. In the transaction, the Equity Group Investments
affiliate invested $28 million in the Company as payment for 1,000,000 shares of
newly issued common stock and warrants to purchase an additional 218,750 shares,
which are exercisable at a price of $32.00 per share. Proceeds of the sale were
used to reduce amounts outstanding under the Company's term loan facility.
On July 6, 1998, the Company announced the signing of a definitive agreement to
merge with Peoples Telephone Company, Inc. ("Peoples Telephone"), based in
Miami, Florida. Under the terms of the agreement, holders of common stock of
Peoples Telephone will receive 0.235 shares of Company common stock for each
outstanding share of Peoples Telephone common stock. The exchange ratio is fixed
and not subject to adjustment. The
14
transaction, which is intended to close in the fall of 1998, is subject to the
approval of the shareholders of both companies, receipt of required regulatory
approvals and other customary conditions. Consummation of the merger is
conditioned on its eligibility for pooling-of-interests accounting treatment.
The transaction is also subject to conversion of Peoples Telephone's convertible
preferred stock into common stock and receipt by the Company of financing for,
and successful consummation of, a cash tender offer for Peoples' 12 1/4% Senior
Notes due 2002, pursuant to which a minimum of 85% of the aggregate outstanding
principal amount of $100 million shall have been tendered. The refinancing of
the combined companies' indebtedness will be achieved through a combination of
high yield debt and a senior credit facility. The Peoples Telephone transaction
is independent of and not contingent on consummation of the Company's merger
with PhoneTel.
11. NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In June 1998, the Financial Accounting Standards Board (FASB) adopted SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No.
133 establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value and that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting. SFAS No.
133 is effective for fiscal years beginning after June 15, 1999. The Company has
not yet quantified the impacts of adopting SFAS No. 133 on its consolidated
financial statements nor has it determined the timing or method of its adoption
of SFAS No. 133. However, SFAS No.133 could increase volatility in earnings and
other comprehensive income.
In April 1998, the FASB adopted Statement of Position (SOP) 98-5, "Reporting on
the Costs of Start-Up Activities," which requires costs of start-up activities
and organization costs to be expenses as incurred. SOP 98-5 is effective for
financial statements for fiscal years beginning after December 15, 1998. The
Company will adopt SOP 98-5 in fiscal 1999 and does not expect adoption to have
a material impact on its consolidated financial statements.
In February 1998, the FASB adopted SFAS No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benenfits," which establishes reporting
requirements related to a business's pensions and other postretirement benefits.
SFAS No. 132 is effective for fiscal years beginning after December 15, 1997,
and does not apply to interim financial statements in the year of adoption. The
Company will adopt SFAS No. 132 for the fiscal year ended December 31, 1998. The
Company does not expect adoption to have a material impact on its consolidated
financial statements.
15
In June 1997, the FASB adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes reporting requirements
related to a business's operating segments, products and services, geographic
areas of operations and major customers. SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997, and does not apply to interim financial
statements in the year of adoption. The Company will adopt SFAS No. 131 for the
fiscal year ended December 31, 1998. The Company does not expect SFAS No. 131 to
have a significant impact on its consolidated financial statements and the
related disclosures.
16
MANAGEMENT`S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
Certain of the statements contained below are forward-looking statements
(rather than historical facts) that are subject to risks and uncertainties that
could cause actual results to differ materially from those described in the
forward-looking statements.
GENERAL
During the second quarter of 1998, the Company derived its revenues from
two principal sources: coin calls and non-coin calls. Coin calls represent calls
paid for by callers with coins deposited in the payphone. Coin call revenues are
recorded in the amount of coins collected from the payphones.
Non-coin calls made from the Company's payphones generate revenues in an
amount that depends upon whether the Company or a long distance company handles
the call. If the non-coin call is handled by the Company through its switch or
an "unbundled" services arrangement, the Company recognizes non-coin revenues
equal to the total amount charged for the call. If the non-coin call is handled
by a long distance company, the Company generally recognizes revenues in an
amount equal to the commission on that call paid to the Company by the long
distance company. Under an unbundled services arrangement, the Company performs
certain functions necessary to service non-coin calls, uses the long distance
company's switching equipment and its other services on an as-needed basis, and
pays the long distance company on an unbundled basis for the operator services
actually used to complete these calls.
The Company also recognizes non-coin revenues from calls that are dialed
from its payphones to gain access to a long distance company other than the one
pre-programmed into the telephone; this is commonly referred to as "dial-around"
access. The Company also derives non-coin revenue from certain local exchange
carriers ("LECs") for intraLATA non-coin calls.
The principal costs related to the ongoing operation of the Company's
payphones include telephone charges, commissions, and service, maintenance and
network costs. Telephone charges consist of payments made by the Company to
LECs, competitive local exchange carriers ("CLECs") and long distance carriers
for access charges and use of their networks. Commission expense represents
payments to owners of locations where the Company's payphones are installed.
Service, maintenance and network costs represent the cost of servicing and
maintaining the payphones on an ongoing basis, costs related to the operation of
the Company's switch and, in connection with unbundled services arrangements,
the fees paid for those services.
17
On February 3, 1998, the Company acquired all the issued and outstanding
shares of common stock, $.01 par value per share of Communications Central, Inc.
("CCI") (including the associated rights to purchase shares of common stock) at
a price of $10.50 per share in cash, or approximately $70 million in the
aggregate, and assumed CCI's outstanding debt of $36.4 million. In order to
finance the acquisition of CCI, the Company entered into a credit agreement,
dated as of February 3, 1998, with NationsBank, N.A., as Administrative Agent,
SunTrust Bank, Tampa Bay, as Documentation Agent, LaSalle National Bank, as Co-
Agent, and other lenders, pursuant to which the lenders made available to the
Company an initial revolving loan commitment of $15 million and a term loan
commitment of $110 million.
OTHER EVENTS
On June 12, 1998, the Company announced the signing of a definitive
agreement to merge with PhoneTel Technologies, Inc, ("PhoneTel"), based in
Cleveland, Ohio. Under the terms of the agreement, shareholders of PhoneTel will
receive Company common stock equal to $3.08 per share based on the Company's
average closing price for the 30 consecutive trading days ending on the second
trading day prior to shareholders' approval; provided, however, that, in no
event, will PhoneTel shareholders receive greater than 0.13765 shares of Company
common stock for each share of PhoneTel stock. The transaction, which is
expected to close in the fall of 1998, is subject to the approval of the
shareholders of both companies and receipt of required regulatory approvals. The
transaction is also subject to other conditions, including PhoneTel's redemption
of its 14% PIK Preferred Stock and consummation of a cash tender offer for its
12% Senior Notes due 2006 at a price not exceeding 101% of the principal amount
of the notes, pursuant to which a minimum of 80% of the aggregate outstanding
principal amount of $125 million shall have been tendered. The refinancing of
the combined companies' indebtedness will be achieved through a combination of
high yield debt and a senior credit facility. The Company expects to account for
the merger as a pooling of interests. PhoneTel owns a network of approximately
45,000 payphones in 42 states.
On June 30, 1998, the Company announced the closing of an investment by an
affiliate of Equity Group Investments, Inc., a privately-held investment company
controlled by Sam Zell. In the transaction, the Equity Group Investments
affiliate invested $28 million in the Company as payment for 1,000,000 shares of
newly issued common stock and warrants to purchase an additional 218,750 shares,
which are exercisable at a price of $32.00 per share. Proceeds of the sale were
used to reduce amounts outstanding under the Company's term loan facility.
On July 6, 1998, the Company announced the signing of a definitive
agreement to merge with Peoples Telephone Company, Inc. ("Peoples Telephone"),
based in Miami, Florida. Under the terms of the agreement, holders of common
stock of Peoples Telephone will receive 0.235 shares of Company common stock for
each outstanding share of Peoples Telephone common stock. The exchange ratio is
fixed and not subject to adjustment. The transaction, which is intended to close
in the fall of 1998, is subject to the
18
approval of the shareholders of both companies, receipt of required regulatory
approvals and other customary conditions. Consummation of the merger is
conditioned on its eligibility for pooling-of-interests accounting treatment.
The transaction is also subject to conversion of Peoples Telephone's convertible
preferred stock into common stock and receipt by the Company of financing for,
and successful consummation of, a cash tender offer for Peoples' 12 1/4% Senior
Notes due 2002, pursuant to which a minimum of 85% of the aggregate outstanding
principal amount of $100 million shall have been tendered. The refinancing of
the combined companies' indebtedness will be achieved through a combination of
high yield debt and a senior credit facility. The Peoples Telephone transaction
is independent of and not contingent on consummation of the Company's merger
with PhoneTel.
REGULATORY IMPACT ON REVENUE
Local Coin Rates
In ensuring "fair compensation" for all calls, the FCC previously
determined that local coin rates from payphones should be generally deregulated
by October 7, 1997, but provided for possible modifications or exemptions from
deregulation upon a detailed showing by an individual state that there are
market failures within the state that would not allow market-based rates to
develop. On July 1, 1997, a federal court issued an order which upheld the FCC's
authority to deregulate local coin call rates. In accordance with the FCC's
ruling and the court order, certain LECs and independent payphone service
providers, including the Company, have increased rates for local coin calls from
$.25 to $.35. While the Company has increased the local coin call rate on its
payphones, it has experienced lower volumes of local coin calls originating from
its payphones in the fourth quarter of 1997 and the first six months of 1998
than experienced in the prior-year periods. Given the lack of direction on the
part of the FCC on specific requirements for obtaining a state exemption, the
Company's inability to predict the responses of individual states or the market,
and the Company's inability to provide assurance that deregulation, if and where
implemented, will lead to higher local coin call rates, the Company is unable to
predict the ultimate impact on its operations of local coin rate deregulation.
Dial Around Compensation
On September 20, 1996, the Federal Communications Commission (FCC) adopted
rules in a docket entitled In the Matter of Implementation of the Payphone
Reclassification and Compensation Provisions of the Telecommunications Act of
1996, FCC 96-388 (the 1996 Payphone Order), implementing the payphone provisions
of Section 276 of the Telecommunications Act of 1996 (the Telcom Act). The 1996
Payphone Order, which became effective November 7, 1996, initially mandated
dial-around compensation for both access code calls and 800 subscriber calls at
a flat rate of $45.85 per payphone per month (131 calls multiplied by $0.35 per
call). Commencing October 7, 1997 and ending October 6, 1999, the $45.85 per
payphone per month rate was
19
to transition to a per-call system at the rate of $0.35 per call. Several
parties filed petitions for judicial review of certain of the FCC regulations
including the dial-around compensation rate. On July 1, 1997, the U.S. Court of
Appeals for the District of Columbia Circuit (the Court) responded to appeals
related to the 1996 Payphone Order by remanding certain issues to the FCC for
reconsideration. These issues included, among other things, the manner in which
the FCC established the dial-around compensation for 800 subscriber and access
code calls, the manner in which the FCC established the interim dial-around
compensation plan and the basis upon which interexchange carriers (IXCs) would
be required to compensate payphone service providers (PSPs). The Court remanded
the issue to the FCC for further consideration, and clarified on September 16,
1997, that it had vacated certain portions of the FCC's 1996 Payphone Order,
including the dial-around compensation rate. Specifically, the Court determined
that the FCC did not adequately justify (i) the per-call compensation rate for
800 subscriber and access code calls at the deregulated local coin rate of
$0.35, because it did not sufficiently justify its conclusion that the costs of
local coin calls are similar to those of 800 subscriber and access code calls;
and (ii) the allocation of the payment obligation among the IXCs for the period
from November 7, 1996 through October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997, the FCC adopted
and released its Second Report and Order in the same docket, FCC 97-371 (the
1997 Payphone Order). This order addressed the per-call compensation rate for
800 subscriber and access code calls that originate from payphones in light of
the decision of the Court which vacated and remanded certain portions of the
FCC's 1996 Payphone Order. The FCC concluded that the rate for per-call
compensation for 800 subscriber and access code calls from payphones is the
deregulated local coin rate adjusted for certain cost differences. Accordingly,
the FCC established a rate of $0.284 ($0.35 - $0.066) per call for the first two
years of per-call compensation (October 7, 1997 through October 6, 1999). The
IXCs are required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. After the first two years of per-call compensation,
the market-based local coin rate, adjusted for certain costs defined by the FCC
as $0.066 per call, is the surrogate for the per-call rate for 800 subscriber
and access code calls. These new rule provisions were made effective as of
October 7, 1997. For the period October 7, 1997 through June 30, 1998, the
Company has recorded dial-around compensation at a rate of $0.284 multiplied by
131 calls or $37.20 per payphone per month. In addition, the 1997 Payphone Order
tentatively concluded that the same $0.284 per-call rate adopted on a going-
forward basis should also govern compensation obligations during the period from
November 7, 1996 through October 6, 1997, and that PSPs are entitled to
compensation for all access code and 800 subscriber calls during the period. The
FCC stated that the manner in which the payment obligation of the IXCs for the
period from November 7, 1996 through October 6, 1997 will be allocated among the
IXCs will be addressed in a subsequent order.
Based on the FCC's tentative conclusion in the 1997 Payphone Order, the
Company has adjusted the amounts of dial-around compensation previously recorded
related to the period from November 7, 1996 through June 30, 1997, from the
initial $45.85 rate to
20
$37.20 ($0.284 per call multiplied by 131 calls). Beginning on July 1, 1997, the
Company has recorded dial-around compensation at the rate of $37.20 per payphone
per month.
The Company recorded dial-around compensation revenue of approximately $4.2
million, $7.9 million, $2.3 million and $4.8 million for the three month and six
month periods ended June 30, 1998 and 1997, respectively.
The Company's counsel, Rammelkamp, Bradney, Kuster, Fritsche & Lindsay,
P.C., is of the opinion that the Company is legally entitled to fair
compensation under the Telcom Act for dial-around calls the Company delivered to
any carrier during the period from November 7, 1996 through October 6, 1997.
Based on the information available, the Company believes that the minimum amount
it is entitled to as fair compensation under the Telcom Act for the period from
November 7, 1996 through October 6, 1997 is $37.20 per payphone per month and
the Company, based on the information available to it, does not believe that it
is reasonably possible that the amount will be materially less than $37.20 per
payphone per month.
While the amount of $0.284 per call constitutes the Company's position of
the appropriate level of fair compensation, certain IXCs have asserted in the
past, are asserting and are expected to assert in the future that the
appropriate level of fair compensation should be lower than $0.284 per call.
Various parties have appealed certain aspects of the 1997 payphone Order to the
Court of Appeals for the District of Columbia. The issues being appealed
include, but are not limited to, the costs included or excluded in the FCC's
determination of the appropriate per-call dial-around compensation rate.
On May 15, 1998, the Court remanded the per-call compensation rate to the
FCC for further explanation without vacating the $0.284 per call rate. The Court
stated that any resulting overpayment would be subject to refund and directed
the FCC to conclude its proceedings within a six-month period from the effective
date of the Court's decision. The Company believes that the FCC will issue its
ruling in the current proceeding within the six-month period established by the
court. Based on the information available to it, the Company does not believe
that it is reasonably possible that the amount of compensation for dial-around
calls will be materially reduced from the amount recorded as dial-around
compensation. While the amount of $0.284 per call constitutes the Company's
position on the minimum appropriate level of fair compensation, certain IXCs
have challenged this rate level, asserting that the appropriate level of fair
compensation should be lower than $0.284 per call, such determination could have
a material adverse impact on the Company's results of operations and financial
position.
On April 3, 1998, the FCC issued a Memorandum Opinion and Order (the "1998
Payphone Order") which was made immediately effective. The 1998 Payphone Order
granted IXCs a waiver of dial-around compensation requirements to enable them to
pay per-phone compensation in lieu of per-call payments for dial-around calls
when payphone-specific coding digits are not available to track the calls as
being generated from a payphone. Payphones that are capable of providing such
digits were determined
21
to receive compensation at a rate of $0.284 per call. For payphones that cannot
provide specific coding digits, the FCC stated that a flat-rate, per-phone
payment must be made by calculating the average monthly number of dial-around
calls received from Regional Bell Operating Company ("RBOC") payphones that can
provide the coding digits. The average number of RBOC payphones providing coding
digits as of the first of each month will be added together for the months of
October 1997 through March 1998 and divided by six to calculate an average
number of RBOC payphones. The average number of calls per month is then divided
by the average number of phones per month to arrive at an average call volume
from RBOC payphones. This average multiplied by $0.284 determines the amount of
monthly flat-rate, per-phone compensation for payphones that cannot supply
payphone-specific coding digits. A six-month average will be used to calculate
such compensation amounts for the fourth quarter of 1997 and first quarter 1998
payments. Beginning in the second quarter of 1998, the individual monthly
average will be used for the month in which compensation is payable.
The FCC further determined that this weighted call average for per-phone
compensation was too high for payphones in non-equal access areas or small to
mid-sized LEC territories where payphone-specific coding digits are not
currently available and the LEC is precluded recovery of the upgrade cost. In
these areas, payers were ordered to compensate PSPs based on the weighted
average of call volumes submitted on the record. Based on data from only two
companies, the FCC found that 16 calls per payphone per month was the
appropriate compensation level. However, the FCC invited parties to submit
additional information to enable it to further evaluate its tentative
conclusions.
At this time, the Company is not able to quantify either the amount of per-
phone compensation where digits are not provided, the number of its payphones
served by non-equal access switches, or the number of equal access switches in
small and mid-sized LEC territories. Under the 1998 Payphone Order, for each
such payphone served by a non-equal access switch or in a small or mid-sized LEC
territory, the Company could experience a reduction in dial-around compensation.
Based on currently available information, the Company believes that the number
of such payphones is less than 3% of its payphone base and any related reduction
would not have a material adverse effect on its financial condition or results
of operations. Further, upon the FCC's review of additional data and
reconsideration of the 1998 Payphone Order, the compensation methodologies
described above could be revised.
The FCC provided that the 1998 Payphone Order was applicable only to the
period beginning October 7, 1997 and not to the period from November 6, 1996 to
October 6, 1997. The FCC indicated that issues related to this period would be
addressed in a subsequent order.
The payment levels for dial-around calls prescribed in the 1996, 1997 and
1998 Payphone Orders significantly increase dial-around compensation revenues to
the Company over the levels received prior to implementation of the
Telecommunications Act. However, market forces and factors outside the Company's
control could
22
significantly affect these revenue increases. These factors include the
following: (i) resolution by the FCC of the method of allocating the initial
interim period flat-rate assessment among the IXCs and the number of calls to be
used in determining the amount of the assessment, (ii) the resolution of the
legal appeals by both the IXCs and representatives of the PSPs of various
aspects of the 1997 Payphone Order, (iii) the possibility of other litigation
seeking to modify or overturn the 1997 Payphone Order or portions thereof, (iv)
pending litigation in the Federal courts concerning the constitutionality or
validity of the 1996 Telecommunications Act, and (v) the IXCs' reaction to the
FCC's recognition that existing regulations do not prohibit an IXC from blocking
800 subscriber numbers from payphones in order to avoid paying per-call
compensation on such calls.
Billed Party Preference
New FCC rules regarding Billed Party Preference require payphone operatiors
to give payphone users the option of receiving a rate quote before a call is
connected when making a 0+ interstate call. These rules, which became effective
on July 1, 1998, could reduce revenues earned by the Company on long-distance
services provided by the Company. The Company cannot currently assess what
impact the new rules will have on its financial performance.
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
For the three months ended June 30, 1998, total revenues increased
approximately $12.8 million, or 108.0%, from approximately $11.9 million in the
three months ended June 30, 1997 to approximately $24.7 million in the same
period of 1998. This growth was primarily attributable to an increase from
18,173 payphones on June 30, 1997 to 38,744 payphones on June 30, 1998, an
increase of 20,571 payphones or 113.2%. The increase in the number of installed
payphones was due primarily to the acquisition of Communications Central Inc. on
February 3, 1998 (the "CCI Acquisition"), which added approximately 19,500
payphones to the Company's network. During 1997 and the first six months of
1998, the Company also added approximately 3,000 payphones to its network
through other acquisitions.
Coin call revenues increased approximately $8.8 million, or 144.8%,
increasing from approximately $6.1 million in the second quarter of 1997, to
approximately $14.9 million in the second quarter of 1998. The growth in coin
income was driven primarily by an increase in the number of installed payphones
primarily due to the CCI Acquisition, and an increase of approximately $0.3
million resulting from other acquisitions and the installation of payphones at
locations with favorable coin call traffic. In accordance with the new FCC
rules, certain LECs and independent payphone service providers, including the
Company, began to increase rates for local coin calls from $.25 to $.35
commencing October 7, 1997. While the Company has increased the local coin call
rate on its payphones, it has experienced lower volumes of local coin calls
originating from its
23
payphones in the fourth quarter of 1997 and the first six months of 1998 than
experienced in the prior-year periods.
Non-coin call revenues increased approximately $4.0 million or 69.3%, from
approximately $5.8 million in the three months ended June 30, 1997, to
approximately $9.8 million in the three months ended June 30, 1998. The growth
in non-coin revenues was primarily due to an increase of approximately $5.5
million in non-coin revenues (including approximately $2.3 million from dial-
around compensation) resulting from an increase in the number of installed
payphones. As a result of the 1997 Payphone Order, the Company recorded dial-
around compensation in the second quarter of 1998 at a rate of $37.20 per phone
per month. Dial-around compensation for the second quarter of 1997 was recorded
at a rate of $45.85 per phone per month, which reflected provisions of the 1996
Payphone Order which was in effect during the period. Had the Company restated
the three-month period ended June 30, 1997 to reflect the 1998 presentation,
growth in non-coin revenues would have been approximately $475,000 higher. The
increase in non-coin call revenues was offset by a decrease of approximately
$1.0 million related to lower volumes of calls per payphone routed through its
long distance network due to an increase in the number of dial-around calls
placed from its payphones and approximately $0.7 million related to the
difference in the dial-around compensation rate between the two periods.
Telephone charges rose approximately $3.0 million, or 131.4%, from
approximately $2.3 million in the second quarter of 1997 to approximately $5.4
million in the three months ended June 30, 1998. The increase was primarily due
to the increase in the number of installed payphones. Due to more favorable
contracts with LECs and CLECs for local line access, the Company's average
monthly telephone charge on a per phone basis decreased from $47.85 in the
second quarter of 1997 to $46.31 in the second quarter of 1998. The company is
currently negotiating contracts that it believes will further reduce local
access charges on a per-phone basis, but is unable to estimate the impact of
further telephone charge reductions at this time.
Commissions rose approximately $2.2 million, or 143.5%, from approximately
$1.4 million in the second quarter of 1997 to approximately $3.8 million in the
three months ended June 30, 1998. The increase was primarily due to the increase
in the number of installed payphones. Commissions as a percentage of revenues
increased from 13.1% in the three months ended June 30, 1997 to 15.3% of
revenues in the second quarter of 1998, reflecting a higher concentration of
national and regional payphone contracts (contracts representing 50 or more
payphones), primarily as a result of the CCI Acquisition. However, this was
partially offset by the fact that while many of the Company's contracts with
location owners provide for commission percentages proportionate with increases
in revenues, some are based on flat monthly rates set by the agreements.
24
Service, maintenance and network costs increased approximately $2.4
million, or 107.3%, from approximately $2.4 million in the second quarter of
1997 to approximately $4.9 million in the three months ended June 30, 1998. The
increase was primarily due to the increase in the number of installed payphones.
The Company's average monthly service, maintenance and network costs on a per
phone basis decreased from $51.09 in the second quarter of 1997 to $42.38 in the
three months ended June 30, 1998. The decrease in service, maintenance and
network costs on a per-phone basis was primarily attributable to increasing
operating efficiencies achieved through increasing density in the Company's
payphone routes resulting from the CCI Acquisition and expansion of its
installed base of payphones.
Selling, general and administrative ("SG&A") expenses increased
approximately $6.3 million, or 206.9%, from the prior year, increasing from
approximately $3.1 million in 1997 to approximately $9.4 million in 1998. The
increase was partially attributable to higher depreciation and amortization
expense, which rose approximately $3.3 million or 331.1%, from the prior year,
primarily reflecting depreciation and amortization expense related to the CCI
Acquisition. The Company also incurred approximately $2.0 million in additional
SG&A expenses associated with the operation of CCI administrative and field
office facilities, and approximately $1.0 million in additional SG&A expenses
related to acquisitions made, branch office facilities opened and increased
salaries and administrative costs during the last two quarters of 1997 and the
first two quarters of 1998. The Company is finalizing the integration of its
operations with the operations of CCI and began eliminating redundant sales and
administrative personnel and office facilities in the second quarter of 1998.
Interest and other income increased approximately $84,000 or 87.5% in the
second quarter of 1998 over the prior-year period, rising from approximately
$96,000 in 1997 to approximately $180,000 in 1998. This increase resulted
primarily from an increase in interest income resulting from higher cash
balances in the Company's interest-bearing accounts in the second quarter of
1998 over the second quarter of 1997. Interest expense in the three months ended
June 30, 1998 increased approximately $2.5 million, or 2,986.7%, compared to the
prior-year period, increasing from approximately $83,000 in 1997 to
approximately $2.6 million in the second quarter of 1998. This increase resulted
primarily from the incurrence of $120.0 million in indebtedness on February 3,
1998 in connection with the CCI Acquisition and refinancing of the Company's
existing credit facility. On June 30, 1998, pursuant to the terms of the 1998
Credit Agreement, the Company reduced the principal amounts outstanding under
its credit facility by $24.3 million, and by $5.5 million on August 6, 1998.
Net income decreased approximately $2.2 million or 139.5% from the prior-
year period, decreasing from net income of approximately $1.6 million, in the
three months ended June 30, 1997 to a net loss of approximately $636,000 in the
second quarter of 1998.
25
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
For the six months ended June 30, 1998, total revenues increased
approximately $21.4 million, or 95.1%, from approximately $22.6 million in the
six months ended June 30, 1997 to approximately $44.0 million in the same period
of 1998. This growth was primarily attributable to an increase from 18,173
payphones on June 30, 1997 to 38,744 payphones on June 30, 1998, an increase of
20,571 payphones or 113.2%. The increase in the number of installed payphones
was due primarily to the CCI Acquisition, which added approximately 19,500
payphones to the Company's network. During 1997 and the first six months of
1998, the Company also added approximately 3,000 payphones to its network
through other acquisitions.
Coin call revenues increased approximately $15.0 million, or 130.7%, from
approximately $11.5 million in the six months ended June 30, 1997, to
approximately $26.4 million in the same period of 1998. The growth in coin
income was driven primarily by an increase of approximately $14.9 million in
coin call revenues resulting from growth in the number of installed payphones
primarily due to the CCI Acquisition, and an increase of approximately $0.1
million resulting from other acquisitions and the installation of payphones at
locations with favorable coin call traffic. In accordance with the new FCC
rules, certain LECs and independent payphone service providers, including the
Company, began to increase rates for local coin calls in many locations from
$.25 to $.35 commencing October 7, 1997. While the Company has increased the
local coin call rate on its payphones, it has experienced lower volumes of local
coin calls originating from its payphones in the fourth quarter of 1997 and the
first six months of 1998.
Non-coin call revenues increased approximately $6.5 million or 58.3%, from
approximately $11.1 million in the six months ended June 30, 1997, to
approximately $17.6 million in the six months ended June 30, 1998. The growth in
non-coin revenues was primarily due to an increase of approximately $9.9 million
in non-coin revenues (including an increase of approximately $4.6 million in
dial-around compensation) resulting from an increase in the number of installed
payphones. As a result of the 1997 Payphone Order, the Company recorded dial-
around compensation in the first six months of 1998 at a rate of $37.20 per
phone per month. Dial-around compensation for the first six months of 1997 was
recorded at a rate of $45.85 per phone per month, which reflected provisions of
the 1996 Payphone Order that were in effect during the period. Had the Company
restated the six-month period ended June 30, 1997 to reflect the 1998
presentation, growth in non-coin revenues would have been approximately $875,000
higher. The increase in non-coin call revenues was offset by a decrease of
approximately $2.1 million related to lower volumes of calls per payphone routed
through its long distance network due to increases in the number of dial-around
calls placed from its payphones, and approximately $1.3 million related to the
difference in the dial-around compensation rate between periods.
26
Telephone charges rose approximately $5.3 million, or 116.2%, from
approximately $4.6 million in 1997 to approximately $9.9 million in the six
months ended June 30, 1998. The increase was primarily due to the increase in
the number of installed payphones. Due to more favorable contracts with LECs and
CLECs for local line access, the Company's average monthly telephone charge on a
per phone basis decreased from $48.19 in 1997 to $46.69 in 1998. The company is
currently negotiating contracts that it believes will further reduce local
access charges on a per-phone basis, but is unable to estimate the impact of
further telephone charge reductions at this time.
Commissions rose approximately $4.0 million, or 138.0%, from approximately
$2.9 million in the six-month period ended June 30, 1997 to approximately $7.0
million in the same period of 1998. The increase was primarily due to the
increase in the number of installed payphones. Commissions as a percentage of
revenues increased from 13.0% in the six months ended June 30, 1997 to 15.8% in
the first two quarters of 1998, reflecting a higher concentration of national
and regional payphone contracts (contracts representing 50 or more payphones),
primarily as a result of the CCI Acquisition. However, this was partially offset
by the fact that while many of the Company's contracts with location owners
provide for commission percentages proportionate with increases in revenues,
some are based on flat monthly rates set by the agreements.
Service, maintenance and network costs increased approximately $4.4
million, or 95.7%, from approximately $4.6 million in the first two quarters of
1997 to approximately $9.0 million in the six months ended June 30, 1998. The
increase was primarily due to the increase in the number of installed payphones.
The Company's average monthly service, maintenance and network costs on a per
phone basis decreased from $48.50 in the first six months of 1997 to $42.55 in
the six months ended June 30, 1998. The decrease in service, maintenance and
network costs on a per-phone basis was primarily attributable to increasing
operating efficiencies achieved through increasing density in the Company's
payphone routes resulting from the CCI Acquisition and expansion of its
installed base of payphones.
Selling, general and administrative ("SG&A") expenses increased
approximately $10.8 million, or 178.7%, from the prior year, from approximately
$6.1 million in 1997 to approximately $16.9 million in the first six months of
1998. The increase was partially attributable to higher depreciation and
amortization expense, which rose approximately $5.6 million or 293.2%, from the
prior year, primarily reflecting depreciation and amortization expense related
to the CCI Acquisition. The Company also incurred approximately $3.7 million in
additional SG&A expenses associated with the operation of CCI administrative and
field office facilities, and approximately $1.5 million in additional SG&A
expenses related to acquisitions made, branch office facilities opened and
increased salaries and administrative costs during the last two quarters of 1997
and the first two quarters of 1998. The Company is finalizing the integration of
its operations with the operations of CCI and began eliminating redundant sales
and administrative personnel and office facilities in the second quarter of
1998. The Company also recognized a non-recurring charge of approximately $0.83
million in the first quarter of
27
1998 related to corporate restructuring resulting from the CCI Acquisition. The
restructuring charge includes reserves of approximately $0.3 million for lease
termination costs, $0.2 million for severance pay and $0.33 million for facility
closing costs.
Interest and other income increased approximately $174,000 or 103.0% in the
six month period ended June 30, 1998 over the prior-year period, from
approximately $169,000 in 1997 to approximately $343,000 in 1998. This increase
resulted primarily from an increase in interest income resulting from higher
cash balances in the Company's interest-bearing accounts in the first two
quarters of 1998 over the same period of 1997. Interest expense in the six
months ended June 30, 1998 increased approximately $4.0 million, or 2,508.7%,
compared to the prior-year period, increasing from approximately $161,000 in
1997 to approximately $4.2 million in the six months ended June 30, 1998. This
increase resulted primarily from the incurrence of $120.0 million in
indebtedness on February 3, 1998 in connection with the CCI Acquisition and
refinancing of the Company's existing credit facility. On June 30, 1998,
pursuant to the terms of the 1998 Credit Agreement, the Company reduced the
principal amounts outstanding under its credit facility by $24.3 million, and by
$5.5 million on August 6, 1998.
Net income decreased approximately $4.7 million or 172.0% from the prior-
year period, from net income of approximately $2.7 million, in the six months
ended June 30, 1997 to a net loss of approximately $2.0 million in the first two
quarters of 1998. Before the effect of the non-recurring restructuring charge of
approximately $0.83 million recognized in the first quarter of 1998, net income
decreased approximately $3.9 million or 141.8% from the prior year period,
decreasing from net income of approximately $2.7 million in the six months ended
June 30, 1997 to a net loss of approximately $1.1 million in the first two
quarters of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
As of June 30, 1998, the Company had a current ratio of 1.25 to 1, as
compared to a current ratio of 3.25 to 1 on December 31, 1997. The decrease was
primarily attributable to an increase in current maturities of long-term debt of
approximately $15.2 million related to the incurrence of indebtedness in
connection with the CCI Acquisition and refinancing of the Company's existing
credit facility. The increases in the Company's assets and liabilities between
December 31, 1997 and June 30, 1998 are generally due to the CCI Acquisition.
Specifically, the allowance for doubtful accounts increased from $0.2 million at
December 31, 1997 to $5.3 million at June 30, 1998, due to a large allowance on
receivables related to CCI's former inmate operations which were not sold in
connection with the sale of the inmate operations to Talton Holdings, Inc. Other
assets increased from $3.5 million at December 31, 1997 to $65.5 million at June
30, 1998 due to the addition of $45.7 million of goodwill and $11.6 million of
other intangible assets in connection with the CCI Acquisition. Additional paid-
in capital
28
increased from $20.7 million at December 31, 1997 to $49.2 million at June
30,1998 due to the sale of 1.0 million shares of the Company's Common Stock for
$28.0 million on June 29, 1998 to an affiliate of Equity Group Investments Inc.,
a privately-held investment company controlled by Sam Zell. Cash flows from
investing activities decreased $101.3 million primarily as a result of the CCI
Acquisition.
The Company's capital expenditures, exclusive of acquisitions, for the six
months ended June 30, 1998 and 1997 were $3.8 million and $2.5 million,
respectively. The Company's capital expenditures primarily consisted of costs
associated with the installation of new payphones. In the first two quarters of
1998, the Company financed its capital expenditures and acquisitions primarily
with approximately $114.8 million in cash provided by financing activities. In
the same period of 1997, the Company financed its capital expenditures primarily
with approximately $2.5 million in cash provided by operating activities and
approximately $3.0 million in cash provided by financing activities.
Credit Agreement
In connection with the CCI Acquisition on February 3, 1998, the Company
entered into a credit agreement dated as of February 3, 1998, with NationsBank,
N.A., as Administrative Agent, SunTrust Bank, Tampa Bay, as Documentation Agent,
LaSalle National Bank, as Co-Agent, and other lenders (the "Lenders"), pursuant
to which the Lenders made available to the Company an initial revolving loan
commitment (the "Revolving Credit Facility") of $15 million, including a $5.0
million sublimit available for the issuance of letters of credit, and a term
commitment (the "Term Loan Facility") of $110 million (the "1998 Credit
Agreement"). The balance outstanding of $8.7 million outstanding on the 1996
Credit Agreement was refinanced simultaneously with the signing of the 1998
Credit Agreement and is included as part of the balances outstanding on the 1998
Credit Agreement.
The loans outstanding under the Term Loan Facility and the Revolving Credit
Facility bear interest, at the Company's option, equal to (i) the Base Rate (as
defined in the 1998 Credit Agreement ) plus a margin of 1.25% or (ii) LIBOR (as
defined in the 1998 Credit Agreement), based on one, two, three or six month
periods, plus a margin of 2.75%, with the applicable margins for the Term Loan
Facility and the Revolving Credit Facility being subject to reductions based on
the Company's ratio of Funded Debt (as defined in the 1998 Credit Agreement) to
EBITDA (as defined in the 1998 Credit Agreement) at given times. As of August
13, 1998, the interest rates on the balance of $80.2 million outstanding under
the Term Loan Facility and on a $1.0 million and an $8.0 million note
outstanding under the Revolving Credit Facility were 8.44%, 8.50% and 8.44%,
respectively.
Amounts outstanding under the Term Loan Facility are required to be repaid
in consecutive quarterly installments, the first was paid on June 30, 1998 and
the next two installments (each in the aggregate principal amount of
approximately $3.33 million) are
29
due on the last day of each of the two calendar quarters commencing with the
quarter ending September 30, 1998. The next 20 installments in the aggregate
principal amount of $5.0 million each will be due on the last day of each
calendar quarter commencing with the quarter ending March 31, 1999. The final
installment under the Term Loan Facility will be payable on February 3, 2004.
The Revolving Credit Facility will mature on February 3, 2004. As of August 13,
1998, $80.2 million in outstanding principal amount had been borrowed under the
Term Loan Facility and $9.0 million in outstanding principal amount had been
borrowed under the Revolving Credit Facility.
Loans under the Term Loan Facility and the Revolving Credit Facility may be
prepaid at any time and are subject to certain mandatory prepayments in an
amount equal to (i) 100% of the net proceeds in excess of $1.0 million received
from the issuance of equity by the Company or its subsidiaries, (ii) 100% of the
net proceeds from certain asset sales in excess of $0.5 million in any calendar
year and (iii) 50% (75% for the Company's 1998 fiscal year) of the Company's
Excess Cash Flow (as defined in the 1998 Credit Agreement) if the ratio of its
Funded Debt to EBITDA as of the last day of the fiscal year is less than 2.5 to
1.0. Prepayments under the Revolving Loan Facility will be applied first to
reduce Base Rate loans until they are reduced to zero and then to reduce LIBOR
loans. On June 30, 1998, pursuant to the terms of the 1998 Credit Agreement, the
Company reduced the principal amounts outstanding under the Term Loan Facility
by $24.3 million, and by $5.5 million on August 6, 1998.
The Term Loan Facility and the Revolving Credit Facility are guaranteed, on
a joint and several basis, by the Company and certain of the direct and indirect
subsidiaries of the Company. The 1998 Credit Agreement contains representations
and warranties, affirmative and negative covenants and events of default
customary for similar financings.
On June 30, 1998, the Company and the Lenders agreed to the third amendment
to the 1998 Credit Agreement which revised the definition of the borrowing base
to include the entire amount of the Revolving Loan Facility through November 30,
1998. As of June 30, 1998, the company was in violation of the covenant
contained in the 1998 Credit Agreement which required the ratio of funded debt
to EBITDA for the trailing twelve month period to be at or below 4.25 to 1. The
Company and the Lenders have agreed to waive this requirement by entering into
the fourth amendment to the 1998 Credit Agreement to increase the maximum
allowable ratio of funded debt to EBITDA to 5.00 to 1.00 for each of the fiscal
quarters ended June 30, 1998 and September 30, 1998. The fourth amendment also
increases the amount of capital expenditures allowed from $6.0 million, to $10.0
million to allow the Company to pursue additional payphone acquisitions.
The Company believes that cash generated from operations and available
borrowings under the credit facility will be sufficient to fund the Company's
foreseeable cash requirements, including capital expenditures through February
3, 2004. The Company also believes that it will be able to fund any future
acquisitions through a
30
combination of cash generated from operations, additional borrowing and the
issuance of shares of its Common Stock. There can be no assurance, however, that
the Company will continue to expand at its current rate or that additional
financing will be available when needed or, if available, will be available on
terms acceptable to the Company.
IMPACT OF INFLATION
Inflation is not a material factor affecting the Company's business.
General operating expenses such as salaries, employee benefits and occupancy
costs are, however, subject to normal inflationary pressures.
SEASONALITY
The Company's revenues from its payphone operating regions are affected by
seasonal variations, geographic distribution of payphones and type of location.
Because many of the Company's payphones are located outdoors, weather patterns
have differing effects on the Company's results depending on the region of the
country where they are located. Most of the Company's payphones in Florida
produce substantially higher call volume in the first and second quarters than
at other times during the year, while the Company's payphones throughout the
midwestern and eastern United States produce their highest call volumes during
the second and third quarters. While the aggregate effect of the variations in
different geographical regions tend to counteract the effect of one another, the
Company has historically experienced higher revenue and income in the second and
third quarters than in the first and fourth quarters. Changes in the
geographical distribution of its payphones may in the future result in different
seasonal variations in the Company's results.
YEAR 2000 ISSUE
The Company is working to resolve the potential impact of the year 2000 on
the ability of the Company's computerized information systems to accurately
process information that may be date-sensitive. Any of the Company's programs
that recognize a date using "00" as the year 1900 rather than the year 2000
could result in errors or system failures. The Company utilizes a number of
computer programs across its entire operation. The Company has assessed the
impact of the year 2000 on both its computer programs and its computer systems.
As the Company acquires other payphone assets, it will continue to assess the
impact of the year 2000 on such acquired assets. To date, the Company has spent
approximately $0.1 million in assessing and addressing year 2000 issues and
estimates that its total costs will not exceed $0.2 million, which is
approximately 10% of the Company's budgeted expenditures for information
technology. The Company does not believe that these costs will have a material
effect on its financial position. The Company is also in the process of
addressing the potential impact of the year 2000 on its suppliers and other
parties on whom it relies in providing payphone and operator services. The
Company intends to complete this assessment by December 31, 1998. The failure of
third parties on which the Company relies to address their year 2000
31
issues in a timely manner could result in a material financial risk to the
Company. Through its assessment of the impact of year 2000 on both its computer
programs and systems, the Company believes that it has sufficient resources
available to implement new and modified computer systems to address the impact
of the year 2000, and accordingly, has not to date identified any need for other
contingency planning. However, the Company's continuing assessment of its assets
and of third parties external to the Company may reveal the need for contingency
planning in the future. The Company plans to devote all resources required to
resolve any significant year 2000 issues in a timely manner.
32
PART II - OTHER INFORMATION
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Reports on Form 8-K.
On April 20 and April 21, 1998, the Company filed Current Reports on Form
8-K/A to include pro forma financial statements and exhibits in connection
with the acquisition of Communications Central Inc.
On April 30, 1998, the Company filed a Current Report on Form 8-K to report
that its Board of Directors had approved the adoption of a Shareholder
Rights Plan which authorized the issuance of one preferred share purchase
right for each outstanding share of common stock, without par value, of the
Company.
On June 23, 1998, the Company filed a Current Report on Form 8-K to report
the closing of an agreement with an affiliate of Equity Group Investments,
Inc., a privately-held investment company controlled by Sam Zell, and to
announce the signing of a definitive agreement to merge with PhoneTel
Technologies, Inc., based in Cleveland, Ohio.
On July 22, 1998, the Company filed a Current Report on Form 8-K to report
the signing of a definitive agreement to merge with Peoples Telephone
Company, Inc., based in Miami, Florida.
33
SIGNATURE
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Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Amendment No. 2 on Form 10-Q/A to be signed
on its behalf by the undersigned thereunto duly authorized.
DAVEL COMMUNICATIONS GROUP, INC.
Date: November 9, 1998 /s/ Michael E. Hayes
------------------------------
Michael E. Hayes
Senior Vice President and
Chief Financial Officer
34