U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
COMMISSION FILE NUMBER 0-16715
PHONETEL TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
OHIO 34-1462198
---- ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
NORTH POINT TOWER, 7TH FLOOR, 1001 LAKESIDE AVENUE,
CLEVELAND, OHIO 44114-1195
--------------- ----------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(216) 241-2555
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
COMMON STOCK, PAR VALUE $0.01 NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, $0.01 PAR VALUE
----------------------- -----
(TITLE OF CLASS)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
---- ----
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [ X ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 18, 2002 was $347,000.
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 after the distribution of securities under a plan confirmed
by a court.
Yes X No
---- ----
The number of shares outstanding of the registrant's Common Stock, $.01 par
value, as of March 18, 2002 was 10,189,684.
Documents Incorporated by Reference
None
PART I
RECENT DEVELOPMENTS
On June 13, 2001, PhoneTel Technologies, Inc. ("PhoneTel") announced that
it had signed a letter of intent to merge with Davel Communications, Inc.
("Davel") which is headquartered in Tampa, Florida and operates approximately
54,000 payphones in 44 states and the District of Columbia. On February 19,
2002, the Company executed a definitive merger agreement with Davel (the "Davel
Merger Agreement") which was unanimously approved by the boards of directors of
both companies. In connection with the expected merger, PhoneTel will become a
wholly owned subsidiary of Davel. In addition, in June 2001 the two companies
entered into a servicing agreement designed to commence cost savings initiatives
in advance of the closing of the merger. During the third quarter of 2001, the
two companies implemented the servicing agreement by combining field service
office operation networks on a geographic basis to gain efficiencies resulting
from the increased concentration of payphone service routes. The Company and
Davel were able to close 21 district operations facilities, eliminate 104
vehicles, and reduce the number of field service personnel by 114 in connection
with the servicing agreement. The companies estimate that this will result in an
annual cost saving of approximately $6.0 million, which is reflected in the
combined field operations cost that is being shared by both companies in
proportion to the number of pay telephones owned by each pursuant to the
servicing agreement.
In connection with the merger, the existing secured lenders of both Davel
and PhoneTel have agreed to exchange a substantial amount of debt for equity
securities of the respective companies and to restructure the remaining debt. In
addition, on February 19, 2002 Davel and PhoneTel have each executed amendments
to their existing credit agreements and have entered into a new combined
$10,000,000 senior credit facility.
In connection with PhoneTel's debt exchange, its existing secured lenders
will own 87% of PhoneTel's outstanding common stock immediately prior to the
merger with the remaining secured debt not to exceed $36,500,000 (compared to
$62,635,000 outstanding at December 31, 2001, including accrued interest).
Existing holders of PhoneTel common stock will own 9% of PhoneTel's outstanding
shares immediately prior to the merger, and 4% will be reserved for issuance of
post-closing employee options and other stock-based incentives, on a fully
diluted basis. In connection with Davel's debt exchange, its existing secured
lenders will own 93% of Davel's outstanding common stock immediately prior to
the merger, with the remaining secured debt not to exceed $63,500,000 (compared
to approximately $274,000,000 outstanding at December 31, 2001, including
accrued interest). Existing shareholders of Davel common stock will own 3% of
Davel's outstanding shares immediately prior to the merger, and 4% of the common
stock will be reserved for issuance of post-closing employee options and other
stock-based incentives, on a fully diluted basis.
Immediately following the merger, current PhoneTel shareholders will own
approximately 3.28% of the shares of Davel common stock and current Davel
shareholders will own approximately 1.91%. Of the remaining shares, 4.00% are
intended to be reserved for issuance of post-closing employee options and other
stock-based incentives, on a fully diluted basis and the companies' existing
lenders will own approximately 90.81%.
Effective with the merger, the then outstanding debt of both entities,
currently in the approximate amount of $337,000,000, will be converted to
$100,000,000 in debt of the merged entity through the debt and equity
restructuring outlined above. Of this $100,000,000 of restructured debt,
$50,000,000 will be amortizing term debt with interest and principal payable
from operating cash flows. Payment of the interest and principal on the
remaining $50,000,000 of term debt will be payable at maturity. Under the
commitment letter issued by the existing secured lenders of both PhoneTel and
Davel on February 19, 2002, interest on the term debt will be payable at a rate
of 10% per annum and the debt will mature on December 31, 2005. The commitment
is contingent upon the consummation of the merger and expires on August 31,
2002. Upon consummation of the debt restructuring described above, the Company
estimates, based on the carrying value of its debt at December 31, 2001, that it
will have an extraordinary gain relating to the restructuring of approximately
$6.7 million.
The Davel Merger is subject to approval by the shareholders of both
companies and the receipt of material third party and governmental approvals and
consents. In conjunction with the transaction, PhoneTel will also seek
shareholder approval to increase the number of authorized shares of common stock
from 45,000,000 to approximately 125,000,000 shares. No dates have been set for
the stockholders' meetings.
1
As discussed in Note 3 to the consolidated financial statements and Item 7,
Liquidity and Capital Resources, the Company has incurred recurring operating
losses, has a substantial working capital deficiency and has been unable to
comply with the terms of its secured debt agreement. These conditions raise
substantial doubt regarding the Company's ability to continue as a going
concern. The Company believes, but cannot assure, that the new combined
$10,000,000 senior credit facility, the operational achieved efficiencies under
the servicing agreement, and the additional cost savings expected in connection
with the servicing agreement will allow the Company to sustain its operations
and meet its obligations through the remainder of 2002, or until the proposed
merger with Davel is completed.
ITEM 1. BUSINESS
GENERAL
PhoneTel Technologies, Inc. (the "Company" or "PhoneTel") was incorporated
under the laws of the State of Ohio on December 24, 1984. The Company operates
in the telecommunications industry, which encompasses the installation and
operation, in and on property owned by others, of public payphones on a revenue
sharing basis and the resale of operator assisted and long distance services.
The Company considers this to be a single reportable business segment. The
Company's principal executive offices are located at North Point Tower, 7th
Floor, 1001 Lakeside Avenue, Cleveland, Ohio 44114-1195 and its telephone number
is (216) 241-2555.
The Company owns, operates, services, and maintains a system of public
payphones. The Company derives substantially all of its revenues from coin and
non-coin calls placed from its public payphones. The Company enters into
contracts with the owners of premises ("Location Owners") to operate public
payphones at locations where significant demand exists for public payphone
services, such as shopping centers, convenience stores, service stations,
grocery stores, restaurants, truck stops and bus terminals.
The Company has increased its revenue base from 2,350 installed public
payphones at December 31, 1993 to 29,583 at March 8, 2002. This growth from 1993
was principally achieved through acquisitions and to a lesser extent through new
payphone installations resulting from the Company's internal sales and marketing
efforts.
During 1993 through 1998, the Company's objective was to expand its
payphone base through acquisitions, as well as through internal growth, thereby
achieving economies of scale while implementing cost savings principally through
elimination of duplicate functions. Selective acquisitions enabled PhoneTel to
expand its geographic presence and further its strategy of clustering its public
payphones more rapidly than would have been possible through internal growth.
Beginning in 1998, the Company's revenues began to decline as a result of
increased competition from providers of wireless communication services and the
impact of certain regulatory changes. Since 1998 the Company's strategy has been
to improve the Company's operating results through improved assets management,
enhanced revenue sources and cost controls. In that regard, the Company's
strategy in the last two years has been to remove low revenue payphones that do
not meet the Company's minimum criteria of profitability and to improve the
density of the Company's payphone routes. During the years ended December 31,
2000 and 2001, the Company removed approximately 3,400 and 2,000 payphones,
respectively, many of which have been or will be redeployed to new locations
where the potential to generate sufficient revenue is better. The Company has an
ongoing program to evaluate and identify payphones for removal that are not
economically viable.
The Company has focused its internal sales and marketing efforts to obtain
additional contracts to own and operate public payphones with new and existing
national, regional and local accounts. In evaluating locations for the
installation of public payphones, the Company conducts a site survey to examine
various factors, including population density, traffic patterns, historical
usage information and other geographic factors. The installation of public
payphones in new locations is generally less expensive than acquiring public
payphones. As part of its strategy to continue to reduce operating costs, the
Company outsources its long distance and operator services to a number of
subcontractors that are operator service providers ("OSPs"), and in January 2000
selected One Call Communications, Inc., d/b/a Opticom ("Opticom") as its
principal OSP.
Substantially all of the Company's public payphones are "smart" telephones
and are operated by means of advanced microprocessor technology that enables the
telephones to perform substantially all of the necessary
2
coin-driven and certain non coin-driven functions independent of the Company's
central office. Unlike "dumb" telephones used by most Regional Bell Operating
Companies ("RBOCs") and other Local Exchange Carriers ("LECs"), smart
telephones, in concert with PhoneTel's management information systems, enable
PhoneTel to continuously determine each telephone's operability and need for
service as well as its readiness for collection of coin revenues. Rate changes
and other software-dependent functions can be performed from the central office
without dispatching service technicians to individual public payphones of the
Company.
The Company employs both advanced telecommunications technology and trained
field technicians as part of its commitment to provide superior customer
service. The technology used by PhoneTel enables it to maintain accurate records
of telephone activity which can be verified by customers, as well as respond
quickly to equipment malfunctions. The Company's standard of performance is to
repair malfunctions within 24 hours of the time in which it is reported.
The Company seeks to promote and achieve recognition of its products and
services by posting the "PhoneTel" label on all of its public payphones. The
Company believes that achieving market recognition will facilitate its expansion
strategy by enhancing its ability to obtain additional accounts and encouraging
the use of its public payphones in locations where consumers have multiple
payphone options.
Events Leading up to the Company's Chapter 11 Bankruptcy Reorganization
-----------------------------------------------------------------------
The Company financed its growth from 1996 to 1998, which resulted
principally from acquisitions, by completing concurrent publicly underwritten
offerings of Common Stock (the "Company Equity Offering") and $125,000,000
aggregate principal amount 12% Senior Notes due 2006 (the "Senior Notes" or
"Company Debt Offering") in December 1996. Some of the Company's acquisitions,
capital expenditures and working capital requirements were also financed by the
Company's secured borrowings under its Credit Agreement. As a result of
declining revenues caused by competition from wireless communications companies
and the impact of aggressive marketing of long distance service offered by
interexchange carriers, the Company was unable to make the interest payment due
on December 15, 1998 on its Senior Notes and was therefore in default on this
debt. Further, the Company was not in compliance with certain financial
covenants under its Credit Agreement at December 31, 1998 and was also in
default on this debt.
At the end of 1998, the Company entered into discussions with an unofficial
committee of Senior Noteholders (the "Unofficial Committee") in an attempt to
restructure its debt. In January 1999, the Company announced that it had reached
an agreement in principle with the Unofficial Committee providing for the
conversion, through a prepackaged plan of reorganization (the "Prepackaged
Plan"), of the Senior Notes and accrued interest thereon into 95% of a new issue
of common stock, $0.01 par value per share ("Common Stock (Successor Company)")
of the reorganized Company (the "Restructuring").
The Company solicited and received acceptances of the Prepackaged Plan from
the holders of the Senior Notes and the 14% Cumulative Redeemable Convertible
Preferred Stock (the "14% Preferred") in anticipation of the commencement of a
case under Chapter 11 of the Bankruptcy Code (the "Case"). On July 14, 1999, the
Company commenced the Case in the U.S. Bankruptcy Court in the Southern District
of New York (the "Court") and thereafter continued to operate its business
through November 17, 1999 as a debtor-in-possession. On July 21, 1999, the
Company refinanced its Credit Agreement from the proceeds of a
debtor-in-possession financing agreement obtained from the Company's existing
secured lender. The Company also obtained a commitment from its existing lender
to provide post reorganization financing.
Confirmation and Consummation of the Prepackaged Plan
-----------------------------------------------------
On October 20, 1999, the Court confirmed the Prepackaged Plan. On November
17, 1999, the Company executed a post reorganization loan agreement ("Exit
Financing Agreement") and consummated the Prepackaged Plan. Pursuant to the
terms of the Prepackaged Plan, claims of employees, trade and other creditors of
the Company, other than holders of the Senior Notes were to be paid in full in
the ordinary course of business, unless otherwise agreed. Holders of the Senior
Notes received 9,500,000 shares of the Common Stock (Successor Company) in
exchange for the Senior Notes. In addition, the Unofficial Committee
representing a majority in principal amount of the Senior Notes appointed four
of the five members of the Board of Directors of the Company (the "New Board").
3
Holders of the 14% Preferred received 325,000 shares of Common Stock
(Successor Company) and warrants to purchase up to 722,200 shares of Common
Stock (Successor Company) at an exercise price of $10.50 per share which expire
three years from the date of grant ("New Warrants"). Holders of existing Common
Stock received 175,000 shares of Common Stock (Successor Company) and New
Warrants to purchase up to 388,900 shares of Common Stock (Successor Company).
Options and warrants to purchase existing common stock were extinguished
pursuant to the Prepackaged Plan.
The equity interests issued in connection with the Prepackaged Plan were
subject to dilution by certain other equity issuances, including the issuance of
205,000 shares of Common Stock (Successor Company) to certain financial advisors
for services rendered in connection with the reorganization, and issuances
resulting from the exercise of certain options to purchase up to 5% of Common
Stock (Successor Company) to be issued by the New Board pursuant to the terms of
a management incentive plan ("1999 Management Incentive Plan") and other awards
included as part of the Prepackaged Plan.
As of November 17, 1999 (the "Consummation Date"), the total amount of
Common Stock (Successor Company) outstanding, after giving effect to Common
Stock (Successor Company) and New Warrants forfeited in connection with a
warrant put obligation settlement, was 10,188,630 shares. In addition, 1,074,721
shares of Common Stock (Successor Company) were reserved for future issuance
upon the exercise of the New Warrants, and an amount equal to 5% of the shares
of Common Stock (Successor Company) was reserved for issuance pursuant to the
terms of the 1999 Management Incentive Plan.
INDUSTRY OVERVIEW
Public payphones are primarily owned and operated by RBOCs, other LECs and
Independent Payphone Providers ("IPPs"). Certain long distance companies
(referred to as interexchange carriers or "IXCs") also own and operate public
payphones. In 1998, there were approximately 2.1 million public payphones in the
United States that generated revenues of approximately $5.74 billion. As a
percentage of revenues, RBOCs and other LECs had 79.8% of this market while IPPs
and IXCs had market shares of 15.6% and 4.6%, respectively. Within the United
States, the Multimedia Telecommunications Association estimated that there were
approximately 342,000 public payphones owned by IPPs. As a result of competition
from providers of wireless communication services and the use of prepaid calling
cards and other types of dial-around calls, the Company estimates that the
number of public payphones have declined by at least one third and the current
level of revenues has declined by as much as fifty percent.
Today's telecommunications marketplace was principally shaped by the 1984
court-directed divestiture of the RBOCs by American Telephone & Telegraph
Company ("AT&T"). The AT&T divestiture and the many regulatory changes adopted
by the FCC and state regulatory authorities in response to the AT&T divestiture,
including the authorization of the connection of competitive or
independently-owned public payphones to the public switched network, have
resulted in the creation of new business segments in the telecommunications
industry. Prior to these developments, only RBOCs or other LECs owned and
operated public payphones.
As part of the AT&T monopoly break-up, the United States was divided into
geographic areas known as local access transport areas ("LATAs") designed to
differentiate between local telephone service and long-distance telephone
service. Traditionally, RBOCs and other LECs provide intraLATA telephone service
pursuant to tariffs filed with and approved by state regulatory authorities.
Until recently, RBOCs were prohibited from offering or deriving revenues or
income from interLATA telecommunications services. IXCs, such as AT&T and MCI
Worldcom ("MCI"), provide interLATA services and, in some circumstances, may
also provide long distance service within LATAs. An interLATA long distance
telephone call generally begins with an originating LEC transmitting the call
from the originating telephone to a point of connection with a long distance
carrier. The long distance carrier, through its owned or leased switching and
transmission facilities, transmits the call across its long distance network to
the LEC servicing the local area in which the recipient of the call is located.
This terminating LEC then delivers the call to the recipient.
Under the February 8, 1996 enactment of the Telecommunications Act, the
RBOCs may provide interLATA telecommunications services and may compete for the
provision of interLATA toll calls upon receipt of all necessary regulatory
approvals and the satisfaction of applicable conditions. The Telecommunications
Act permits
4
the RBOCs to provide virtually all "out of region" long distance
telecommunications services immediately upon the receipt of any state and/or
federal regulatory approvals otherwise applicable to long distance service. For
the RBOCs and other LECs to provide interLATA toll service within the same
states in which they also provide local exchange service ("in-region service"),
prior FCC approval must be obtained. The timing of such approval is unclear and
may depend on the outcome of litigation related to recent regulations
promulgated by the FCC relating to the duties of RBOCs and other incumbent LECs
under section 251 of the Telecommunications Act. This FCC approval to provide
"in-region" service is conditioned upon, among other things, a showing by an
RBOC or other LEC that, with certain limited exceptions, facilities-based local
telephone competition is present in its market, and that it has satisfied the
14-point "competitive checklist" established by the Telecommunications Act which
includes, among other things, that the RBOC or other LEC has entered into at
least one interconnection agreement. In addition, the Telecommunications Act is
designed to facilitate the entry of any entity (including cable television
companies and utilities) into both the competitive local exchange and long
distance telecommunications markets. As a result of the Telecommunications Act,
long distance companies (such as AT&T and MCI), cable television companies,
utilities and other new competitors will be able to provide local exchange
service in competition with the incumbent RBOC or other LEC. This should
ultimately increase the number and variety of carriers that provide local access
line service to IPPs such as PhoneTel.
Prior to 1987, coin calls were the sole source of revenues for IPPs. Long
distance calling card and collect calls from these public payphones were handled
exclusively by AT&T. Beginning in 1987, a competitive operator service system
developed which allowed OSPs, including long distance companies such as MCI, to
handle non-coin calls and to offer IPPs commissions for directing operator
assisted or calling card calls to them. See "Regulatory Matters."
Generally, public payphone revenues may be generated through: (i) coin
calls; (ii) operator service calls ("0+," i.e., credit card, collect and third
number billing calls, and "0-," i.e., calls transferred by the LECs to the OSPs
requested by the caller); and (iii) access code calls using carrier access
numbers (e.g., "1010XXX" codes, "1-800," "1-888" or "950"). Section 276 of the
Telecommunications Act and the FCC's implementing regulations permit IPPs to
generate additional revenues from all of these three categories, each of which
consists of local, intraLATA toll, intrastate interLATA, interstate interLATA
and international call components. See "Regulatory Matters."
ACQUISITIONS
In 1993 through 1998, the Company sought to grow its payphone base through
acquisitions. The following table summarizes in reverse chronological order the
Company's significant acquisitions since January 1, 1997.
NUMBER OF
DATE OF INSTALLED PRIMARY
COMPANY ACQUIRED ACQUISITION PAYPHONES AREAS SERVED
---------------- ----------- --------- ------------
TDS Telecommunications Corporation ("TDS") May 18, 1998 3,407 Tennessee, Wisconsin,
Maine, Michigan,
Minnesota
London Communications, Inc. ("London") June 10, 1997 2,519 Georgia, North
Carolina, South
Carolina
American Public Telecom, Inc. ("American") May 30, 1997 859 Michigan
Advance Pay Systems, Inc. ("Advance") May 30, 1997 800 Virginia
Coinlink, LLC ("Coinlink") February 14, 1997 300 Oklahoma
RSM Communications, Inc. ("RSM") January 31, 1997 292 Tennessee
Americom, Inc. ("Americom") January 17, 1997 99 Arizona
Texas Coinphone ("Texas Coinphone") January 14, 1997 1,250 Texas
Cherokee Communications, Inc. ("Cherokee") January 1, 1997 13,949 Texas, New Mexico,
------ Colorado, Utah, Montana
Total installed public payphones acquired
in the two year period ended December 31, 1998 23,475
======
Total installed public payphones at March 8, 2002 29,583
======
5
The Company has not made any acquisitions since 1998. With the exception of
Cherokee, each of the companies or businesses listed in the foregoing chart was
acquired by PhoneTel either as an asset purchase or a stock purchase with a
subsequent merger of the acquired entity into the Company, with PhoneTel being
the surviving corporation. Cherokee is the Company's sole active subsidiary and
is 100% owned by the Company.
PRODUCTS AND SERVICES
The Company's primary business is to install and operate payphones on a
revenue sharing basis by obtaining contracts, either through acquisitions or
internal growth, from Location Owners. The Company installs public payphones in
properties owned or controlled by others where significant demand exists for
public payphone services, such as shopping centers, convenience stores, service
stations, grocery stores, restaurants, truck stops and bus terminals, at no cost
to the Location Owner. The Company services and collects the revenue generated
from the public payphones and pays the Location Owner a share of the revenues
generated by the telephone in consideration for permitting the installation of
the payphone on its premises.
The term of a location agreement generally ranges from three to ten years
and usually provides for an automatic renewal of the term of the contract unless
it is canceled in writing by the Location Owner pursuant to the terms of the
agreement. The Company can generally terminate a location agreement on 30 days'
prior notice to the Location Owner if the public payphone does not generate
sufficient total revenues for two consecutive months. Under certain of the
Company's Location Owner agreements, the failure of PhoneTel to remedy a default
within a specified period after notice may give the Location Owner the right to
terminate such location agreement. The duration of the contract and the
commission arrangement depends on the location, number of telephones and revenue
potential of the account.
Substantially all of the Company's public payphones accept coins as well as
other forms of payment for local or long-distance calls. The Company's public
payphones generate coin revenues primarily from local calls. Prior to October 7,
1997, state regulatory authorities typically set the maximum rate for local coin
calls that could be charged by RBOCs, other LECs and IPPs. The Company generally
was required to charge the same rate as the RBOCs and the other LECs for local
calls in substantially all of the states in which the Company's public payphones
are located. In most states that charge was $0.25, although in some
jurisdictions the charge was less than $0.25 per local call, and in a limited
number of other jurisdictions that had already deregulated the price of local
calls, the charge was $0.35. On October 7, 1997, the effective date of the FCC's
mandate to deregulate the local coin rate, the Company increased the amount
charged to place a local coin call from $0.25 to $0.35 on substantially all of
its payphones. See "Regulatory Matters." At the end of 2001 and early 2002, the
Company further increased the local coin rate to $0.50. A majority of the
Company's pay telephones currently have a local coin rate of $0.50, although
rates are lower in some markets due to competitive conditions.
Traditionally, local coin calls are provided using flat rate service,
although some jurisdictions in which the Company's public payphones are located
allow call timing, which requires the deposit of an additional amount after a
specified period of time has elapsed. The Company pays monthly line and usage
charges to LECs or competitive local exchange carriers ("CLECs") for all of its
installed public payphones. These charges cover basic telephone service as well
as the transport of local coin calls.
The Company outsources its long distance and operator service operations to
a number of OSPs, including Opticom, which is PhoneTel's primary provider of
such services. The revenue PhoneTel receives from each OSP is determined based
on the volume of calls carried by the OSP and the amount of revenues generated
by the calls. PhoneTel also receives revenues from long distance carriers for
calls made from its public payphones, including dial-around calls when the
caller dials a code to obtain access to an OSP or a long distance company other
than one designated by the Company. See "Regulatory Matters."
Management believes that the implementation of the Telecommunications Act
and the resultant FCC Rules will continue to provide significant additional
revenues for PhoneTel, net of related expenses and processing fees. There can be
no assurance, however, that the rules, regulations, and policies adopted by the
FCC on its own or after judicial review will not have a material adverse affect
on PhoneTel's business, results of operations, or financial condition. See
"Regulatory Matters."
6
TELEPHONE EQUIPMENT SUPPLIERS
The Company purchases the majority of its payphones from two manufacturers
of public payphones, New Intellicall Company, Inc. (formerly Intellicall, Inc.)
and Protel, Inc. Although each manufacturer uses similar technology, the Company
seeks to install primarily a single brand of telephone within a specific
geographic area. This maximizes the efficiency of the Company's field
technicians and makes stocking of appropriate spare parts more effective. As a
result of the Company's ongoing program to redeploy equipment that is removed
from service at unprofitable locations, the Company's current level of demand
for new equipment has declined. The Company expects the basic availability of
such products and services to continue in the future; however, the continuing
availability of alternative sources cannot be assured. Although the Company is
not aware of any current circumstances that would require the Company to seek
alternative suppliers for any material portion of the products used in the
operation of its business, transition from the Company's existing suppliers, if
necessary, could have a disruptive effect on the Company's operations and could
give rise to unforeseen delays and/or expenses. In connection with the service
agreement entered into with Davel, the Company has been utilizing Davel to
assemble, repair and refurbish its payphone equipment. It is the Company's
policy to place the PhoneTel name on telephones that it installs or acquires.
SALES AND MARKETING
The Company utilizes its internal sales force and independent sales
representatives to market its products and services. The internal sales force
receives salary plus incentive compensation for each public payphone installed,
and the independent sales representatives are paid on a commission-only basis
for each public payphone installed. In addition, in certain instances, the
Company pays a fee to its technicians for securing location agreements for new
installations. The Company also markets its products and services through
advertising in booths at trade shows and referrals from existing customers.
The Company directs a major portion of its marketing efforts for public
payphones to multi-station accounts, such as shopping centers, convenience
stores, service stations, grocery stores, restaurants, truck stops and bus
terminals. These multi-station accounts have the advantage of greater efficiency
in collection and maintenance. PhoneTel also solicits single station accounts
where there is a demonstrated high demand for public payphone service. In
evaluating locations for the installation of public payphones, the Company
generally conducts a site survey to examine various factors, including
population density, traffic patterns, historical usage information and other
geographical factors. The Company generally will not install a public payphone
unless management believes, based on the site survey, that the site will
generate an adequate level of revenues.
CUSTOMERS
The Company's public payphone operations are diversified on both a
geographical and customer account basis. Currently, PhoneTel owns and operates
public payphones in 45 states and the District of Columbia (approximately 94% of
such public payphones are located in 24 states, including 15.1% in Texas)
through agreements both with multi-station customers such as shopping centers,
convenience stores, service stations, grocery stores, restaurants, truck stops
and bus terminals and with single station customers. No single customer
generated 10% or more of PhoneTel's total revenue for the years ended December
31, 1999, 2000, or 2001.
GOVERNMENT REGULATIONS
The FCC and state regulatory authorities have traditionally regulated
payphone and long-distance services, with regulatory jurisdiction being
determined by the interstate or intrastate character of the service and the
degree of regulatory oversight varying among jurisdictions. On September 20 and
November 8, 1996, the FCC adopted rules and policies to implement section 276 of
the Telecommunications Act. The Telecommunications Act substantially
restructured the telecommunications industry, included specific provisions
related to the payphone industry and required the FCC to develop rules necessary
to implement and administer the provisions of the Telecommunications Act on both
an interstate and intrastate basis. Among other provisions, the
Telecommunications Act granted the FCC the power to preempt state regulations to
the extent that any state requirements are inconsistent with the FCC's
implementation of section 276.
7
Federal regulation of local coin and dial-around calls
------------------------------------------------------
The Telephone Operator Consumer Services Improvement Act of 1990 ("TOCSIA")
established various requirements for companies that provide operator services
and for call aggregators, including payphone providers, who send calls to those
companies. The requirements of TOCSIA as implemented by the FCC included call
branding, information posting, rate quoting, the filing of information tariffs
and the right of payphone users to obtain access to any OSP to make non-coin
calls. TOCSIA also required the FCC to take action to limit the exposure of
payphone companies to undue risk of fraud.
TOCSIA further directed the FCC to consider the need to provide
compensation for IPPs for dial-around calls (non-coin calls placed from a
payphone that utilizes any carrier other than the IPPs presubscribed carrier for
long distance and operator assisted calls). Accordingly, the FCC ruled in May
1992 that IPPs were entitled to dial-around compensation. Because of the
complexity of establishing an accounting system for determining per call
compensation for these calls and other reasons, the FCC temporarily set this
compensation at $6.00 per payphone per month based on an assumed average of 15
interstate carrier access code dial-around calls at $0.40 per call. The failure
by the FCC to provide compensation for 800 subscriber dial-around calls was
challenged by the IPPs, and a federal court subsequently ruled that the FCC
should have provided for compensation for these calls.
In 1996, recognizing that IPPs had been at a severe competitive
disadvantage under the existing system of regulation and had experienced
substantial increases in the volume of dial-around calls without a corresponding
adjustment in compensation, Congress enacted section 276 of the
Telecommunications Act to promote both competition among payphone service
providers and the widespread deployment of payphones. Section 276 directed the
FCC to implement FCC Rules by November 1996 which would:
- create a standard regulatory scheme for all public payphone
providers;
- establish a per-call compensation plan to ensure that all
payphone service providers are fairly compensated for each and
every completed intrastate and interstate call except for 911
emergency and telecommunications relay service calls;
- terminate subsidies for LEC payphones from LEC-regulated base
operations;
- prescribe, at a minimum, nonstructural safeguards to eliminate
discrimination between LECs and IPPs and remove the LEC payphones
from the LEC's regulated asset base;
- provide for the RBOCs to have the same rights that IPPs have to
negotiate with Location Owners over the selection of interLATA
carrier services subject to the FCC's determination that the
selection right is in the public interest and subject to existing
contracts between the Location Owners and interLATA carriers;
- provide for the right of all payphone service providers to choose
the local, intraLATA and interLATA carriers subject to the
requirements of, and contractual rights negotiated with, Location
Owners and other valid state regulatory requirements;
- evaluate the requirement for payphones which would not normally
be installed under competitive conditions but which might be
desirable as a matter of public policy, and establish how to
provide for and maintain such payphones if it is determined that
they are required; and
- preempt any state requirements which are inconsistent with the
FCC's regulations implementing section 276.
In September and November 1996, the FCC issued an order implementing
section 276 (the "1996 Payphone Order"). In the 1996 Payphone Order, the FCC
determined that the best way to ensure fair compensation to independent and LEC
payphone providers for each and every call was to deregulate to the maximum
extent possible the price of all calls originating from payphones. For local
coin calls, the FCC mandated that deregulation of the local coin rate would not
occur until October 1997 in order to provide a period of orderly transition from
the previous system of state regulation. As a result of the deregulation of the
local coin rate, most of the RBOCs and other payphone providers (including
PhoneTel) implemented an increase in the local coin rate to $0.35 per call in
most jurisdictions. More recently, many of the RBOCs and
8
other payphone providers, including PhoneTel, have further increased the local
coin call to $0.50 or more in many jurisdictions.
To achieve fair compensation for dial-around calls through deregulation and
competition, the FCC in the 1996 Payphone Order directed a two-phase transition
from a regulated market. Among other things, the 1996 Payphone Order prescribed
compensation payable to the payphone providers by certain IXCs for dial-around
calls placed from payphones and, to facilitate per-call compensation, the FCC
required the payphone providers to transmit payphone specific coding digits that
would identify each call as originating from a payphone ("Flex Ani"). The FCC
required LECs to make such coding available to the payphone providers as a
transmit item included in the local access line service. The 1996 Payphone Order
set an initial monthly rate of $45.85 per pay telephone for the first year after
its implementation (the "Interim Period"), an increase from the monthly per pay
telephone rate of $6.00 in periods prior to its implementation. Thereafter, the
FCC set dial-around compensation on a per-call basis, at the assumed deregulated
coin rate of $0.35. The monthly rate during the Interim Period was arrived at by
the product of the assumed deregulated coin rate ($0.35) and the then monthly
average compensable dial-around calls per payphone. A finding from the record
established at the time that the monthly average compensable calls were 131 per
phone.
The 1996 Payphone Order was appealed by various parties, including the
IXCs, to the United States Court of Appeals for the District of Columbia Circuit
(the "Appeals Court"). Among other items, the Appeals Court found that the FCC
erred in using a market-based method for calculating the amount of dial-around
compensation and further determined that the method of allocating payment among
IXCs was erroneous. In July 1997, the Appeals Court vacated the 1996 Payphone
Order and remanded it to the FCC for further consideration. As a result of this
ruling by the Appeals Court, certain IXCs discontinued or reduced the amount of
dial-around compensation actually paid to payphone service providers for the
Interim Period.
In response to the remand by the Appeals Court, in October 1997 the FCC
issued a new order implementing Section 276 (the "1997 Payphone Order"). The FCC
utilized a market-based method to arrive at a per call compensation rate and
then reduced it by certain costs attributable to a coin call which it did not
believe applied to a dial-around call, and adjusted the per-call rate from $0.35
to $0.284 (the "Default Rate"). The FCC concluded that the Default Rate should
be retroactively utilized in determining compensation during the Interim Period
and reiterated that payphone providers were entitled to compensation for every
call pursuant to the provisions of Section 276; however, the FCC deferred for
later decision the method of allocation of the payment among the IXCs.
The 1997 Payphone Order was subsequently appealed by various parties. In
May 1998, the Appeals Court again remanded the per-call compensation rate to the
FCC for further explanation, without vacating the Default Rate, indicating that
the FCC had failed to adequately explain its derivation of the Default Rate.
In response to the remand of the 1997 Payphone Order, on February 4, 1999
the FCC issued its Third Report and Order, and Order on Reconsideration of the
Second Report and Order (the "1999 Payphone Order") wherein it adjusted the
Default Rate to $0.238, (the "Adjusted Default Rate) retroactive to October 7,
1997. In adjusting the rate, the FCC shifted its methodology from the
market-based method utilized in the 1996 and 1997 Payphone Orders to a
cost-based method citing technological impediments that it viewed as inhibiting
the marketplace and the unreliability of certain assumptions underlying the
market-based method as a basis for altering its analysis. In setting the
Adjusted Default Rate, the FCC incorporated its prior treatment of certain
payphone costs and examined new estimates of payphone costs submitted as part of
the proceeding. Pursuant to the 1999 Payphone Order, the $0.24 amount ($0.238
plus $0.002 for amounts charged by LECs for providing Flex Ani) became the
Adjusted Default Rate for coinless payphone calls through January 31, 2002.
The 1999 Payphone Order deferred a final ruling on the treatment of
dial-around compensation during the Interim Period to a later order; however, it
appeared from the 1999 Payphone Order that the Adjusted Default Rate would be
applied to the Interim Period. The FCC further ruled that a true-up will be made
for all payments or credits, together with applicable interest due and owing
among the IXCs and the payphone service providers for the Interim Period and the
payment period October 7, 1997 through April 20, 1999 (the "Intermediate
Period").
The 1999 Payphone Order was appealed by various parties and in June 2000,
the Appeals Court issued its ruling on the matter. The Appeals Court denied all
petitions for review of the per-call compensation rate and kept in place the
Adjusted Default Rate mandated by the 1999 Payphone Order.
9
On January 31, 2002, the FCC released its Fourth Order on Reconsideration
and Order on Remand (the "2002 Payphone Order") that provides a partial decision
on how retroactive dial-around compensation adjustments for the Interim Period
and Intermediate Period may apply. The 2002 Payphone Order increases the flat
monthly dial-around compensation rate for true-ups between individual IXCs and
PSPs during the Interim Period from $31.178 to $33.892 (the "New Default Rate").
The New Default Rate is based on 148 calls per month at $0.229 per call. The New
Default Rate also applies to flat rate dial-around compensation during the
Intermediate Period when the actual number of dial-around calls for each
payphone is not available. The 2002 Payphone Order excludes resellers but
expands the number of IXCs required to pay dial-around compensation during the
Interim and Intermediate Periods. It also prescribes the Internal Revenue
Service interest rate for refunds as the interest rate to be used to calculate
overpayments and underpayments of dial-around compensation for the Interim
Period and Intermediate Period.
The 2002 Payphone Order kept in place the Adjusted Default Rate for per-call
compensation during the Intermediate and subsequent periods. However, the FCC
deferred to a later, as yet unreleased order, the method of allocating
dial-around compensation among the IXCs responsible for paying fixed rate
per-phone compensation. At the present time, the Company is unable to determine
the effect of the final implementation of the 2002 Payphone Order. However, it
is possible that any retroactive adjustments for the Interim Period and
Intermediate Period could have a material adverse effect on the Company.
On April 5, 2001, the FCC issued an order which makes the first switched
based carrier that issues toll-free numbers to resellers, including prepaid
calling card companies, responsible for paying dial-around compensation on
coinless calls placed from payphones by individuals utilizing such toll-free
numbers. Previously, these carriers were not required to pay dial-around
compensation on such calls and were not required to disclose the identity of
resellers responsible for payment. The FCC order became effective on November
27, 2001. Although the Company expects this FCC order to improve its ability to
identify and collect amounts relating to dial-around calls that would otherwise
become uncollectible, the amount of the increase in revenues from dial-around
compensation, if any, cannot be determined at this time.
Effect of federal regulation of local coin and dial-around calls
- ----------------------------------------------------------------
DIAL-AROUND CALLS. The payments for dial-around calls prescribed in the
1999 and 2002 Payphone Orders significantly increased dial-around compensation
revenues to PhoneTel over the levels received prior to implementation of the
Telecommunications Act. Market forces and factors outside PhoneTel's control,
however, could significantly affect the resulting revenue impact. These factors
include the following: (1) resolution by the FCC of the method of allocating the
Interim Period flat-rate assessment among the IXCs, (2) the possibility of other
litigation seeking to modify or overturn the 1999 Payphone Order or portions
thereof, (3) pending litigation in the federal courts concerning the
constitutionality or validity of the Telecommunications Act, (4) 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, and (5) ongoing technical or other
difficulties in the responsible carriers' ability and willingness to properly
track or pay for dial-around calls actually delivered to them. Based on the
FCC's tentative conclusion in the 1997 Payphone Order, PhoneTel adjusted the
amounts of dial-around compensation previously recorded for the period, November
6, 1996 to June 30, 1997, from $45.85 to $37.20 per phone, per month ($0.284 per
call multiplied by 131 calls). Based on this adjustment, PhoneTel recorded a
charge of $395,000 in the three-month period ended September 30, 1997 to reflect
the retroactive reduction in revenue from dial-around compensation relating to
1996. Beginning with the fourth quarter 1997, PhoneTel began receiving
dial-around compensation on a per-call basis or, to the extent per-call
information was not available, dial-around compensation based on a surrogate
rate. In the third quarter of 1997 through the third quarter of 1998, PhoneTel
continued to record dial-around compensation at the rate of $37.20 per payphone
per month. In the fourth quarter of 1998, based on the reduction in the per-call
compensation rate from $0.284 to $0.238 in the FCC's 1999 Payphone Order,
PhoneTel recorded an adjustment, which included $3,733,000 applicable to prior
years, to further reduce revenue recognized from dial-around compensation for
the period November 6, 1996 to September 30, 1998. Beginning in the fourth
quarter of 1998, PhoneTel recorded dial-around compensation at the rate of
$31.18 per payphone, per month ($0.238 per call multiplied by 131 calls per
month).
Effective April 1999, the per-call compensation rate includes 0.2 cents for
Flex Ani costs and became $0.24 per call (or $31.44 per payphone, per month
based upon 131 calls per month). The Company continued to record revenue from
dial-around compensation at this rate until September 30, 2000. For the year
ended December 31, 2000, the Company recorded bad debt losses of $4,944,000
related to dial-around compensation. Of this amount,
10
$4,429,000 applicable to amounts previously recognized as revenue for the period
November 1996 to September 2000 was recorded in the fourth quarter of 2000 due
to the lack of progress by the FCC in ordering a true-up for underpayments by
IXCs in the Interim Period and a true up to the Adjusted Default Rate for the
Intermediate Period, as well as the Company's historical collection experience.
In the fourth quarter of 2000, the Company began recording dial-around
compensation based on the estimated number of calls per pay telephone that the
Company expects to collect at a rate of $0.24 per call.
LOCAL COIN CALLS. 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, the Appeals Court issued an order which
upheld the FCC's authority to deregulate local coin call rates, which issue the
United States Supreme Court has declined to consider on appeal. In accordance
with the FCC's rulings and the Court's orders, certain LECs and IPPs, including
PhoneTel, began to adjust rates for local coin calls to reflect market based
pricing. PhoneTel believes that due to the historical subsidization of local
coin rates under regulation, such deregulation, where implemented, will likely
result in higher rates charged for local coin calls and increase revenues from
such calls.
Initial experience with local coin call rate increases indicates that price
sensitivity of consumers for the service does exist and has resulted and will
result in some reduction in the number of calls made. Although PhoneTel believes
that deregulation of local coin rates will ultimately result in revenue
increases, PhoneTel is unable to predict at this time with any degree of
certainty the magnitude or likelihood of the increase, if any. PhoneTel is also
unable to provide assurance that deregulation, if and where implemented, will
lead to higher local coin call rates, and PhoneTel is thus unable to predict the
ultimate impact on its operations of local coin rate deregulation.
Other provisions of the Telecommunications Act and FCC Rules
------------------------------------------------------------
As a whole, the Telecommunications Act and FCC Rules have significantly
altered the competitive framework of the payphone industry. PhoneTel believes
that implementation of the Telecommunications Act and FCC Rules have addressed
certain historical inequities in the payphone marketplace and will lead to a
more equitable competitive environment for all payphone providers. There are
numerous uncertainties in the implementation and interpretation of the
Telecommunications Act, however, which make it impossible for PhoneTel to
provide assurance that the Telecommunications Act or the FCC Rules will result
in a long-term positive impact on PhoneTel. Those uncertainties include the
following:
- There are various matters pending in several federal courts
which, while not directly challenging section 276 of the
Telecommunications Act, relate to the validity and
constitutionality of the Telecommunications Act, as well as other
uncertainties related to the impact, timing and implementation of
the Telecommunications Act.
- The FCC Rules required that LEC payphone operations be removed
from the regulated rate base on April 15, 1997. The LECs were
also required to make the access lines that are provided for
their own payphones equally available to IPPs and to ensure that
the cost to payphone providers for obtaining local lines and
services met the FCC's new services test guidelines which require
that LECs price payphone access lines at the cost to the LEC plus
a reasonable margin of profit.
- In the past, RBOCs were allegedly impaired in their ability to
compete with the IPPs because they were not permitted to select
the interLATA carrier to serve their payphones. Recent changes to
the FCC Rules remove this restriction. Under the current rules,
the RBOCs are now permitted to participate with the Location
Owner in selecting the carrier of interLATA services to their
payphones effective upon FCC approval of each RBOC's Comparably
Efficient Interconnection Plans. Existing contracts between
Location Owners and payphone or long-distance providers which
were in effect as of February 8, 1996 are grandfathered and will
remain in effect.
- The FCC Rules preempt state regulations that may require IPPs to
route intraLATA calls to the LEC by containing provisions that
allow all payphone providers to select the intraLATA carrier of
their choice. The FCC Rules did not preempt state regulations
that, for public safety reasons, require
11
routing of "0-" calls to the LEC, provided that the state does
not require that such calls be routed to the LEC when the call is
determined to be non-emergency in nature.
- The FCC Rules determined that the administration of programs for
maintaining public interest payphones should be left to the
states within certain guidelines.
Billed Party Preference and rate disclosure
-------------------------------------------
The FCC issued a Second Notice of Proposed Rulemaking regarding Billed
Party Preference and associated call rating issues, including potential rate
benchmarks and caller notification requirements for 0+ and 0- interstate
long-distance calls. On January 29, 1998, the FCC released its Second Report and
Order on Reconsideration entitled In the Matter of Billed Party Preference for
InterLATA 0+ Calls, Docket No. 92-77. Effective July 1, 1998, all carriers
providing operator services were required to give consumers using payphones the
option of receiving a rate quote before a call is connected when making a 0+
interstate call. All of the IXCs servicing PhoneTel's payphones are in
compliance with this requirement and have been since November 1998; however,
PhoneTel is unable at this time to assess the ultimate impact, if any, on its
future operations or results.
Universal Services Fund
-----------------------
The Telecommunications Act provided for the establishment of a Joint Board
to make recommendations to the FCC concerning the continued provision of
"universally available" telecommunications services throughout the United
States. Congress directed the FCC, upon the recommendation of the Joint Board,
to implement and provide funding for (1) access to advanced telecommunications
services in rural, insular, and high-cost areas at the same cost as similar
services are provided in urban areas, (2) access to advanced telecommunications
services for health care providers in rural areas and (3) below-cost access to
advanced telecommunications services for schools and libraries. On May 8, 1997,
the FCC affirmed the Universal Services Order which required all
telecommunications providers, including payphone providers such as PhoneTel, to
contribute to universal services support beginning in January 1998. The FCC
established mechanisms in the Universal Services Order and related subsequent
orders whereby carriers and payphone providers would be billed monthly, based on
previously filed semi-annual gross revenue call traffic reports, at rates
assessed quarterly by Universal Service Administrative Co. ("USAC"). In February
1998, the USAC issued its first monthly assessment, which applied to January
1998. The FCC initially determined that carriers and payphone providers would be
assessed at a factor of 0.0072 on its interstate, intrastate, and international
coin and long-distance revenues to meet the anticipated needs of the schools,
libraries, and rural health care funds and at 0.0319 on its interstate and
international coin and long-distance revenues for the high-cost and low-income
funds. These factors are subject to periodic modification. The Universal Service
Fee ("USF") assessments have increased the monthly costs to PhoneTel, which it
is currently paying under protest.
In July 1999, the U.S. Court of Appeals for the Fifth Circuit ruled that
federal USF payments could not be based on the intrastate revenues of USF
payers. The Court required the FCC to re-evaluate the assessment of USF payments
based on the international revenues of payers and reversed the FCCs decision to
require LECs to recover USF payments only through their interstate access
charges.
On October 8, 1999, the FCC issued an order implementing the Court's
ruling, (1) eliminating intrastate revenues from the USF base, (2) creating a
limited international revenue exception for assessing international revenues,
and (3) allowing LECs to recover their USF payments through either access
charges or end user charges. This ruling became effective November 1, 1999. With
the limitations placed on the USF by the FCC, the amount of USF payments the
Company is required to pay has decreased. This decrease however, has been offset
by USF fees that are assessed by certain states. See "State and Local
Regulation".
12
Presubscribed IXC charge
------------------------
Other changes in federal regulations affect the charges incurred by
PhoneTel for local and long distance telecommunications services. For example,
in May 1997, the FCC adopted new regulations that restructure interstate access
charges. As a result of these changes, LECs were required to reduce the
per-minute interstate access charges to IXCs. To partially offset these
reductions, LECs were authorized to assess IXCs a flat "Presubscribed
Interexchange Carrier Charge" that averages approximately $2.75 per line per
month and which, at the IXC's option, could be passed through to the end users.
In the event that an end user elects not to designate a presubscribed IXC, the
LEC is authorized to assess an equivalent charge to the end user. As a net
result of these and other changes, many carriers have restructured their rates.
Based upon these latter FCC actions, PhoneTel is experiencing an increase in
carrier costs that will be subsumed within, and to some extent offset by, the
carrier cost reductions otherwise expected from application of the FCC's new
services test and the advent of competition in LEC services.
State and local regulation
--------------------------
State regulatory authorities have primarily been responsible for regulating
the rates, terms, and conditions for intrastate payphone services. Regulatory
approval to operate payphones in a state typically involves submission of a
certification application and an agreement by PhoneTel to comply with applicable
rules, regulations and reporting requirements. States that currently permit IPPs
to supply local and long-distance payphone service, and the District of
Columbia, have adopted a variety of state-specific regulations that govern rates
charged for coin and non-coin calls as well as a broad range of technical and
operational requirements. The Telecommunications Act contains provisions that
require all states to allow payphone competition on fair terms for both LECs and
IPPs. State authorities also regulate LECs' tariffs for interconnection of
independent payphones, as well as the LECs' own payphone operations and
practices.
In an effort to fund "universally available" telecommunication services
beyond that which is available from USAC, certain states have adopted
regulations requiring carriers and payphone providers to contribute to state USF
funds. Such contributions, while not material, have increased the cost of
providing payphone service in these states. Although the Company cannot predict
how many states will create and require contributions to their own USF funds,
the Company expects that the number of such states will increase in the future.
PhoneTel is also affected by state regulation of operator services. Most
states have capped the rates that consumers can be charged for coin toll calls
and non-coin local and intrastate toll calls made from payphones. In addition,
PhoneTel must comply with regulations designed to afford consumers notice at the
payphone location of the long-distance company servicing the payphone and the
ability to obtain access to alternate carriers. PhoneTel believes that it is
currently in material compliance with all regulatory requirements pertaining to
their offerings of operator services directly or through other long-distance
companies.
In accordance with requirements under the Telecommunications Act, state
regulatory authorities are currently reviewing the rates that LECs charge IPPs
for local line access and associated services. Local line access charges have
been reduced in certain states and PhoneTel believes that selected states'
continuing review of local line access charges, coupled with competition for
local line access service resulting from implementation of the
Telecommunications Act, could lead to more options available to PhoneTel for
local line access at competitive rates. No assurance can be given, however, that
such options or local line access rates will become available. The
Telecommunications Act and FCC Rules also contain other provisions that will
affect the rates payphone providers can charge for local coin calls and other
aspects of the regulation of payphone services by the states, although the
extent of any future federal preemption of state regulation cannot be accurately
predicted.
Management believes that an increasing number of municipalities and other
units of local government have begun to impose taxes, license fees, and
operating rules on the operations and revenues of payphones. Some of these fees
and restrictions may violate provisions of the Telecommunications Act
prohibiting barriers to entry into the business of operating payphones and the
policy of the Telecommunications Act to encourage wide deployment of payphones.
In at least one instance involving a challenge to a payphone ordinance adopted
by the Village of Huntington Park, California, however, the FCC declined to
overturn a total ban on payphones in a downtown area. The proliferation of local
government licensing, restriction, taxation, and regulation of payphone services
could have an adverse affect on PhoneTel unless the industry is successful in
resisting this trend.
13
SERVICEMARK
The Company uses the servicemark "PhoneTel" on its telephones, letterhead,
and in various other manners. On November 22, 1988, the United States Patent and
Trademark Office granted the Company a Certificate of Registration for the
servicemark "PhoneTel" for providing telecommunications services for a period of
twenty years.
COMPETITION
The public payphone industry is, and can be expected to remain, highly
competitive. While PhoneTel's principal competition comes from RBOCs and other
LECs, PhoneTel also competes with other IPPs, major OSPs, and IXCs. In addition,
PhoneTel competes with providers of cellular communications services and
personal communications services, which provide an alternative to the use of
public payphones. Furthermore, pursuant to section 276 of the Telecommunications
Act and the FCC's implementing regulations, RBOCs are permitted to negotiate
with Location Owners and select interLATA long distance service providers for
their public payphones. See "Regulatory Matters." This will enable RBOCs to
generate revenues from a new service, as well as to compete with IPPs for
locations to install their public payphones by offering Location Owners higher
commissions for long distance calls than those currently offered by IPPs.
While RBOCs and other LECs control the largest share of the public payphone
markets, the extent to which they will continue to compete with PhoneTel in the
future cannot be predicted. In February 2001, Bell South, an RBOC that operates
in nine states in the southeastern part of the United States has announced that
it plans to phase-out its payphone operations over the next two years. In
addition, other IPPs have experienced financial difficulties in recent times
which may impair their ability to compete. The Company perceives these
situations as opportunities for obtaining new location contracts and plans to
pursue these opportunities in the future. The extent to which the Company will
be able to secure additional locations for its payphones as a result of these
opportunities cannot be determined.
Some of the other public payphone companies have pursued an acquisition
strategy similar to PhoneTel's and frequently compete with PhoneTel for the most
favorable public payphone contracts and sites. Although PhoneTel is one of the
largest IPPs, most RBOCs and other LECs and long distance carriers have, and
some IPPs with which PhoneTel competes may have, substantially greater
financial, marketing and other resources than PhoneTel. In addition, in response
to competition from public payphone companies, many RBOCs and other LECs have
increased their compensation arrangement with Location Owners by offering higher
commissions.
PhoneTel believes the principal competitive factors in the public payphone
industry are: (i) the amount of commission payments to Location Owners; (ii) the
ability to serve accounts with locations in several LATAs or states; (iii) the
quality of service provided to Location Owners and public payphone users; and
(iv) responsiveness to customer service needs.
EMPLOYEES
PhoneTel had 237 employees as of February 28, 2002. The Company considers
its relations with its employees to be satisfactory. None of the employees of
PhoneTel is a party to agreements with any unions.
IMPACT OF SEASONALITY
PhoneTel completed eight acquisitions that added approximately 20,100
telephones in the first six months of 1997 and approximately 3,400 telephones
during 1998. The seasonality of PhoneTel's historical operating results has been
affected by shifts in the geographic concentrations of its telephones resulting
from such acquisitions. Historically revenues and related expenses during the
first three months of the year have been lower than comparable periods during
the remainder of the year due to weather conditions that affect pay telephone
usage.
14
ITEM 2. PROPERTIES
The Company's executive offices are located at North Point Tower, 7th
Floor, 1001 Lakeside Avenue, Cleveland, Ohio 44114-1195, where the Company
leases 32,919 square feet with rent of $41,148 per month. The lease expires on
October 31, 2003. The Company also leases approximately 22 district operations
facilities with lease terms that are generally three years or less. Such
facilities are generally less than 3,000 square feet. In connection with the
servicing agreement entered into with Davel (see "Recent Developments"),
PhoneTel also shares six district operations facilities that are currently being
leased by Davel. The Company considers its facilities adequate for its purposes.
ITEM 3. LEGAL PROCEEDINGS
On June 11, 1998, the Company entered into an Agreement and Plan of Merger
and Reorganization (the "Original Davel Merger Agreement") with Davel
Communications Group, Inc. On July 5, 1998, Peoples Telephone Company, Inc., a
publicly held, independent pay telephone provider ("Peoples"), also entered into
a merger agreement (the "Peoples Merger Agreement") with Davel.
On September 29, 1998, the Company received a letter from Davel purporting
to terminate the Original Davel Merger Agreement. Thereafter, a complaint
against the Company was filed in the Court of Chancery of New Castle County,
Delaware by Davel, which was subsequently amended, alleging, among other things,
equitable fraud and breach of contract relating to the Original Davel Merger
Agreement. On October 27, 1998, the Company filed its answer to the amended
complaint denying the substantive allegations contained therein and filed a
counterclaim against Davel for breach of contract. At the same time, PhoneTel
filed a third party claim against Peoples (acquired by Davel on December 23,
1998) for tortuous interference with contract alleging that Peoples induced
Davel to not comply with the terms of the Original Davel Merger Agreement. The
counterclaim and third party claim seek specific performance from Davel, which
would require Davel to comply with the terms of the Original Davel Merger
Agreement or, alternatively, for compensatory damages and costs of an
unspecified amount. On February 19, 2002, the Company and Davel entered into a
settlement agreement which provides for the dismissal of each company's claims
at the time the current merger of the companies is completed.
The Company is not a party to any other legal proceedings which,
individually or in the aggregate, would have a material adverse effect on the
Company's business, results of operations, financial condition, or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December 31, 2001, no
matters were submitted to a vote of the Company's shareholders.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
On November 17, 1999, the Company consummated its Prepackaged Plan and all
of the Common Stock (Predecessor Company) and 14% Preferred was converted to
Common Stock (Successor Company). In addition, other issues of preferred stock
and all outstanding options and warrants were cancelled. The Common Stock
(Successor Company), $0.01 par value, began trading over-the-counter on the
electronic bulletin board ("OTC:BB") under the symbol PHTE in December 1999.
Pursuant to the terms of the Prepackaged Plan, the Company issued and at
December 31, 2001 had outstanding New Warrants to purchase 1,077,024 shares of
Common Stock, (Successor Company) through November 17, 2002 at an exercise price
of $10.50 per share. The New Warrants were to be traded over-the-counter and
quoted on the National Quotation Service Pink Sheets under the symbol PHTEW. To
date, no established public trading market has developed for the New Warrants.
15
The following table sets forth on a per share basis, for the periods
indicated, the high and low bid prices of the Common Stock as reported for
over-the-counter quotations. Over-the-counter market quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.
Price Range
High Low
---- ---
COMMON STOCK
2000:
First Quarter................................................................. $ 2.38 $ 1.00
Second Quarter................................................................ 1.25 0.28
Third Quarter................................................................. 0.53 0.28
Fourth Quarter................................................................ 0.31 0.13
2001:
First Quarter................................................................. 0.31 0.17
Second Quarter................................................................ 0.17 0.12
Third Quarter................................................................. 0.11 0.01
Fourth Quarter................................................................ 0.05 0.01
As of February 28, 2002, there were 1,992 shareholders of record. The closing
market price of the Company's Common Stock was $0.05 per share on March 18,
2002.
DIVIDEND POLICY ON COMMON STOCK
The Company has never declared or paid any dividends on its Common Stock.
The Company currently intends to retain its earnings to finance the growth and
development of its business and does not anticipate paying cash dividends in the
foreseeable future. Under the Company's current and prior debt agreements, the
Company was not permitted to pay any dividends on its Common Stock, other than
stock dividends, during the Company's two most recent fiscal years. Any future
declaration of dividends, if permitted, will be subject to the discretion of the
Board of Directors of the Company. The timing, amount and form of dividends, if
any, will depend, among other things, on the Company's financial condition,
capital requirements, cash flow, profitability, plans for expansion, business
outlook and other factors deemed relevant by the Board of Directors of the
Company.
SALES AND ISSUANCES OF COMMON STOCK
There were no unregistered sales or issuances of the Company's securities
during 2001.
16
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the
consolidated financial statements of the Company. The data should be read in
conjunction with the consolidated financial statements, related notes thereto
and other financial information included herein.
PREDECESSOR COMPANY
------------------------------------------------------
TEN MONTHS
Statement of Operations Data: AND SEVENTEEN
(In thousands except share and per share amounts) YEAR ENDED DECEMBER 31 DAYS ENDED
-------------------------------- NOVEMBER 17
1997 1998 1999
-------------- --------------- -------------------
Revenues:
Coin calls $58,520 $52,544 $36,220
Non-coin telecommunication services 39,292 31,516 25,065
Dial-around compensation adjustment (395) (3,733) -
Other 500 143 210
-------------- --------------- -------------------
97,917 80,470 61,495
-------------- --------------- -------------------
OPERATING EXPENSES:
Line and transmission charges 24,518 29,607 17,575
Location commissions 16,628 14,179 11,263
Field operations 21,100 22,009 18,043
Selling, general and administrative 10,713 12,354 9,156
Depreciation and amortization 21,525 23,731 20,719
Provision for uncollectible accounts receivable 267 428 345
Charges relating to location contracts - - 864
Other unusual charges and contractual settlements 9,095 2,762 1,030
-------------- --------------- -------------------
103,846 105,070 78,995
-------------- --------------- -------------------
Loss from operations (5,929) (24,600) (17,500)
-------------- --------------- -------------------
OTHER INCOME (EXPENSE):
Interest expense - related parties (1,994) (1,400) -
Interest expense - others (15,891) (19,364) (19,575)
Interest and other income 560 547 191
-------------- --------------- -------------------
(17,325) (20,217) (19,384)
-------------- --------------- -------------------
Loss before extraordinary item (23,254) (44,817) (36,884)
Extraordinary item:
Gain (loss) on extinguishment of debt - - 77,172
-------------- --------------- -------------------
NET INCOME (LOSS) ($23,254) ($44,817) $40,288
============== =============== ===================
Net income (loss) applicable to common shareholders ($24,262) ($46,213) $39,078
Net income (loss) per common share, basic and diluted ($1.51) ($2.73) $2.08
Weighted average number of shares, basic and diluted 16,040,035 16,923,499 18,754,133
EBITDA from recurring operations (1) $24,691 $1,893 $5,113
Cash flow provided by (used in):
Operating activities ($4,720) ($6,470) ($685)
Investing activities (57,197) (6,763) (1,882)
Financing activities 21,998 12,482 3,375
BALANCE SHEET DATA:
Total assets $169,826 $150,674 $127,804
Long-term debt and mandatorily redeemable preferred
stock, less current portion of debt (2) 157,938 9,118 47,992
Shareholders' equity (deficit) (4,042) (51,598) 63,492
Cash dividends per common share - - -
SUCCESSOR COMPANY
-----------------------------------------------------------
ONE MONTH
Statement of Operations Data: AND THIRTEEN
(In thousands except share and per share amounts) DAYS ENDED YEAR ENDED DECEMBER 31
DECEMBER 31 ---------------------------------------
1999 2000 2001
------------------ --------------------------------------
Revenues:
Coin calls $4,378 $33,110 $26,911
Non-coin telecommunication services 2,667 25,147 17,060
Dial-around compensation adjustment - - -
Other 26 587 1,000
------------------ --------------------------------------
7,071 58,844 44,971
------------------ --------------------------------------
OPERATING EXPENSES:
Line and transmission charges 2,088 17,211 16,378
Location commissions 968 8,467 7,382
Field operations 2,184 17,405 12,822
Selling, general and administrative 1,359 9,056 7,691
Depreciation and amortization 2,316 17,469 12,986
Provision for uncollectible accounts receivable 59 4,944 328
Charges relating to location contracts - 21,205 17,582
Other unusual charges and contractual settlements (333) 579 862
------------------ --------------------------------------
8,641 96,336 76,031
------------------ --------------------------------------
Loss from operations (1,570) (37,492) (31,060)
------------------ --------------------------------------
OTHER INCOME (EXPENSE):
Interest expense - related parties - - -
Interest expense - others (1,162) (11,168) (11,345)
Interest and other income 38 254 (176)
------------------ --------------------------------------
(1,124) (10,914) (11,521)
------------------ --------------------------------------
Loss before extraordinary item (2,694) (48,406) (42,581)
Extraordinary item:
Gain (loss) on extinguishment of debt - - -
------------------ --------------------------------------
NET INCOME (LOSS) ($2,694) ($48,406) ($42,581)
================== ======================================
Net income (loss) applicable to common shareholders ($2,694) ($48,406) ($42,581)
Net income (loss) per common share, basic and diluted ($0.26) ($4.75) ($4.18)
Weighted average number of shares, basic and diluted 10,188,630 10,189,684 10,189,684
EBITDA from recurring operations (1) $413 $1,761 $370
Cash flow provided by (used in):
Operating activities ($852) $1,260 $587
Investing activities (420) (2,429) (445)
Financing activities 396 (106) (342)
BALANCE SHEET DATA:
Total assets $124,399 $81,189 $49,428
Long-term debt and mandatorily redeemable preferred
stock, less current portion of debt (2) 48,642 1,062 1,116
Shareholders' equity (deficit) 60,798 12,431 (30,150)
Cash dividends per common share - - -
17
(1) EBITDA from recurring operations represents earnings before interest income
and expense, depreciation, amortization, charges relating to location
contracts, other unusual charges and contractual settlements, and
extraordinary items. EBITDA from recurring operations is not intended to
represent an alternative to operating income (as defined in accordance with
generally accepted accounting principles) as an indicator of the Company's
operating performance, or as an alternative to cash flows from operating
activities (as defined in accordance with generally accepted accounting
principles) as a measure of liquidity. The Company believes that EBITDA
from recurring operations is a meaningful measure of performance because it
is commonly used in the public pay telephone industry to analyze comparable
public pay telephone companies on the basis of operating performance,
leverage and liquidity.
(2) At December 31, 1998, 2000, and 2001 certain long-term debt was classified
as a current liability because the Company was not in compliance with
certain financial covenants or was in default on such debt, or the debt was
otherwise due within one year.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
Statements, other than historical facts, contained in this Form 10-K are
"forward looking statements" within the meaning of section 27A of the Securities
Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934,
as amended. Although the Company believes that its forward looking statements
are based on reasonable assumptions, it cautions that such statements are
subject to a wide range of risks and uncertainties with respect to the Company's
operations in fiscal 2002 as well as over the long term such as, without
limitation: (i) a downturn in the public pay telephone industry which is
dependent on consumer spending and subject to the impact of domestic economic
conditions, changes in technology, increased use of wireless communications, and
regulations and policies regarding the telecommunications industry; (ii) the
ability of the Company to consummate the previously announced merger with Davel
and substantial debt restructuring contemplated thereby, and if consummated, the
Company's ability to successfully integrate its operations with Davel's; (iii)
impairment of the Company's liquidity arising from potential actions of lenders
with respect to defaults under the Company's debt agreement; (iv) regulatory
changes effecting the dial-around compensation rate and the coin drop rate and
(v) the ability of the Company to continue to realize efficiencies generated by
the Servicing Agreement with Davel. Any or all of these risks and uncertainties
could cause actual results to differ materially from those reflected in the
forward looking statements. These forward looking statements are based on
certain assumptions and analyses made by the Company in light of its experience
and its perception of historical trends, current conditions, expected future
developments and other factors it believes are appropriate in the circumstances.
In addition, such statements are subject to a number of assumptions, risks and
uncertainties including, without limitation, the risks and uncertainties
identified in this report, general economics and business conditions, the
business opportunities (or lack thereof) that may be presented to and pursued by
the Company, changes in laws or regulations and other factors, many of which are
beyond the control of the Company. Investors and prospective investors are
cautioned that any such statements are not guarantees of future performance and
that actual results or developments may differ materially from those projected
in the forward looking statements.
OVERVIEW
The Company derives substantially all of its revenues from coin calls and
non-coin calls placed from its public pay telephones. Coin revenue is generated
from local and long-distance calls that are placed from the Company's public pay
telephones. Non-coin revenue is generated from calling card, credit card,
collect and third party billed calls. Typically, each public pay telephone has a
presubscribed (dedicated) provider of long distance and operator services. The
Company receives revenues for non-coin calls placed from its public pay
telephones from its presubscribed long distance and operator service provider
("OSP") based on the volume of calls carried by the OSP and the amount of
revenue generated by those calls. The Company also receives dial-around
compensation (revenue from non-coin calls placed from the Company's payphones
utilizing a carrier other than the Company's presubscribed OSP). Net revenue
from dial-around compensation was $14,980,000, $13,442,000, and $9,877,000 for
the years ended December 31, 1999, 2000, and 2001, respectively.
18
Effective November 6, 1996, pursuant to FCC regulations, the Company
derived additional revenues from dial-around calls placed from its public pay
telephones. From November 6, 1996 to June 30, 1997, the Company recorded gross
dial-around revenues at the then mandated rate of $45.85 per telephone per
month, compared with the flat fee of $6.00 per telephone per month in place
prior to November 6, 1996. Pursuant to the FCC's Second Report and Order, in the
third quarter of 1997, the Company began recording gross dial-around revenue at
a rate of $37.20 per installed pay telephone per month and recorded a charge for
the retroactive reduction in the dial-around compensation rate from $45.85 to
$37.20 per pay telephone per month, applicable to the November 6, 1996 to
September 30, 1997 period. From October 1997 to September 1998, the Company
recorded dial-around compensation at a per-call rate of $0.284 based on the
Company's estimate of the actual number of dial-around calls ($37.20 per month
based on 131 calls per month) placed from each of its public pay telephones. In
the fourth quarter 1998, pursuant to the FCC's Third Report and Order, the
Company recorded revenues from dial-around compensation based upon a per-call
rate of $0.238 and recorded a retroactive adjustment to reduce revenues
previously recorded at a rate of $0.284 per-call. This adjustment included a
charge of $3,733,000 in 1998 to reflect the reduction in the dial-around
compensation rate for the period November 6, 1996 to December 31, 1997 as a
result of this regulatory change. In the fourth quarter of 2000, the Company
began reporting revenues based on the estimated number of monthly dial-around
calls per phone and the current per-call compensation rate of $0.24. In the
fourth quarter of 2000, the Company also recorded a bad debt loss of $4,429,000
applicable to amounts previously recognized as revenue for the period November
1996 to September 2000 to more closely reflect the Company's historical
collection experience and the number of calls for which the Company expects to
be compensated.
In October 1997, states were required to deregulate the price of a local
phone call, which has allowed the Company to increase its local coin call rate
thereby generating additional revenues. Effective October 7, 1997, the Company
increased the local coin call rate at a majority of its pay telephones to $0.35
in states in which the local call rate was previously limited to $0.25. At the
end of 2001 and early 2002, the Company further increased the local coin call
rate to $0.50. A majority of the Company's pay telephones currently charge a
local coin rate of $0.50 although rates are lower in some markets due to
competitive conditions. However, there can be no assurance as to the ultimate
effect of recently adopted FCC regulations on the Company's business, results of
operations or financial condition or, that such regulation will withstand
judicial review. See "Business -- Governmental Regulations."
The Company's principal operating expenses consist of: (i) telephone line
and transmission charges; (ii) commissions paid to location providers which are
typically expressed as a percentage of revenues and are fixed for the term of
the agreements with each respective location provider; and (iii) field
operations costs which are principally comprised of personnel, service vehicle
and repair part costs of collecting coins from and maintaining the Company's
public pay telephones. The Company pays monthly local access and usage charges
to RBOCs and other LECs for interconnection to the local network for local
calls, which are generally computed on a flat monthly charge, and may also
include either a per message or usage rate based on the time and duration of the
call. The Company also pays fees to RBOCs and other LECs and long distance
carriers based on usage for local or long distance coin calls.
Since the end of 1998, the Company has initiated several profit improvement
measures. The Company has been able to obtain lower local access line charges
through negotiations and promotional programs with certain of its incumbent LECs
or by utilizing competitive LECs ("CLECs"). The Company entered into agreements
with new OSPs to obtain an improvement in rates for operator service revenues
and long distance line charges. The Company reduced the number of field
operations personnel and related costs, abandoned location contracts relating to
approximately 7,300 unprofitable phones and, prior to the implementation of the
servicing agreement with Davel, closed eight district operations facilities to
reduce costs. The Company also reduced the number of administrative and sales
personnel and eliminated or reduced certain non-essential expenses. The Company
believes these measures will continue to have a positive impact on the results
of its operations.
Proposed Merger with Davel Communications, Inc.
As more fully set forth in "Recent Developments", the Company executed a
definitive merger agreement with Davel on February 19, 2002 which was
unanimously approved by the boards of directors of both companies. In connection
with the expected merger, PhoneTel will become a wholly owned subsidiary of
Davel and the existing secured lenders of both Davel and PhoneTel will exchange
a substantial amount of debt for equity securities of the respective companies
and restructure the remaining debt. In addition, on February 19, 2002 Davel and
PhoneTel
19
have each executed amendments to their existing credit agreements and have
entered into a new combined $10,000,000 senior credit facility. See Item 1 -
"Recent Developments".
In addition, on June 13, 2001, the two companies entered into a servicing
agreement designed to commence cost savings initiatives in advance of the
closing of the merger. During the third quarter of 2001, the two companies
implemented the servicing agreement by combining field service office operation
networks on a geographic basis to gain efficiencies resulting from the increased
concentration of payphone service routes. The Company and Davel were able to
close 21 district operations facilities, eliminate 104 vehicles, and reduce the
number of field service personnel by 114 in connection with the servicing
agreement. The companies estimate that this will result in an annual cost saving
of approximately $6.0 million, which is reflected in the combined field
operations cost that is being shared by both companies in proportion to the
number of pay telephones owned by each pursuant to the servicing agreement.
Debt Restructuring and Chapter 11 Bankruptcy Filing
On July 14, 1999, the Company commenced a case under chapter 11 of the
United States Bankruptcy Code (the "Case") by filing a prepackaged plan of
reorganization (the "Prepackaged Plan") in the United States Bankruptcy Court
for the Southern District of New York (the "Court"). On October 20, 1999, the
Court entered an order confirming the Company's Prepackaged Plan, which became
effective on November 17, 1999 ("the Consummation Date").
Pursuant to the terms of the Prepackaged Plan, claims of employees, trade
and other creditors of the Company, other than holders of the Company's
$125,000,000 aggregate principal amount 12% Senior Notes (the "Senior Notes"),
were to be paid in full in the ordinary course, unless otherwise agreed. Holders
of the Senior Notes received 9,500,000 shares of a new issue of common stock
("Common Stock (Successor Company)") in exchange for the Senior Notes.
Holders of the Company's 14% Cumulative Redeemable Convertible Preferred
Stock ("14% Preferred") received 325,000 shares of Common Stock (Successor
Company) and warrants to purchase up to 722,200 shares of Common Stock
(Successor Company) at an exercise price of $10.50 per share which expire three
years from the date of grant ("New Warrants"). Holders of existing Common Stock
("Common Stock (Predecessor Company)") received 175,000 shares of Common Stock
(Successor Company) and New Warrants to purchase up to 388,900 shares of Common
Stock (Successor Company).
Upon emergence from its Chapter 11 proceedings, the Company adopted fresh
start reporting pursuant to the provisions of AICPA Statement of Position 90-7
("SOP 90-7"). The Company has recorded the effects of fresh start reporting as
of November 17, 1999, the Consummation Date of the Company's Prepackaged Plan.
In accordance with SOP 90-7, assets and liabilities were restated as of November
17, 1999 to reflect the reorganization value of the Company, which approximated
their fair values at the Consummation Date. In addition, the accumulated deficit
of the Company through the Consummation Date was eliminated and the debt and
capital structure of the Company was recast pursuant to the provisions of the
Prepackaged Plan.
The Predecessor Company's financial statements through to November 17, 1999
are not comparable to the reorganized Company's financial statements subsequent
to November 17, 1999. (See Note 13 to the Company's Consolidated Financial
Statements.) However, for purposes of management's discussion and analysis of
results of operations, the year ended December 31, 1999 for the Predecessor and
Successor Company combined is being compared to 2000 and 2001 since the results
of operations are comparable except for the extraordinary item and the
elimination of interest expense relating to the Predecessor Company's Senior
Notes, which resulted from the implementation of the Prepackaged Plan, and the
effect on depreciation and amortization of adopting fresh start reporting.
20
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
information derived from the Company's Consolidated Statements of Operations,
included elsewhere in this Form 10-K.
(In thousands)
Year Ended December 31
--------------------------------------
1999 2000 2001
---- ---- ----
Revenues:
Coin calls...................................... $ 40,598 $ 33,110 $ 26,911
Non-coin telecommunication services............. 27,732 25,147 17,060
Other .......................................... 236 587 1,000
---------- ----------- -----------
Total revenues.................................. 68,566 58,844 44,971
---------- ----------- -----------
Operating expenses:
Line and transmission charges................... 19,663 17,211 16,378
Location commissions............................ 12,231 8,467 7,382
Field operations................................ 20,227 17,405 12,822
Selling, general and administrative............. 10,515 9,056 7,691
Depreciation and amortization................... 23,035 17,469 12,986
Provision for uncollectible accounts receivable. 404 4,944 328
Charges relating to location contracts.......... 864 21,205 17,582
Other unusual charges and
contractual settlements...................... 697 579 862
---------- ----------- -----------
Total operating expenses........................ 87,636 96,336 76,031
---------- ----------- -----------
Loss from operations................................. (19,070) (37,492) (31,060)
---------- ----------- -----------
Other income (expense):
Interest expense................................ (20,737) (11,168) (11,345)
Interest and other income (expense)............. 229 254 (176)
---------- ----------- -----------
Total other income (expense).................... (20,508) (10,914) (11,521)
---------- ----------- -----------
Loss before extraordinary item....................... (39,578) (48,406) (42,581)
Extraordinary gain on extinguishment of debt......... 77,172 - -
---------- ----------- -----------
Net income (loss).................................... $ 37,594 ($48,406) ($42,581)
========== =========== ============
Cash flow provided by (used in):
Operating activities............................ ($1,537) $ 1,260 $ 587
Investing activities............................ (2,302) (2,429) (445)
Financing activities............................ 3,771 (106) (342)
EBITDA from recurring operations (1)................. 5,526 1,761 370
(1) See Item 6, Selected Financial Data for definition of EBITDA from recurring
operations.
The Company's reported results of operations can be affected by the use of
estimates and the Company's critical accounting policies. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates, among others,
include amounts relating to the carrying value of the Company's accounts
receivable and payphone location contracts and the related revenues and expenses
applicable to dial-around compensation and asset impairment. Actual results
could differ from those estimates.
Revenues from coin calls, reselling operator assisted and long distance
services, and compensation for dial-around calls are recognized in the period in
which the customer places the related call. The FCC has the authority pursuant
to the Telecommunications Act of 1996 to effect rates related to revenue from
dial-around compensation, including retroactive rate adjustments and refunds.
(See discussion of revenues from non-coin telecommunication services under "Year
Ended December 31, 2001 Compared to Year Ended December 31, 2000"). Rate
adjustments arising from FCC rate actions that require refunds to interexchange
or other carriers are recorded in the first period
21
that they become both probable of payment and estimable in amount. Rate
adjustments that result in payments to the Company by interexchange or other
carriers are recorded when received.
Under the Company's accounting policy relating to asset impairment, the
Company periodically evaluates potential impairment of long-lived assets based
upon the cash flows derived from each of the Company's operating districts, the
lowest level for which operating cash flows for such asset groupings are
identifiable. A loss relating to an impairment of assets occurs when the
aggregate of the estimated undiscounted future cash inflows expected to be
generated by the Company's asset groups (including any salvage values) are less
than the related assets' carrying value. Impairment is measured based on the
difference between the higher of the fair value of the assets or present value
of the discounted expected future cash flows and the assets' carrying value. No
impairment was incurred in 1999. In 2000 and 2001, the Company incurred asset
impairment losses relating to its payphone location contracts of $14,787,000 and
$15,830,000, respectively, as more fully described below.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
REVENUES Total revenues decreased by $13,873,000 or 23.6% from $58,844,000
for the year ended December 31, 2000 to $44,971,000 for the year ended December
31, 2001. This decrease is primarily due to a decrease in the average number of
installed pay telephones, a decline in coin call volume, and the decrease in
revenues from non-coin telecommunication services, including dial-around
compensation, as discussed below. The average number of installed pay telephones
decreased from 36,841 for the year ended December 31, 2000 to 33,754 for the
year ended December 31, 2001, a decrease of 3,087, or 8.4%. This decrease was
principally due to expired location contracts which were not renewed and the
removal of approximately 3,400 unprofitable pay telephones in the last half of
2000 and approximately 2,000 pay telephones in the third quarter of 2001.
Revenues from coin calls were $33,110,000 and $26,911,000 for the years
ended December 31, 2000 and 2001, respectively. This decrease of $6,199,000, or
18.7%, is primarily due to a decrease in the average number of payphones and a
decline in the number of local and long distance coin calls. Long distance and
local call volumes and coin revenues have been adversely affected by the growth
of wireless communication services, which serve as an increasingly competitive
alternative to payphone usage. Coin revenues from long distance calls have also
declined due to the impact of prepaid calling cards and other types of
dial-around calls placed from the Company's payphones as discussed below.
Revenues from non-coin telecommunication services decreased by $8,087,000
or 32.2%, from $25,147,000 for the year ended December 31, 2000 to $17,060,000
for the year ended December 31, 2001. Of this decrease, long distance revenues
from operator service providers decreased by $4,522,000 or 38.6% principally due
to a reduction in the number of operator service calls resulting from the
decline in the average number of installed pay telephones, continuing aggressive
dial-around advertising by long distance carriers such as AT&T and MCI Worldcom
and the use of prepaid phone cards. Long distance revenues from operator service
providers have also been adversely affected by the growth in wireless
communications. Revenues from dial-around compensation decreased by $3,565,000
or 26.5% compared to 2000 primarily due to the decrease in the average number of
installed pay telephones and a reduction in the estimated number of dial-around
calls used to record revenues beginning in the fourth quarter of 2000 as
discussed below. The reduction in the average number of dial-around calls per
phone was also primarily due to the increased use of wireless communication
services by consumers.
Effective November 6, 1996, pursuant to the rules and regulations
promulgated by the FCC under section 276 of the Telecommunications Act ("Section
276"), the FCC issued an order to achieve fair compensation for dial-around
calls placed from pay telephones (the "1996 Payphone Order"). Among other
things, the 1996 Payphone Order prescribed compensation payable to the payphone
providers by certain interexchange carriers ("IXCs") for dial-around calls
placed from payphones and, to facilitate per-call compensation, the FCC required
the payphone providers to transmit payphone specific coding digits that would
identify each call as originating from a payphone ("Flex Ani"). The FCC required
local exchange carriers ("LECs") to make such coding available to the payphone
providers as a transmit item included in the local access line service. The 1996
Payphone Order set an initial monthly rate of $45.85 per pay telephone for the
November 6, 1996 to October 7, 1997 period (the "Interim Period"), an increase
from the monthly per pay telephone rate of $6.00 in periods prior to its
implementation. Thereafter, the FCC set dial-around compensation on a per-call
basis, at the assumed deregulated coin rate of $0.35. The Interim Period monthly
rate was arrived at by the product of the assumed deregulated coin rate ($0.35)
and the then monthly average compensable dial-around calls per payphone. A
finding from the record established at the time that the monthly average
compensable calls were 131 per phone.
22
The 1996 Payphone Order was appealed by various parties, including the
IXCs, to the United States Court of Appeals for the District of Columbia Circuit
(the "Appeals Court"). Among other items, the Appeals Court found that the FCC
erred in using a market-based method for calculating the amount of dial-around
compensation and further determined that the method of allocating payment among
IXCs was erroneous. In July 1997, the Appeals Court vacated the 1996 Payphone
Order and remanded it to the FCC for further consideration. As a result of this
ruling by the Appeals Court, certain IXCs discontinued or reduced the amount of
dial-around compensation actually paid to payphone service providers for the
Interim Period.
In response to the remand by the Appeals Court, in October 1997 the FCC
issued a new order implementing Section 276 (the "1997 Payphone Order"). The FCC
utilized a market-based method to arrive at a per call compensation rate and
then reduced it by certain costs attributable to a coin call which it did not
believe applied to a dial-around call, and adjusted the per-call rate from $0.35
to $0.284 (the "Default Rate"). The FCC concluded that the Default Rate should
be retroactively utilized in determining compensation during the Interim Period
and reiterated that payphone providers were entitled to compensation for every
call pursuant to the provisions of Section 276; however, the FCC deferred for
later decision the method of allocation of the payment among the IXCs.
The 1997 Payphone Order was subsequently appealed by various parties. In
May 1998, the Appeals Court again remanded the per-call compensation rate to the
FCC for further explanation, without vacating the Default Rate, indicating that
the FCC had failed to adequately explain its derivation of the Default Rate.
In response to the remand of the 1997 Payphone Order, on February 4, 1999
the FCC issued its Third Report and Order, and Order on Reconsideration of the
Second Report and Order (the "1999 Payphone Order") wherein it adjusted the
Default Rate to $0.238, (the "Adjusted Default Rate) retroactive to October 7,
1997. In adjusting the rate, the FCC shifted its methodology from the
market-based method utilized in the 1996 and 1997 Payphone Orders to a
cost-based method citing technological impediments that it viewed as inhibiting
the marketplace and the unreliability of certain assumptions underlying the
market-based method as a basis for altering its analysis. In setting the
Adjusted Default Rate, the FCC incorporated its prior treatment of certain
payphone costs and examined new estimates of payphone costs submitted as part of
the proceeding. Pursuant to the 1999 Payphone Order, the $0.24 amount ($0.238
plus $0.002 for amounts charged by LECs for providing Flex Ani) became the
Adjusted Default Rate for coinless payphone calls through January 31, 2002.
The 1999 Payphone Order deferred a final ruling on the treatment of
dial-around compensation during the Interim Period to a later order; however, it
appeared from the 1999 Payphone Order that the Adjusted Default Rate would be
applied to the Interim Period. The FCC further ruled that a true-up will be made
for all payments or credits, together with applicable interest due and owing
among the IXCs and the payphone service providers for the payment period
November 7, 1996 through April 20, 1999. In the fourth quarter of 1998, the
Company recorded an adjustment to reduce revenues previously recognized for the
period from November 7, 1996 to September 30, 1998 due to the decrease in the
per-call compensation rate to the Adjusted Default Rate.
The 1999 Payphone Order was appealed by various parties and in June 2000,
the Appeals Court issued its ruling on the matter. The Appeals Court denied all
petitions for review of the per-call compensation rate and kept in place the
Adjusted Default Rate mandated by the 1999 Payphone Order. Due to the lack of
progress by the FCC in ordering a true-up for underpayments by IXCs during the
Interim Period and a true-up for overpayments by IXCs to the Adjusted Default
Rate for the payment period October 7, 1997 to April 20, 1999, (the
"Intermediate Period") as well as the Company's historical collection
experience, the Company recorded a bad debt loss of $4,944,000 in 2000. Of this
amount, $4,429,000 applicable to amounts previously recognized as revenue for
the period November 1996 to September 2000 was recorded in the fourth quarter of
2000. In the fourth quarter of 2000, the Company began reporting revenues from
dial-around compensation based on $0.24 per call and the Company's current
estimate of the average monthly compensable calls per phone to more closely
reflect the Company's historical collection experience and expected future call
volume.
On January 31, 2002, the FCC released its Fourth Order on Reconsideration
and Order on Remand (the "2002 Payphone Order") that provides a partial decision
on how retroactive dial-around compensation adjustments for the Interim Period
and Intermediate Period may apply. The 2002 Payphone Order increases the flat
monthly dial-around compensation rate for true-ups between individual IXCs and
PSPs during the Interim Period from $31.178 to $33.892 (the "New Default Rate").
The New Default Rate is based on 148 calls per month at $0.229 per call. The New
Default Rate also applies to flat rate dial-around compensation during the
Intermediate Period when the actual
23
number of dial-around calls for each payphone is not available. The 2002
Payphone Order excludes resellers but expands the number of IXCs required to pay
dial-around compensation during the Interim and Intermediate Periods. It also
prescribes the Internal Revenue Service interest rate for refunds as the
interest rate to be used to calculate overpayments and underpayments of
dial-around compensation for the Interim Period and Intermediate Period.
The 2002 Payphone Order kept in place the Adjusted Default Rate for
per-call compensation during the Intermediate and subsequent periods. However,
the FCC deferred to a later, as yet unreleased order, the method of allocating
dial-around compensation among the IXCs responsible for paying fixed rate
per-phone compensation. At the present time, the Company is unable to determine
the effect of the final implementation of the 2002 Payphone Order. However, it
is possible that any retroactive adjustments for the Interim Period and
Intermediate Period could have a material adverse effect on the Company.
On April 5, 2001, the FCC issued an order which makes the first switched
based carrier that issues toll-free numbers to resellers, including prepaid
calling card companies, responsible for paying dial-around compensation on
coinless calls placed from payphones by individuals utilizing such toll-free
numbers. Previously, these carriers were not required to disclose the identity
of resellers responsible for payment. The FCC order became effective on November
27, 2001. Although the Company expects this FCC order to improve its ability to
identify and collect amounts relating to dial-around calls that would otherwise
become uncollectible, the amount of the increase in revenues from dial-around
compensation, if any, cannot be determined at this time.
Other revenues were $587,000 and $1,000,000 for the years ended December
31, 2000 and 2001, respectively. This increase of $413,000 was primarily due to
a $426,000 increase in revenues from telecommunication contractor services
provided to Urban Telecommunications, Inc., a related party.
OPERATING EXPENSES. Total operating expenses decreased $20,305,000, or
21.1%, from $96,336,000 for the year ended December 31, 2000 to $76,031,000 for
the year ended December 31, 2001. This decline was due to decreases in
substantially all operating expense categories. Such decreases in operating
expenses were due to the decrease in the average number of installed pay
telephones, the decrease in the number of sales, administrative and operating
personnel, other cost reduction programs and the implementation of the servicing
agreement with Davel.
In 2001, line and transmission charges declined by $833,000, or 4.8%. Line
and transmission charges were $17,211,000 in 2000 and $16,378,000 in 2001 and
represented 29.2% and 36.4% of total revenues for the years ended December 31,
2000 and 2001, respectively. The dollar decrease was due to the decrease in the
average number of installed pay telephones, the decrease in local and long
distance line charges that are based upon call volumes and duration, and lower
line charges resulting from the use of CLECs. This decrease was partially offset
by approximately $1,783,000 of credits in 2000 relating to the recovery of prior
years' sales and excise taxes charged by LECs. The increase as a percentage of
revenues is primarily due to the lower revenues reported in 2001.
Location commissions were $8,467,000 in 2000 and $7,382,000 in 2001.
Location commissions declined by $1,085,000, or 12.8%, and represented 14.4% and
16.4% of total revenues for the years ended December 31, 2000 and 2001,
respectively. The dollar decrease reflects the effect of the decrease in
revenues in 2001 compared to 2000 which is used as the basis for calculating
location commissions. The percentage increase is due to the use of higher
commission accrual rates in 2001 to recognize the increasing commission rates
resulting from location contracts with new and existing location providers and
to reflect the removal of unprofitable phones which tend to have lower
commission rates.
Field operations, which consist principally of personnel costs, rents and
utilities of the local service facilities, and repair and maintenance of the
Company's installed pay telephone base, decreased $4,583,000, or 26.3%, from
$17,405,000 in 2000 to $12,822,000 for the year ended December 31, 2001. Field
operations as a percentage of total revenues decreased from 29.6% of total
revenues for the year ended December 31, 2000 to 28.5% of total revenues in
2001. The dollar and percentage decreases in 2001 compared to 2000 was primarily
due to lower aggregate payroll and vehicle costs resulting from the reduction in
personnel, a decrease in sales and other taxes based on revenues, a decrease in
service and repair part costs and other cost reductions. Included in the
decrease in sales and other taxes are credits of $449,000 in 2000 and $833,000
in 2001 for reductions in sales tax
24
assessments previously recorded as expense. A portion of the decrease in payroll
and other field operations expenses is attributable to efficiencies resulting
from the implementation of the servicing agreement with Davel during the third
quarter of 2001.
Selling, general and administrative ("SG&A") expenses decreased
$1,365,000, or 15.1%, from $9,056,000 for the year ended December 31, 2000 to
$7,691,000 for the year ended December 31, 2001. SG&A expenses represented 15.4%
of total revenues for the year ended December 31, 2000 and 17.1% in 2001. The
dollar decrease was due to a decrease in administrative and sales personnel, a
reduction in corporate office telephone expense and other decreases in
administrative expenses as a result of cost reduction efforts in 2001. The
increase as a percentage of revenues is primarily due to lower revenues reported
in 2001.
Depreciation and amortization decreased $4,483,000, or 25.7%, from
$17,469,000 for the year ended December 31, 2000 to $12,986,000 for the year
ended December 31, 2001. Depreciation and amortization represented 29.7% of
total revenues for the year ended December 31, 2000 and 28.9% of total revenues
for the year ended December 31, 2001, a decrease of 0.8%. The dollar and
percentage decreases were primarily due to a $4,280,000 reduction in
amortization expense in 2001. This reduction in amortization expense was due to
a $21,205,000 write-off of intangible assets relating to losses on asset
impairment and the abandonment of payphone location contracts recorded in the
last half of 2000 and, to a lesser extent, the $17,582,000 write-off of
intangible assets in 2001.
The provision for uncollectible accounts receivable decreased $4,616,000
from $4,944,000 in 2000 to $328,000 in 2001. The provision for uncollectible
accounts receivable represented 8.4% of total revenues in 2000 and 0.7% in 2001,
a decrease of 7.7%. The dollar and percentage decreases were due to the
write-off of accounts receivable relating to dial-around compensation in 2000 to
more closely reflect the actual number of dial-around calls for which the
Company currently expects to be paid.
Charges relating to location contracts decreased $3,623,000 from
$21,205,000 for the year ended December 31, 1999 to $17,582,000 for the year
ended December 31, 2001. In 2000, the loss consisted of $6,418,000 relating to
the removal of 3,376 unprofitable pay telephones as part of the Company's
continuing program to evaluate the profitability of its payphones. The loss in
2000 also included an asset impairment loss of $14,787,000 to write-down the
carrying value of the Company's payphone location contracts to their estimated
fair value. In 2001, the loss consisted of $1,752,000 relating to the removal of
1,960 unprofitable pay telephones and an asset impairment loss of $15,830,000.
Charges relating to location contracts represented 36.0% of total revenues in
2000 and 39.1% of total revenues in 2001.
Other unusual charges and contractual settlements increased $283,000 from
$579,000 for the year ended December 31, 2000 to $862,000 for the year ended
December 31, 2001. For the year ended December 31, 2000, other unusual charges
and contractual settlements consisted of: (i) professional fees and other costs
related to the company's Prepackaged Plan, $78,000; (ii) other contractual
settlements, $284,000; and (iii) costs relating to unsuccessful refinancing
efforts and other matters, $217,000. In 2001, other unusual charges contractual
settlements consisted of: (i) costs relating to the Davel Merger Agreement,
$650,000; (ii) settlement of an employee contractual obligation, $108,000; (iii)
other contractual settlements, $21,000; and (iv) other non-recurring charges,
$83,000. Other unusual charges and contractual settlements represented 1% and
1.9% of total revenues in 2000 and 2001, respectively.
OTHER INCOME (EXPENSE). Other income (expense) is comprised principally of
interest expense incurred on debt and interest and other income (expense). Total
interest expense increased $177,000, or 1.6%, from $11,168,000 for the year
ended December 31, 2000 to $11,345,000 for the year ended December 31, 2001.
Interest expense represented 19.0% of total revenues for the year ended December
31, 2000 and 25.2% of total revenues for the year ended December 31, 2001, an
increase of 6.2%. The dollar and percentage increases in interest expense were
due to an increase in the outstanding balance of the Company's secured debt
resulting from the capitalization of interest and fees in 2001, offset by a
reduction in the interest rate which varies with the lenders' base interest
rate. Interest and other income (expense) decreased $430,000, from $254,000 in
2000 to ($176,000) in 2001. This decrease was primarily due to a $378,000 loss
on the sale of approximately 1,080 payphones and related operating assets for
two of the Company's district operations facilities located in Montana. The
Company received $648,000 for the sale of these assets in December 2001, a
portion of which was used to pay principal on its secured debt.
25
EBITDA FROM RECURRING OPERATIONS. EBITDA from recurring operations (income
before interest income, interest expense, taxes, depreciation and amortization,
charges relating to location contracts, other unusual charges and contractual
settlements and extraordinary items) decreased $1,391,000, or 79.0%, from
$1,761,000 for the year ended December 31, 2000 to $370,000 for the year ended
December 31, 2001. EBITDA from recurring operations represented 3.0% of total
revenues for the year ended December 31, 2000 and 0.8% of total revenues for the
year ended December 31, 2001, a decrease of 2.2%. The dollar and percentage
decreases are primarily due to the decrease in revenues offset by decreases in
certain operating expenses . EBITDA from recurring operations is not intended to
represent an alternative to operating income (as defined in accordance with
generally accepted accounting principles), as an indicator of the Company's
operating performance, or as an alternative to cash flows from operating
activities (as determined in accordance with generally accepted accounting
principles) as a measure of liquidity. See "Liquidity and Capital Resources" for
a discussion of cash flows from operating, investing and financing activities.
The Company believes that EBITDA from recurring operations is a meaningful
measure of performance because it is commonly used in the public pay telephone
industry to analyze comparable public pay telephone companies on the basis of
operating performance, leverage and liquidity.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
REVENUES Total revenues decreased by $9,722,000 or 14.2% from $68,566,000
for the year ended December 31, 1999 to $58,844,000 for the year ended December
31, 2000. This decrease is primarily due to a decrease in the average number of
installed pay telephones, a decline in coin call volume, and the decrease in
revenues from non-coin telecommunication services, including dial-around
compensation, as discussed below. The average number of installed pay telephones
decreased from 40,063 for the year ended December 31, 1999 to 36,841 for the
year ended December 31, 2000, a decrease of 3,222, or 8.0%. This decrease was
principally due to expired location contracts which were not renewed and the
removal of approximately 2,000 unprofitable pay telephones in the fourth quarter
of 1999 and approximately 1,500 unprofitable pay telephones in the third quarter
of 2000.
Revenues from coin calls were $40,598,000 and $33,110,000 for the years
ended December 31, 1999 and 2000, respectively. This decrease of $7,488,000, or
18.4%, is primarily due to a decrease in the average number of payphones and a
decline in the number of local and long distance coin calls. Long distance and
local call volumes and coin revenues have been adversely affected by the growth
of wireless communication services, which serves as an increasingly competitive
alternative to payphone usage. Coin revenues from long distance calls have also
declined due to the impact of dial-around calls placed from the Company's
payphones as discussed below.
Revenues from non-coin telecommunication services decreased by $2,585,000
or 9.3%, from $27,732,000 for the year ended December 31, 1999 to $25,147,000
for the year ended December 31, 2000. Of this decrease, long distance revenues
from operator service providers decreased by $1,047,000 or 8.2% principally due
to a reduction in the number of operator service calls resulting from the
decline in the average number of installed pay telephones, continuing aggressive
dial-around advertising by long distance carriers such as AT&T and MCI Worldcom
and the use of prepaid phone cards. Long distance revenues from operator service
providers have also been adversely affected by the growth in wireless
communications. These decreases in long distance revenues were partially offset
by higher commission rates received as a result of a change in the Company's
primary operator service provider in January 2000. Revenues from dial-around
compensation decreased by $1,538,000 or 10.3% compared to 1999 primarily due to
the decrease in the average number of installed pay telephones and a reduction
in the estimated number of dial-around calls used to record revenues at the end
of 2000. In the fourth quarter of 2000, the Company reported revenues at a rate
of $27.00 per pay telephone per month based on $0.24 per call and an estimated
114 calls per pay telephone per month to more closely reflect the actual number
of calls for which the Company expects to be compensated.
OPERATING EXPENSES. Total operating expenses increased $8,700,000, or 9.9%,
from $87,636,000 for the year ended December 31, 1999 to $96,336,000 for the
year ended December 31, 2000. The increase was due to an increase in the
provision for uncollectible accounts receivable and in charges relating to
location contracts offset by decreases in other operating expense categories.
Such decreases in other operating expenses were due in part to decreases in
depreciation and amortization resulting from the adoption of fresh start
reporting, the decrease in
26
the average number of installed pay telephones, the decrease in the number of
sales, administrative and operating personnel and other cost reduction programs.
Line and transmission charges decreased $2,452,000, or 12.5%, from
$19,663,000 for the year ended December 31, 1999 to $17,211,000 for the year
ended December 31, 2000. Line and transmission charges represented 28.7% of
total revenues for the year ended December 31, 1999 and 29.2 % of total revenues
for the year ended December 31, 2000, an increase of 0.5%. The dollar decrease
was due to the decrease in the average number of installed pay telephones, the
decrease in local and long distance line charges that are based upon call
volumes and duration, and lower line charges resulting from the use of CLECs. In
2000, the Company also recovered approximately $1,783,000 of prior years' sales
and excise taxes charged by LECs compared to $1,688,000 of reductions in line
and transmission charges in 1999 relating to cost-based rate reductions ordered
by state regulators, promotional allowances, and sales and excise taxes charged
by LECs. The increase as a percentage of revenues is primarily due to the lower
revenues reported in 2000.
Location commissions were $12,231,000 in 1999 and $8,467,000 in 2000.
Location commissions declined by $3,764,000, or 30.8%, and represented 17.8% and
14.4% of total revenues for the years ended December 31, 1999 and 2000,
respectively. The dollar decrease reflects the effect of the decrease in
revenues in 2000 compared to 1999 which is used as the basis for calculating
location commissions. The percentage decrease is due to the use of higher
commission accrual rates in 1999 to recognize the increasing commission rates
resulting from location contracts with new and existing location providers.
Field operations, which consist principally of personnel costs, rents and
utilities of the local service facilities, and repair and maintenance of the
Company's installed pay telephone base, decreased $2,822,000, or 14.0%, from
$20,227,000 in 1999 to $17,405,000 for the year ended December 31, 2000. Field
operations as a percentage of total revenues increased slightly from 29.5% of
total revenues for the year ended December 31, 1999 to 29.6% of total revenues
in 2000. The dollar decrease in 2000 compared to 1999 was primarily due to lower
aggregate salaries and wages resulting from the reduction in personnel, a
decrease in sales and other taxes based on revenues during 2000 and other cost
reduction measures. Included in the decrease in sales and other taxes is
$920,000 for reductions in sales tax assessments previously recorded as expense
and lower universal telephone service fees ("USF fees"). As a result of a court
ruling in the first quarter of 2000, USF fees can only be assessed on interstate
coin revenues which reduces the amount of such fees the Company is required to
pay. The percentage increase was a result of the lower revenues during 2000.
SG&A expenses decreased $1,459,000, or 13.9%, from $10,515,000 for the year
ended December 31, 1999 to $9,056,000 for the year ended December 31, 2000. SG&A
expenses represented 15.3% of total revenues for the year ended December 31,
1999 and 15.4% in 2000. The dollar decrease was due to a decrease in
administrative and sales personnel, a reduction in corporate office telephone
expense and other decreases in administrative expenses as a result of cost
reduction efforts in 2000. The increase as a percentage of revenues is primarily
due to lower revenues reported in 2000.
Depreciation and amortization decreased in 2000 primarily due to the
adoption of fresh start reporting as of November 17, 1999, the Consummation Date
of the Company's Prepackaged Plan. Under fresh start reporting, the carrying
values of property and equipment and of intangible assets were adjusted to equal
the fair value of such assets at that date. The new cost basis of these assets
is being depreciated or amortized over their remaining useful lives.
Depreciation and amortization decreased $5,566,000, or 24.2%, from $23,035,000
for the year ended December 31, 1999 to $17,469,000 for the year ended December
31, 2000. Depreciation and amortization represented 33.6% of total revenues for
the year ended December 31, 1999 and 29.7% of total revenues for the year ended
December 31, 2000, a decrease of 3.9%.
The provision for uncollectible accounts receivable increased $4,540,000
from $404,000 in 1999 to $4,944,000 in 2000. The provision for uncollectible
accounts receivable represented 0.6% of total revenues in 1999 and 8.4% in 2000,
an increase of 7.8%. The dollar and percentage increases were due to the
write-off of accounts receivable relating to dial-around compensation in 2000 to
more closely reflect the actual number of dial-around calls for which the
Company currently expects to be paid.
Charges relating to location contracts increased $20,341,000 from $864,000
for the year ended December 31, 1999 to $21,205,000 for the year ended December
31, 2000. The loss in 1999 related to the removal of 1,839 pay
27
telephones as part of the Company's continuing program to evaluate the
profitability of its payphones. In 2000, the loss consisted of $6,418,000
relating to the removal of 3,376 unprofitable pay telephones and an asset
impairment loss of $14,787,000 to write-down the carrying value of the Company's
payphone location contracts to their estimated fair value. Charges relating to
location contracts represented 1.3% of total revenues in 1999 and 36.0% of total
revenues in 2000.
Other unusual charges and contractual settlements decreased $118,000 from
$697,000 for the year ended December 31, 1999 to $579,000 for the year ended
December 31, 2000. For the year ended December 31, 1999, other unusual charges
and contractual settlements consisted of: (i) professional fees and other costs
related to the Company's Prepackaged Plan, $883,000; (ii) other matters,
$178,000; less (iii) recovery of expense relating to settlement of professional
fees, $364,000. Other unusual charges and contractual settlements represented
1.0% of total revenues in 1999 and 2000.
OTHER INCOME (EXPENSE). Other income (expense) is comprised principally of
interest expense incurred on debt and interest income. Total interest expense
decreased $9,569,000, or 46.1%, from $20,737,000 for the year ended December 31,
1999 to $11,168,000 for the year ended December 31, 2000. Interest expense
represented 30.2% of total revenues for the year ended December 31, 1999 and
19.0% of total revenues for the year ended December 31, 2000, a decrease of
11.2%. The dollar decrease occurred as a result of the conversion of the
Company's Senior Notes to Common Stock (Successor Company) pursuant to the
Company's Prepackaged Plan. Interest relating to the Senior Notes, including
amortization of deferred financing costs, was $13,905,000 in 1999 (through
November 17, 1999). This decrease was offset by an increase in interest expense
relating to the Company's secured debt as a result of additional borrowings in
1999 and an increase in the effective rate of interest arising principally from
the amortization of higher fees relating to the Company's Exit Financing
Agreement. Interest and other income increased $25,000, from $229,000 in 1999 to
$254,000 in 2000. This increase consisted of a decrease in interest income
offset by an increase in other income in 2000.
EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT. The extraordinary gain on
extinguishment of debt of $77,172,000 in 1999 consists of the gain on conversion
of Senior Notes to Common Stock (Successor Company) of $79,267,000 less a loss
of $2,095,000 due to the write-off of deferred financing costs upon refinancing
of the Company's Credit Agreement.
EBITDA FROM RECURRING OPERATIONS. EBITDA from recurring operations (income
before interest income, interest expense, taxes, depreciation and amortization,
charges relating to location contracts, other unusual charges and contractual
settlements and extraordinary items) decreased $3,765,000, or 68.1%, from
$5,526,000 for the year ended December 31, 1999 to $1,761,000 for the year ended
December 31, 2000. EBITDA from recurring operations represented 8.1% of total
revenues for the year ended December 31, 1999 and 3.0% of total revenues for the
year ended December 31, 2000, a decrease of 5.1%. The dollar and percentage
decreases are primarily due to the decrease in revenues and the increase in the
provision for uncollectible accounts receivable relating to dial-around
compensation offset by decreases in certain operating expenses. See "Liquidity
and Capital Resources "for a discussion of cash flows from operating, investing
and financing activities.
LIQUIDITY AND CAPITAL RESOURCES
On February 19, 2002, in connection with the Davel Merger Agreement,
PhoneTel and Davel jointly entered into a new $10,000,000 senior secured credit
facility (the "Senior Credit Agreement") with Madeleine L.L.C. and ARK CLO
2000-1, Limited (the "Senior Lenders"). Under the Senior Credit Agreement,
PhoneTel and Davel each received $5,000,000 of loan proceeds and will each pay
50% of the interest, fees and principal due thereunder. The companies have joint
and several liability for this obligation and each would be responsible for the
entire obligation in the event of default by the other party.
The Senior Credit Agreement is secured by substantially all of the assets
of PhoneTel and Davel and provides for the payment of monthly interest at 15%
per annum and, beginning July 31, 2002, monthly principal payments of $833,000
through the earlier of June 30, 2003, the maturity date of the loan, or the
termination of the Davel Merger
28
Agreement (which will occur on August 31, 2002 if not then extended by the
Lenders). The Senior Credit Agreement also provides for the payment of a 1% loan
fee, loan costs incurred by the Senior Lenders, and advanced payments of
principal from excess cash flow or certain types of cash receipts. The Company
incurred $190,000 for its share of costs and loan fees. The Senior Credit
Agreement also requires PhoneTel and Davel to maintain a minimum level of
combined earnings (as defined in the Senior Credit Agreement) and limits the
incurrence of cash expenditures and indebtedness, the payment of dividends, and
certain asset disposals.
CASH FLOWS FROM OPERATING ACTIVITIES Net cash provided by (used in)
operating activities during the fiscal years ended December 31, 1999, 2000 and
2001 was ($1,537,000), $1,260,000, and $587,000, respectively. Net cash provided
by (used in) operating activities consisted primarily of the funding of
operating losses (before extraordinary item) and the decrease in current
liabilities in 1999, offset by depreciation and amortization, the increase in
current liabilities in 2000, non-cash charges relating to location contracts and
accounts receivable, and non-cash interest charged to expense. The decrease in
non-cash interest from 1999 to 2000 was due to the discharge of accrued interest
then owed on the Company's 12% Senior Notes in the Company's Chapter 11
Bankruptcy Case in 1999. The increase in non-cash interest from 2000 to 2001
relates to approximately $5,565,000 of interest that was originally due in 2001
that the Company was permitted to capitalize as a result of amendments to the
Company's Exit Financing Agreement.
CASH FLOWS FROM INVESTING ACTIVITIES Cash used in investing activities
during the fiscal years ended December 31, 1999, 2000, and 2001 was $2,302,000,
$2,429,000, and $445,000, respectively. Cash used in investing activities
consisted primarily of capital expenditures resulting from the purchase and
installation of new pay telephone equipment and other expenditures to extend the
useful life of existing pay telephone equipment, and costs relating to new
location contracts. In 2001, the Company was able to reduce capital expenditures
for pay telephone equipment by redeploying equipment removed from unprofitable
locations. The Company was also able to remain competitive while substantially
eliminating signing bonuses to new location providers in 2001. Cash used in
investing activities in 2001 also declined as a result of a $648,000 payment
received for the sale of assets relating to two district office facilities.
CASH FLOWS FROM FINANCING ACTIVITIES Cash provided by financing activities
during the fiscal year ended December 31, 1999 was $3,771,000, which consisted
primarily of net proceeds from borrowings under the Company's credit facilities
offset by payments of debt related to refinancings, payment of debt financing
costs and other repayments of debt. In 2000 and 2001, cash used in financing
activities was $106,000 and $342,000, respectively which consisted primarily of
payments of existing debt and debt financing costs.
POST REORGANIZATION LOAN AGREEMENT The Company executed an agreement with
Foothill Capital Corporation ("Foothill") for post reorganization financing
("Exit Financing Agreement") on November 17, 1999. The Exit Financing Agreement
provides for a $46,000,000 revolving credit commitment (the "Maximum Amount"),
excluding interest and fees capitalized as part of the principal balance. The
Exit Financing Agreement is secured by substantially all of the assets of the
Company and was originally scheduled to mature on November 16, 2001.
The Exit Financing Agreement provides for various fees aggregating
$9,440,000 over the original term of the loan, including a $1,150,000 deferred
line fee, which was originally payable one year from the date of closing,
together with interest thereon, and a $10,000 servicing fee which is payable
each month. The Exit Financing Agreement, as amended, also provides for an
additional fee of $575,000 per month for each month after the original maturity
date of the loan. At the option of the Company, payment of other fees, together
with interest due thereon, may be deferred and added to the then outstanding
principal balance. Fees due pursuant to the Exit Financing Agreement were
subject to certain reductions for early prepayment, providing the Company was
not in default on the Exit Financing Agreement.
The Exit Financing Agreement provides for interest on the outstanding
principal balance at 3% above the base rate (as defined in the Exit Financing
Agreement) or 10.75%, whichever is greater, with interest on the Maximum Amount
payable monthly in arrears. The Exit Financing Agreement, as amended on December
31, 1999, includes covenants, which among other things, require the Company to
maintain ratios as to fixed charges, debt to earnings, current ratio, interest
coverage and minimum levels of earnings, payphones and operating cash (all as
defined in the
29
Exit Financing Agreement). Other covenants limit the incurrence of long-term
debt, the level of capital expenditures, the payment of dividends, and the
disposal of a substantial portion of the Company's assets.
From December 31, 2000 through December 31, 2001, the Company was not in
compliance with certain financial covenants under the Exit Financing Agreement.
In addition, the Company did not pay the monthly interest payments that were
originally due on February 1, 2001 through March 1, 2002 nor the deferred line
fee that was originally due on November 17, 2000. Effective November 13, 2000,
February 1, March 1, April 1, May 1 and August 13, 2001, and February 19, 2002,
the Company executed amendments to the Exit Financing Agreement (the
"Amendments") which extended the due date of the deferred line fee and the
maturity date of the Exit Financing Agreement to August 31, 2002. The Amendments
provide for the capitalization of monthly interest that was originally due on
February 1, 2001 through August 1, 2002 as part of the principal balance and
waives defaults through December 31, 2001 for the Company's failure to comply
with certain financial covenants. The Amendments also amended or eliminated
certain financial covenants and permits the Company to incur the debt under the
Senior Credit Agreement described below, which debt is senior in right of
payment to Company's Exit Financing Agreement. Although the lenders have waived
defaults by the Company through December 31, 2001, there can be no assurances
that the Company will be able to comply with its financial covenants through the
remainder of 2002. If a default occurs with respect to the Company's Exit
Financing Agreement, this obligation, subject to the rights of the Senior
Lenders, could be declared immediately due and payable.
On February 19, 2002, PhoneTel's and Davel's existing secured lenders,
including Foothill, consented to the Davel Merger, agreed to exchange a
substantial amount of debt for equity securities, and committed to restructure
the remaining debt. The Company previously received consent from Foothill to
enter into the servicing agreement with Davel referred to above.
FINANCIAL CONDITION The Company's working capital deficiency, excluding the
current portion of long-term debt, increased from $2,698,000 at December 31,
2000 to $3,841,000 at December 31, 2001, which represents a decrease in working
capital of $1,143,000. The Company's cash provided by operating activities
decreased from $1,260,000 for the year ended December 31, 2000 to $587,000 for
the year ended December 31, 2001. In addition, the Company has incurred
continuing operating losses, was not in compliance with certain financial
covenants under its Exit Financing Agreement from December 31, 2000 through
December 31, 2001 and has not made the monthly scheduled interest payments that
were originally due on February 1, 2001 through March 1, 2002. As a result of
certain amendments to the Company's Exit Financing Agreement, the lenders have
waived all defaults relating to the Company's failure to comply with certain
financial covenants, extended the due date of the loan, deferred all monthly
interest payments to the maturity date of the loan, and have amended or
eliminated certain financial covenants. The Company's existing lenders have also
agreed to restructure this debt in connection with the Davel Merger as described
above. However, if the Company is unable to complete the Davel Merger and does
not comply with the terms of the Exit Financing Agreement, as amended, this
debt, subject to the rights of the Senior Lenders, could become immediately due
and payable.
The Company's working capital, liquidity and capital resources may be
limited by its ability to generate sufficient cash flow from its operations or
its investing or financing activities. Cash flow from operations depends on
revenues from coin and non-coin sources, including dial-around compensation, and
management's ability to control expenses. There can be no assurance that coin
and operator service revenues will not decrease, that revenues from dial-around
compensation will continue at the rates anticipated, or that operating expenses
can be maintained at present or reduced to lower levels. In the event that cash
flow from operating activities is insufficient to meet the Company's cash
requirements, there can be no assurance that the Company can obtain additional
or alternative financing to meet its debt service and other cash requirements.
On February 19, 2002, the Company obtained $5,000,000 of new financing
under the Senior Credit Agreement. The Company also implemented the servicing
agreement with Davel and has begun to achieve the anticipated efficiencies and
cost savings associated with the consolidation of both companies' field office
operations. As part of the Company's ongoing evaluation of its payphone base, in
the third quarter of 2001, the Company removed approximately 2,000 additional
payphones that had become unprofitable. In addition, the Company is developing
alternate sources of revenue. With the current operational efficiencies and
additional cost savings expected in connection with the Davel Merger and the
continued support of its lenders, management believes, but cannot assure, that
cash flow from operations, including any new sources of revenue, will allow the
Company to sustain its
30
operations and meet its obligations through the remainder of 2002 or until the
proposed merger with Davel is completed.
CAPITAL EXPENDITURES For the year ended December 31, 2001, the Company had
capital expenditures of $575,000 which were financed by cash flows from
operating activities. Capital expenditures are principally for replacement and
expansion of the Company's installed public pay telephones, related equipment,
operating equipment and computer hardware. The Company has no significant
commitments for capital expenditures at December 31, 2001.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"), which requires companies
to recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. In 2001, the
Company adopted SFAS No. 133 (as amended by SFAS No. 137) which was effective
for fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 did
not have a material effect on the Company's financial position or results of
operations.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
`Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interests method of accounting for business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, upon adoption
of SFAS No. 142, that the Company reclassify the carrying amounts of intangible
assets and goodwill based on the criteria in SFAS No. 141.
SFAS No. 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS No. 142 requires that the Company identify reporting units for
the purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
were initially recognized. SFAS No. 142 requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
Company is also required to reassess the useful lives of other intangible assets
within the first interim quarter after adoption of SFAS No. 142.
As of December 31, 2000 and 2001, the net carrying amounts of
intangible assets was $48,374,000 and $22,770,000 respectively. Amortization
expense during the ten months and seventeen days ended November 17, 1999, the
one month and thirteen days ended December 31, 1999 and the years ended December
31, 2000 and 2001 were $13,345,000 $1,623,000, $12,337,000 and $8,057,000,
respectively. The Company does not expect the adoption of SFAS No. 141 and SFAS
No. 142 to affect the classification or useful lives of its intangible assets or
the amounts of amortization expense or impairment losses to be recognized under
the new standards.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets." SFAS No. 144 replaces SFAS No.
121, "Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed of." SFAS No. 144 retains the fundamental provisions of
SFAS No. 121 for the recognition and measurement of the impairment of long-lived
assets to be disposed of by sale. Under SFAS No. 144, long-lived assets are
measured at the lower of the carrying amount or fair value, less cost to sell.
The Company will be required to adopt this statement no later than January 1,
2002. The Company is currently assessing the impact of this statement on its
results of operations, financial condition, and cash flows.
31
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, the financial position of the Company is
subject to a variety of risks. In addition to the market risk associated with
movements in interest rates on the Company's outstanding debt, the Company is
subject to a variety of other types of risk such as the collectibility of its
accounts receivable and the recoverability of the carrying values of its
long-term assets. The Company's long-term obligations primarily consist of
approximately $63 million in borrowings and capitalized fees and interest under
the Company's Exit Financing Agreement and $5 million in new fixed-rate
borrowings under the Senior Credit Agreement.
The Company's earnings and cash flows are subject to market risk resulting
from changes in interest rates with respect to its borrowings under its Exit
Financing Agreement. The Company does not presently enter into any transactions
involving derivative financial instruments for risk management or other purposes
due to the stability in interest rates in recent times and because Management
does not consider the potential impact of changes in interest rates to be
material.
The Company's available cash balances are invested on a short-term basis
(generally overnight) and, accordingly, are not subject to significant risks
associated with changes in interest rates. Substantially all of the Company's
cash flows are derived from its operations within the United States and the
Company is not subject to market risk associated with changes in foreign
exchange rates.
ITEM 8. FINANCIAL STATEMENTS
The consolidated financial statements of the Company are set forth in Item
14 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company filed a report on Form 8-K dated December 21, 2001 under Item 4
reporting that the Company's independent accountants, BDO Seidman, LLP ("BDO"),
were dismissed. During the Company's two fiscal years ended December 31, 2000
and through December 21, 2001, there have been no disagreements with BDO on any
matter of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of BDO, would have caused it make reference to the subject matter
of the disagreements in connection with its report.
The Company's report on Form 8-K dated December 21, 2001 also reported
under Item 4 that the Company engaged Aidman, Piser & Company, P.A. as its new
independent accountants to audit the Company's financial statements for its
fiscal year ended December 31, 2001.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The table below sets forth the names and ages of the Directors of the
Company as of March 1, 2002 and their positions, offices and business experience
during the past five years.
NAME AND AGE TENURE AS DIRECTOR AND POSITIONS,
OFFICES AND BUSINESS EXPERIENCE DURING
LAST FIVE YEARS
- --------------------------------------------------------------------------------
John D. Chichester, Age 53 Served as a Director of the Company
since November 1999. Served as President
and Chief Executive Officer of the
Company since March 1999. Prior to
joining the Company, Mr. Chichester
served as a director and Executive Vice
President of Urban Telecommunications,
Inc. and continues to serve in that
capacity. From 1970 to 1992, Mr.
Chichester held various positions with
the Public Communications Department of
32
NYNEX including Director of Operations
where he directed that company's
payphone operations.
Eugene I. Davis, Age 47 Served as a Director of the Company
since November 1999. Mr. Davis has been
Chairman and Chief Executive Officer of
Pirinate Consulting Group, L.L.C., a
consulting firm, from 1999 to present.
From 1998 to 1999, he was Chief
Operating Officer of Totaltel USA
Communications, a company engaged in the
telecommunications business. From 1992
until 1997, Mr. Davis was President and
Vice-Chairman, Emerson Radio
Corporation, a company engaged in the
electronics business. From 1996 to 1997,
Mr. Davis was Chief Executive Officer
and Vice-Chairman of Sport Supply Group,
a company engaged in the sporting goods
industry. Mr. Davis is a director of
Murdock Communications Corporation, Coho
Energy, Inc., Tipperary Corporation and
Eagle Geophysical, Inc.
Peter G. Graf, Age 64 Served as a Director of the Company
since July 1995. Mr. Graf also served as
Chairman of the Company from July 1995
to November 1999, and served as Chief
Executive Officer from July 1995 to
March 1999. Mr. Graf is licensed as an
attorney and certified public accountant
and serves as an officer and/or director
of various privately-held companies and
as the Managing Partner of Graf, Repetti
& Company, an accounting firm.
Bruce Ferguson, Age 45 Served as a Director of the Company
since January 2001. In 2002, Mr.
Ferguson joined Summit Investment
Partners, LLC, an investment management
company, as Managing Director of Special
Situation Investments. Previously he
served as a Senior Vice President of
Pacholder Associates, Inc., an
investment management company, from 1999
to 2001. He served as a Managing
Director of Marshall Financial Group,
Inc., a firm providing acquisition and
management services to operating
companies, from 1991 to 1998.
Kevin Schottlaender, Age 42 Served as a Director of the Company
since November 1999. Mr. Schottlaender
is President of Access Advisory Group,
LLC, a technical consultant to the
investment banking community. Prior
thereto, Mr. Schottlaender was
President, Director and Chief Executive
Officer of Global Interactive
Communications Corp. ("Global"), a
telecommunications company serving the
multi-family housing industry, from
December 1998 to September 2001. On July
26, 2001, an involuntary petition under
Chapter 7 of the U.S. Bankruptcy Code
was filed against Global in the Northern
District of Texas. The case is currently
pending and proceeding toward
liquidation. From June 1996 to December
1998, he was President, Director and
Chief Executive Officer of Interactive
Cable Systems, a telecommunications
company serving the multi-family housing
industry.
EXECUTIVE OFFICERS
The table below sets forth the names and ages of the executive officers of the
Company as of March 1, 2002 and their positions and business experience during
the past five years.
NAME AND AGE POSITIONS, OFFICES AND BUSINESS EXPERIENCE
DURING LAST FIVE YEARS
John D. Chichester, Age 53 For a description of the positions,
offices and business experience of Mr.
Chichester, see "Directors", above.
33
Richard P. Kebert, Age 55 Served as Chief Financial Officer and
Treasurer of the Company since September
1996 and Secretary of the Company since
March 2000. Prior to joining the
Company, Mr. Kebert was an independent
consultant. From 1994 to 1996, he was
Vice President-Finance and
Administration of Acordia of Cleveland,
Inc. For 12 years prior thereto, Mr.
Kebert held several senior management
positions with Mr. Coffee, inc.,
including Vice President of
Administration and Secretary. Mr. Kebert
is a certified public accountant.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Pursuant to the rules of the Securities Exchange Act of 1934 (the
"Act"), the Company is obligated to identify each person who, at any time during
the fiscal year, was a director, officer and/or beneficial owner of more than
10% of any class of equity securities of the Company registered pursuant to
Section 12 of the Act, or any other person subject to Section 16 of the Act with
respect to the Company (a "Reporting Person") that failed to file on a timely
basis, as disclosed in the Forms (as defined below), reports required by Section
16(a) of the Act during the fiscal year ended December 31, 2001, or prior fiscal
years.
The Company has, therefore, reviewed the following reports of Reporting
Persons received on or before March 21, 2002: Form 3--Initial Statement of
Beneficial Ownership of Securities and Form 4--Statement of Changes in
Beneficial Ownership, and amendments thereto, furnished to the Company during
the fiscal year ended December 31, 2001, and Form 5--Annual Statement of Changes
in Beneficial Ownership, and amendments thereto, furnished to the Company with
respect to the fiscal year ended December 31, 2001 (collectively, the "Forms").
Based on this review, the Company believes that all Reporting Persons timely
filed all Forms required to be filed with respect to the year ended December 31,
2001.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth a summary of all compensation for
services rendered during the three-year period ended December 31, 2001 paid to
the Company's Chief Executive Officer and to the Company's other executive
officer who was serving as an executive officer at December 31, 2001 and whose
total salary and bonus for fiscal 2001 exceeded $100,000 (together, the "Named
Executive Officers").
34
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------------- ------------------------
AWARDS PAYOUTS
------------------------- ----------
SECURITIES
RESTRICTED UNDERLYING LONG-TERM ALL OTHER
NAME AND OTHER ANNUAL STOCK OPTIONS/ INCENTIVE COMPEN-
PRINCIPAL SALARY BONUS COMPENSATION AWARD(S) SARS PAYOUTS SATION
POSITION YEAR ($) ($) ($) ($) (#) ($) ($)
- ------------------- -------- ------------ ----------- ---------------- ------------- -------------- ----------- -----------
John D. 2001 $360,231 $50,000 -- -- -- -- --
Chichester, 2000 343,269 75,000 -- -- 125,000(b) -- --
Director, 1999 231,250(a) -- -- -- -- -- --
President and
Chief Executive
Officer
Richard P. Kebert, 2001 145,000 -- -- -- -- -- --
Chief Financial 2000 144,039 11,875 -- -- 30,000(c) - --
Officer, 1999 120,000 15,000 -- -- -- -- --
Treasurer and
Secretary
(a) Represents salary received by Mr. Chichester from March 30, 1999, the date
of his employment, to December 31, 1999.
(b) Of these stock options, 50,000 were granted in 2000 under the PhoneTel
Technologies, Inc. 1999 Management Incentive Plan (the "1999 Plan") and
vest in equal thirds on April 1, 2001, 2002 and 2003 and 75,000 options
were granted not under the 1999 Plan on May 23, 2000 and were vested
immediately upon grant.
(c) These stock options were granted under the 1999 Plan. The stock options
vest in equal thirds on March 9, 2001, 2002 and 2003.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT, AND CHANGE-IN-CONTROL
ARRANGEMENTS
Effective April 1, 2000, the Company entered into an Employment
Agreement (the "Agreement") with John D. Chichester. The Agreement provided that
he would be President and Chief Executive Officer of the Company and had a term
of two years from April 1, 2000 ("Initial Term") that may be extended for an
additional one-year period (collectively, the "Extended Term"). Under the
Agreement, Mr. Chichester was to receive an annual base salary of not less than
$350,000, subject to an increase of 4% per annum, health and welfare benefits
and the opportunity to earn an annual cash incentive bonus based upon the annual
financial performance of the Company (the "Annual Bonus"). In addition, Mr.
Chichester was granted under the Agreement stock options to purchase 50,000
shares of Common Stock under the 1999 Plan. The stock options vest 16,667 on
April 1, 2001; 16,667 on April 1, 2002 and the remaining balance on April 1,
2003.
The target Annual Bonus for the first year of the Initial Term of the
Agreement was $90,000, and the percentage earned depended upon the "achievement
percentage" represented as the actual annual EBITDA performance of the Company
divided by the Company's projected EBITDA performance for the subject year as
defined in the Agreement. Under the formula, Mr. Chichester was eligible to earn
the following "bonus opportunity percentage" of his target Annual Bonus amount
with respect to a fiscal year during which the Annual Bonus is in effect.
35
ANNUAL BONUS CALCULATION SCHEDULE
ACHIEVEMENT PERCENTAGE BONUS OPPORTUNITY PERCENTAGE
Less than 80% 0%
80.1% to 90% 90%
90.1% to 100% 100%
100.1% to 110% 110%
Greater than 110% 120%
The target Annual Bonus amount for the second year of the Initial Term of the
contract is $100,000. Notwithstanding that the foregoing formula would have
resulted in no bonus for 2000 or 2001, the Compensation Committee of the
Company's Board of Directors elected to award Mr. Chichester a discretionary
bonus of $50,000 for 2000 which was paid in 2001. The Compensation Committee is
currently evaluating Mr. Chichester's 2001 bonus.
On February 28, 2002, the Agreement was amended to replace the one year
Extended Term with successive ninety-day renewal terms (each an "Extended Term")
which commence upon the expiration of the Initial Term and each Extended Term,
unless notice is given by the Board of Directors at least 30 days prior to the
expiration of any term that the Agreement will not be renewed (the "Amendment").
In addition, the Bonus Calculation Schedule applicable to such amended Extended
Term was amended as follows:
PERCENTAGE OF PROJECTED
EBITDA ACHIEVED BONUS PERCENTAGE
Less than 80% 0%
80.0% to 84.9% 80%
85.0% to 89.9% 85%
90.0% to 94.9% 90%
95.0% to 99.9% 95%
100% or higher 100%
The Amendment further provides that the Annual Bonus earned during the
Extended Term shall be prorated for the number of months elapsed between April
1, 2002 and the expiration or other termination of the Employment Agreement
(other than for cause).
The Agreement may be terminated by the Company in the event of Mr.
Chichester's death, disability, for cause or without cause. If the Agreement was
terminated by the Company without cause during the Initial Term, Mr. Chichester
would have been entitled to the following: (i) immediate vesting of all unvested
stock incentive options previously granted, (ii) a severance payment ("Severance
Payment") equal to the sum of (A) salary for remaining months in the Initial
Term and (B) $7,500 for each calendar month then remaining in the Initial Term
for which Mr. Chichester had not yet qualified or been paid the Annual Bonus.
The amount of the Severance Payment would have been increased by a factor of 25%
to account for loss of benefits. The Amendment provides that in the event the
Agreement is terminated by the Company without cause during the Extended Term,
Mr. Chichester shall be entitled to the following: (i) immediate vesting of all
unvested stock incentive options previously granted, (ii) a Severance Payment
equal to his salary for remaining months in the Extended Term (increased by a
factor of 20% to account for loss of benefits), and (iii) his prorated Annual
Bonus.
In addition, Mr. Chichester may elect to terminate the Agreement at any
time upon 60 days written notice or upon 30 days written notice upon the
occurrence of a "Trigger Event," as defined in the Agreement. A Trigger Event
shall be deemed to occur if (i) the Company is merged or consolidated into
another entity not affiliated with the Company, (ii) all or substantially all
the assets of the Company are sold to another entity that is not affiliated with
the Company, or (iii) any person, with the exception of an affiliate existing as
of the date of the Agreement, becomes a beneficial owner of securities of the
Company representing 50% or more of the combined voting power of the Company's
then outstanding securities entitled to vote generally in the election of
directors, other than by means of a public offering. In the event a Trigger
Event occurs, Mr. Chichester would be entitled to the Severance Payment
calculated in the manner required by a termination of his employment by the
Company without cause. Mr. Chichester would not be entitled to such payment if
he has been advised by the
36
Company, or its successor, that subsequent to the Trigger Event he is to be
retained for the remainder of the Initial Term or Extended Term of the
Agreement, subject to the terms and conditions thereof, and that he will perform
substantially the same functions as those that he performed prior to the Trigger
Event; provided, however, that Mr. Chichester shall not be required to relocate
his primary residence to another location.
The Company is also obligated to provide Mr. Chichester with a
vehicle for business and personal use and to pay for all expenses incident to
the operation of said vehicle. Under the Agreement, Mr. Chichester is also
permitted to continue as an officer and director of Urban Telecommunications,
Inc. provided such involvement does not interfere in any material respect with
his services to the Company. In addition, the Agreement contains certain
non-solicitation and non-competition provisions to which Mr. Chichester has
agreed to be subject.
STOCK OPTIONS
The following table contains information concerning stock options,
including stock options granted under the 1999 Plan to the Named Executive
Officers. No stock options or stock appreciation rights were granted during
2001.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR END OPTION/SAR VALUES
Number of Securities
Underlying Unexercised Value of Unexercised
Options/SARs at Fiscal In-the-Money Options at
Year End Year End
Shares
Acquired on Value Exercisable/ Exercisable/
Name Exercise Realized Unexercisable Unexercisable
---- -------- -------- ------------- -------------
John D. Chichester -- -- 91,667/33,333 $1,500/$0
Richard P. Kebert -- -- 10,000/20,000 $0/$0
COMPENSATION OF DIRECTORS
The Company's Amended and Restated Code of Regulations provides that
the Board of Directors may compensate Directors for serving on the Board and
reimburse them for any expenses incurred as a result of Board meetings. From
January 1, 2001 to December 31, 2001 each non-employee Director received
quarterly cash compensation payments of $5,000. The Board also authorized the
issuance of 20,000 options to purchase Common Stock of the Company to each
non-employee Director. On December 27, 1999, the Company granted such options
to the non-employee Directors as additional compensation for services to be
rendered during the 1999-2000 service year. Such options vested on the date of
grant, were exercisable immediately at an exercise price of $1.14 per share and
have a term of three (3) years.
37
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of the Common Stock owned by each Director of the Company,
each person known by the Company to own beneficially more than 5% of the
outstanding Common Stock, the Named Executive Officers and all Directors and
officers as a group as of March 1, 2002. Unless otherwise indicated, the number
of shares of Common Stock owned by the named shareholders assumes the exercise
of the warrants or options that are exercisable within 60 days, the number of
which is separately referred to in a footnote, and the percentage shown assumes
the exercise of such warrants or options and assumes that no warrants or options
held by others are exercised. This information is based upon information
furnished by such persons, statements filed with the Commission or other
information known to the Company.
NAME OF BENEFICIAL OWNER NUMBER OF SHARES PERCENTAGE
(AND ADDRESS OF FIVE PERCENT OF COMMON STOCK OF
BENEFICIAL OWNER) BENEFICIALLY OWNED CLASS
DIRECTORS
John D. Chichester (a) 108,334 1.05%
Director, President and
Chief Executive Officer
Eugene I. Davis (b) 20,000 *
Director
Bruce Ferguson None *
Director
Peter G. Graf (c) 382,512 3.68%
Director
Kevin Schottlaender (d) 20,000 *
Director
NAMED EXECUTIVE OFFICERS
Richard P. Kebert (a) 20,000 *
Chief Financial Officer, Treasurer,
and Secretary
Executive Officers and Directors (d) 550,846 5.21%
As a group (6 persons)
38
NAME OF BENEFICIAL OWNER NUMBER OF SHARES PERCENTAGE
(AND ADDRESS OF FIVE PERCENT OF COMMON STOCK OF
BENEFICIAL OWNER) BENEFICIALLY OWNED CLASS
------------------------------------------------------------------------------------------------------
FIVE PERCENT BENEFICIAL OWNERS
American Express Financial Corporation (e) 3,070,380 30.13%
IDS Tower 10
30th Floor, Unit 273
Minneapolis, MN 55402
Bankers Trust (f)
One Bankers Trust Plaza 732,000 7.18%
130 Liberty Street
New York, NY 10006
Leucadia National Corp. (g)
315 Park Avenue South 722,000 7.09%
New York, NY 10010
CIBC World Markets Corp. (h)
425 Lexington Avenue 608,000 5.97%
New York, NY 10017
Lutheran Brotherhood (i)
625 Fourth Avenue South 532,000 5.22%
Minneapolis, MN 55415
Paul Graf (j)
1114 Avenue of the Americas 820,000 8.05%
New York, NY 10036
- ----------
* Less than 1.0%
(a) Amount represents vested options to purchase Common Stock.
(b) Includes options to purchase 20,000 shares of Common Stock through December
26, 2002.
(c) Includes warrants to purchase 187,242 shares of Common Stock through
November 17, 2002, options to purchase 20,000 shares of Common Stock
through December 26, 2002 and beneficial ownership of 100,000 shares held
by Mr. Graf's wife. Mr. Graf disclaims beneficial ownership of shares held
by his son, Paul Graf.
(d) Includes beneficial ownership of Common Stock described above with respect
to Messrs. Chichester, Davis, Ferguson, Graf, Schottlaender and Kebert.
(e) The information regarding this holder is as of December 31, 2001 and was
obtained directly from the holder. Reflects beneficial ownership of
American Express Financial Corporation and affiliated entities.
(f) Based on the records of the Company regarding entitlement of holder to
issuance of shares of Common Stock effective November 17, 1999, in
connection with the Prepackaged Plan of Reorganization.
(g) This information is as of February 28, 2002 and was obtained directly from
the holder.
(h) This information is as of March 21, 2002 and was obtained directly from the
holder.
(i) This information is as of April 11, 2001 and was obtained directly from the
holder. Reflects beneficial ownership of Lutheran Brotherhood High Yield
Fund of 212,800 shares and LB Series Fund, Inc. of 319,200 shares.
(j) This information is as of March 15, 2002 and was obtained directly from the
holder. Paul Graf is the son of Peter Graf, a Director of the Company, and
disclaims beneficial ownership of shares of Common Stock beneficially owned
by his father.
39
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Chichester, the Company's President and Chief Executive Officer, is
a Director, Executive Vice President and a 49% shareholder of Urban
Telecommunications, Inc. ("Urban"). During the years ended December 31, 2000 and
2001, the Company had revenue of $81,000 and $507,000, respectively from various
telecommunications contractor services provided to Urban, principally residence
and small business facility provisioning and inside wiring. Accounts receivable
include $38,000 at December 31, 2000 and $188,000 at December 31, 2001 due from
Urban.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS
Report of Aidman, Piser & Company, P.A., Independent Certified Public Accountants......................F-1
Report of BDO Seidman, LLP, Independent Certified Public Accountants...................................F-2
Consolidated Balance Sheets as of December 31, 2000 and 2001...........................................F-3
Consolidated Statements of Operations for the Ten Months and
Seventeen Days Ended November 17, 1999, the One Month
and Thirteen Days Ended December 31, 1999 and the Years
Ended December 31, 2000 and 2001..................................................................F-4
Statements of Changes in Mandatorily Redeemable Preferred Stock
for the Ten Months and Seventeen Days Ended November 17, 1999,
the One Month and Thirteen Days Ended December 31, 1999
and the Years Ended December 31, 2000 and 2001....................................................F-5
Statements of Changes in Non-mandatorily Redeemable Preferred Stock,
Common Stock and Other Shareholders' Equity (Deficit) for the Ten
Months and Seventeen Days Ended November 17, 1999, the One Month
and Thirteen Days Ended December 31, 1999 and the Years Ended
December 31, 2000 and 2001.........................................................................F-6
Consolidated Statements of Cash Flows for
the Ten Months and Seventeen Days Ended November 17, 1999,
the One Month and Thirteen Days Ended December 31, 1999 and the
Years Ended December 31, 2000 and 2001.............................................................F-7
Notes to Consolidated Financial Statements for
the Ten Months and Seventeen
Days Ended November 17, 1999, the One Month and
Thirteen Days Ended December 31, 1999 and the Years Ended
December 31, 2000 and 2001........................................................................F-8
2. FINANCIAL STATEMENT SCHEDULES
Schedule II - Valuation and Qualifying Accounts.......................................................F-28
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.
40
3. EXHIBITS
EXHIBIT NO. DESCRIPTION
2.1 Joint Reorganization Plan of PhoneTel Technologies, Inc. and
Cherokee Communications, Inc. dated May 11, 1999 (1)*
2.2 Findings of Fact, Conclusions of Law and Order Confirming the Joint
Reorganization Plan of PhoneTel Technologies, Inc. and Cherokee
Communications, Inc. dated May 11, 1999. (1)*
2.3 Letter of intent between the Registrant and Davel Communications,
Inc., dated June 12, 2001. (8)*
2.4 Agreement and Plan of Reorganization and Merger dated as of
February 19, 2002, by and among Davel Communications, Inc., Davel
Financing Company, L.L.C., DF Merger Corp., PT Merger Corp. and
PhoneTel Technologies, Inc. (10)*
2.5 Exchange Agreement dated as of February 19, 2002, by and among
Davel Communications, Inc., Davel Financing Company, L.L.C., DF
Merger Corp., PhoneTel Technologies, Inc., Cherokee Communications,
Inc., the persons identified therein as the Davel Lenders and the
persons identified therein as the PhoneTel Lenders. (10)*
3.1 Amended and Restated Articles of Incorporation of PhoneTel
Technologies, Inc. dated as of October 12, 2000. (5)*
3.2 Amended and Restated Code of Regulations of PhoneTel Technologies,
Inc. dated as of November 17, 1999. (2)*
4.1 Warrant Agreement dated as of November 15, 1999 between PhoneTel
Technologies, Inc. and American Securities Transfer and Trust, Inc.
with respect to New Warrants, including the form of Warrant
Certificate. (2)*
10.1 Loan and Security Agreement dated as of November 17, 1999, by and
among PhoneTel Technologies, Inc., Cherokee Communications, Inc.,
the financial institutions that are signatories thereto and
Foothill Capital Corporation as agent. (2)*
10.2 PhoneTel Technologies, Inc. 1999 Management Incentive Plan. (2)* **
10.3 Registration Rights Agreement dated November 17, 1999 among
PhoneTel Technologies, Inc. and the parties identified on Exhibit A
thereto. (2)*
10.4 Operator Services Agreement for COCOT Payphones by and between One
Call Communications, Inc. (d/b/a Opticom) and PhoneTel
Technologies, Inc. dated January 21, 2000. (3)*
10.5 Lump Sum Bonus Addendum to Operator Services Agreement dated
January 21, 2000 by and between Opticom and PhoneTel Technologies,
Inc. dated January 21, 2000. (3)*
10.6 International Services Addendum to Operator Services Agreement
dated January 21, 2000 by and between One Call Communications, Inc.
("Opticom") and PhoneTel Technologies, Inc. dated February 16,
2000. (3)*
10.7 Amendment Number One to Loan and Security Agreement dated as of
December 31, 1999 by and among PhoneTel Technologies, Inc. and
Cherokee Communications, Inc. ("Borrowers") and the financial
institutions that are signatories thereto and Foothill Capital
Corporation as agent (together "Lenders") amending the Loan and
Security Agreement dated as of November 17, 1999 by and between
Borrowers and Lenders. (3)*
10.8 Employment Agreement dated as of April 1, 2000 by and between
PhoneTel Technologies, Inc. and John D. Chichester. (4)* **
41
10.9 Amendment Number Two to Loan and Security Agreement dated as of
November 13, 2000 by and among PhoneTel Technologies, Inc. and
Cherokee Communications, Inc. ("Borrower") and the financial
institutions that are signatories thereto and Foothill Capital
Corporation as agent (together "Lenders") amending the Loan and
Security Agreement dated as of November 17, 1999, as amended,
between Borrowers and Lenders. (5)*
10.10 Amendment Number Three to Loan and Security Agreement dated as of
February 1, 2001 by and among PhoneTel Technologies, Inc. and
Cherokee Communications, Inc. ("Borrower") and the financial
institutions that are signatories thereto and Foothill Capital
Corporation as agent (together "Lenders") amending the Loan and
Security Agreement dated as of November 17, 1999, as amended,
between Borrowers and Lenders. (6)*
10.11 Amendment Number Four to Loan and Security Agreement dated as of
March 1, 2001 by and among PhoneTel Technologies, Inc. and Cherokee
Communications, Inc. ("Borrowers") and the financial institutions
that are signatories thereto and Foothill Capital Corporation as
agent (together "Lenders") amending the Loan and Security Agreement
dated as of November 17, 1999, as amended, between Borrowers and
Lenders. (6)*
10.12 Amendment Number Five to Loan and Security Agreement dated as of
April 1, 2001 by and among PhoneTel Technologies, Inc. and Cherokee
Communications, Inc. ("Borrowers") and the financial institutions
that are signatories thereto and Foothill Capital Corporation as
agent (together "Lenders") amending the Loan and Security Agreement
dated as of November 17, 1999, as amended, between Borrowers and
Lenders. (7)*
10.13 Amendment Number Six to Loan and Security Agreement dated as of May
1, 2001 by and among PhoneTel Technologies, Inc. and Cherokee
Communications, Inc. ("Borrowers") and the financial institutions
that are signatories thereto and Foothill Capital Corporation as
agent (together "Lenders") amending the Loan and Security Agreement
dated as of November 17, 1999, as amended, between Borrowers and
Lenders. (7)*
10.14 Servicing Agreement between the Registrant and Davel
Communications, Inc., dated June 12, 2001. (8)*
10.15 Amendment Number Seven to Loan and Security Agreement dated as of
August 13, 2001 by and among PhoneTel Technologies, Inc. and
Cherokee Communicatons, Inc. ("Borrowers") and the financial
instiutions that are signatories thereto and Foothill Capital
Corporation as agent (together "Lenders") amending the Loan and
Security Agreement dated as of November 17, 1999, as amended,
between Borrowers and Lenders. (9)*
10.16 Letter Agreement, dated August 7, 2001, by and between the Company
and Davel regarding amendment to the Letter of Intent, dated June
12, 2001, between the Company and Davel and the Servicing Agreement
between the Company and Davel. (9)*
10.17 Commitment Letter dated February 19, 2002 by and among PhoneTel
Technologies, Inc., Davel Communications, Inc. and the lenders
named therein with respect to the debt restructuring contemplated
by the Merger Agreement. (10)*
10.18 Voting Agreement dated as of February 19, 2002, by and between
PhoneTel Technologies, Inc. and Samuel Zell. (10)*
10.19 Voting Agreement dated as of February 19, 2002, by and between
PhoneTel Technologies, Inc. and David R. Hill. (10)*
10.20 Amendment Number Eight to Loan and Security Agreement dated as of
February 19, 2002, by and among PhoneTel Technologies, Inc.,
Cherokee Communications, Inc., and Foothill Capital Corporation, as
Agent for the Lenders therein defined. (10)*
10.21 Credit Agreement dated as of February 19, 2002, by and among Davel
Financing Company, L.L.C., PhoneTel Technologies, Inc. and Cherokee
Communications, Inc.; Davel Communications, Inc. and the domestic
subsidiaries of Davel Financing Company, L.L.C. and Davel
Communications, Inc.; and Madeleine L.L.C. and ARK CLO 2000-1,
Limited. (10)*
10.22 Security Agreement dated as of February 19, 2002, by and among
Davel Communications, Inc., Davel Financing Company, L.L.C.,
PhoneTel Technologies, Inc., Cherokee Communications, Inc. and
Madeleine L.L.C., as Collateral Agent. (10)*
42
10.23 Amendment to Employment Agreement dated February 28, 2002 by and
between PhoneTel Technologies, Inc. and John D. Chichester.**
21 Subsidiaries of PhoneTel Technologies, Inc.
99.1 Joint Press Release of the Registrant and Davel Communications,
Inc. dated June 13, 2001. (8)*
99.2 Joint Press Release of the Registrant and Davel Communications,
Inc. dated February 21, 2002. (10)*
- ----------
* Previously filed.
** Management contract or compensatory plan or arrangement.
(1) Incorporated by reference from the Company's Form 8-K dated October
20, 1999.
(2) Incorporated by reference from the Company's Form 8-K dated
November 17, 1999.
(3) Incorporated by reference from the Company's Form 10-K for the year
ended December 31, 1999.
(4) Incorporated by reference from the Company's Form 10-K/A-1 for the
year ended December 31, 1999.
(5) Incorporated by reference from the Company's Form 10-Q for the
quarter ended September 30, 2000.
(6) Incorporated by reference from the Company's Form 10-K for the year
ended December 31, 2000.
(7) Incorporated by reference from the Company's Form 10-Q for the
quarter ended March 31, 2001.
(8) Incorporated by reference from the Company's Form 8-K dated June
12, 2001.
(9) Incorporated by reference from the Company's Form 10-Q for the
quarter ended June 30, 2001.
(10) Incorporated by reference from the Company's Form 8-K dated
February 19, 2002.
(b) REPORT ON FORM 8-K
In the fourth quarter of 2001, the Company filed a report on Form 8-K
under Item 4 dated December 21, 2001 reporting that the Company's
independent public accountants, BDO Seidman, LLP, were dismissed and that
Aidman, Piser & Company, P.A. had been engaged as the Company's new
independent public accountants. The Company filed a report on Form 8-K
under Item 5 dated February 21, 2002 announcing the execution of a
definitive merger agreement with Davel Communications, Inc., the execution
of a new $10,000,000 Senior Credit Agreement with Davel, and the receipt
of a commitment from the existing secured lenders of PhoneTel and Davel to
exchange a substantial amount of debt for equity securities of the
respective companies.
(c) EXHIBITS
The response to this portion of Item 14 is submitted as a separate section
of this report. See Item 14(a) 3 for a list of Exhibits hereto.
(d) FINANCIAL STATEMENT SCHEDULES
The Financial Statement Schedule to this Form 10-K is set forth as Exhibit
21.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
To the Board of Directors and Shareholders
PhoneTel Technologies, Inc.
We have audited the accompanying consolidated balance sheet of PhoneTel
Technologies, Inc. and Subsidiary (the "Company" or "PhoneTel") as of December
31, 2001, and the related consolidated statements of operations, changes in
mandatorily redeemable preferred stock, changes in non-mandatorily redeemable
preferred stock, common stock and other shareholders' equity (deficit) and cash
flows for the year then ended. Our audit also included the financial statement
schedule listed in the Index at Item 14. These financial statements and schedule
are the responsibility of PhoneTel's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
PhoneTel Technologies, Inc. and Subsidiary at December 31, 2001, and the
consolidated results of their operations and their cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
The accompanying consolidated financial statements have been prepared assuming
that PhoneTel Technologies, Inc. will continue as a going concern. As discussed
in Note 3, the Company has incurred recurring operating losses and has a
substantial working capital deficiency and has been unable to comply with the
terms of its debt agreements. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 3. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
As discussed in Note 4, non-coin dial-around revenues during the period from
November 7, 1996 to April 20, 1999 are the subject of review and reconsideration
by the Federal Communications Commission ("FCC"). As a result of the
proceedings, the FCC has determined that there will be an industry-wide
reconciliation to true-up underpayments and overpayments made during that period
as between the payphone providers, including the Company, and the relevant
"dial-around" carriers. While the timing and amounts of such true-up payments,
if any, are not currently determinable, in management's opinion the final
resolution and implementation of this reconciliation process, and the outcome
of any related administrative or judicial review of such adjustments, could
potentially have a material adverse effect on the Company. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Aidman, Piser & Company, P.A.
Tampa, Florida
February 19, 2002
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
Board of Directors
PhoneTel Technologies, Inc.
Cleveland, Ohio
We have audited the consolidated balance sheets of PhoneTel Technologies, Inc.
and subsidiary as of December 31, 2000 and the related consolidated statements
of operations, changes in mandatorily redeemable preferred stock, changes in
non-mandatorily redeemable preferred stock, common stock and other shareholders'
equity (deficit), and cash flows for the year ended December 31, 2000, the one
month and thirteen day period ended December 31, 1999 (Successor Company), and
the ten month and seventeen day period ended November 17, 1999 (Predecessor
Company). Our audits also included the financial statement schedule for the year
ended December 31, 2000, the one month and thirteen day period ended December
31, 1999, and the ten month and seventeen day period ended November 17, 1999
listed in the accompanying text. These financial statements and schedule are the
responsibility of the management of PhoneTel Technologies, Inc. (the Company).
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
PhoneTel Technologies, Inc. and its subsidiary as of December 31, 2000 and the
consolidated results of their operations and their cash flows for the year ended
December 31, 2000, the one month and thirteen day period ended December 31, 1999
(Successor Company), and the ten month and seventeen day period ended November
17, 1999 (Predecessor Company), in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
The financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Notes 2 and 11 to the financial
statements, the Company has suffered recurring losses from operations, has a
working capital deficiency and has been unable to comply with the terms of its
debt agreement. These factors raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 2. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
New York, New York
February 21, 2001, except for Notes 2 and 11
as to which the date is March 1, 2000
F-2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
DECEMBER 31
--------------------
2000 2001
-------- --------
ASSETS
Current assets:
Cash $4,425 $4,225
Accounts receivable, net of allowance for doubtful accounts
of $84 and $412, respectively 7,632 6,769
Other current assets 1,294 992
-------- --------
Total current assets 13,351 11,986
Property and equipment, net 18,858 13,983
Intangible assets, net 48,374 22,770
Other assets 606 689
-------- --------
$81,189 $49,428
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt $51,647 $62,635
Accounts payable 6,792 7,687
Accrued expenses:
Location commissions 2,702 3,810
Line and transmission charges 1,865 2,379
Personal property and sales taxes 2,753 1,145
Other 1,937 806
-------- --------
Total current liabilities 67,696 78,462
Long-term debt, net of current maturities 1,062 1,116
-------- --------
Total liabilities 68,758 79,578
-------- --------
Commitments and contingencies -- --
Shareholders' equity (deficit):
Common Stock (Successor Company) - $0.01 par value; 45,000,000
shares authorized, 10,189,684 shares issued and outstanding 102 102
Additional paid-in capital 63,429 63,429
Accumulated deficit (51,100) (93,681)
-------- --------
Total shareholders' equity (deficit) 12,431 (30,150)
-------- --------
$81,189 $49,428
======== ========
The accompanying notes are an integral part of these financial statements
F-3
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
PREDECESSOR
COMPANY SUCCESSOR COMPANY
----------------- ------------------------------------------------
TEN MONTHS ONE MONTH
AND SEVENTEEN AND THIRTEEN
DAYS ENDED DAYS ENDED YEAR ENDED DECEMBER 31
NOVEMBER 17 DECEMBER 31 ----------------------------
1999 1999 2000 2001
----------------- ------------- ----------- -----------
REVENUES:
Coin calls $36,220 $4,378 $33,110 $26,911
Non-coin telecommunication services 25,065 2,667 25,147 17,060
Other 210 26 587 1,000
----------------- ------------- ----------- -----------
61,495 7,071 58,844 44,971
----------------- ------------- ----------- -----------
OPERATING EXPENSES:
Line and transmission charges 17,575 2,088 17,211 16,378
Location commissions 11,263 968 8,467 7,382
Field operations 18,043 2,184 17,405 12,822
Selling, general and administrative 9,156 1,359 9,056 7,691
Depreciation and amortization 20,719 2,316 17,469 12,986
Provision for uncollectible accounts receivable 345 59 4,944 328
Charges relating to location contracts 864 - 21,205 17,582
Other unusual charges (income) and
contractual settlements 1,030 (333) 579 862
----------------- ------------- ----------- -----------
78,995 8,641 96,336 76,031
----------------- ------------- ----------- -----------
Loss from operations (17,500) (1,570) (37,492) (31,060)
OTHER INCOME (EXPENSE):
Interest expense (19,575) (1,162) (11,168) (11,345)
Interest and other income (expense) 191 38 254 (176)
----------------- ------------- ----------- -----------
(19,384) (1,124) (10,914) (11,521)
----------------- ------------- ----------- -----------
Loss before extraordinary item (36,884) (2,694) (48,406) (42,581)
Extraordinary item - gain on extinguishment of debt 77,172 - - -
----------------- ------------- ----------- -----------
NET INCOME (LOSS) $40,288 ($2,694) ($48,406) ($42,581)
================= ============= =========== ===========
EARNINGS (LOSS) PER SHARE CALCULATION:
Loss before extraordinary item ($36,884) ($2,694) ($48,406) ($42,581)
Preferred dividend payable in kind (13) - - -
Accretion of 14% Preferred to its redemption value (1,197) - - -
----------------- ------------- ----------- -----------
Loss before extraordinary item applicable to
common shareholders (38,094) (2,694) (48,406) (42,581)
Extraordinary item - gain on extinguishment of debt 77,172 - - -
----------------- ------------- ----------- -----------
Net income (loss) applicable to common shareholders $39,078 ($2,694) ($48,406) ($42,581)
================= ============= =========== ===========
Loss per common share before extraordinary item ($2.03) ($0.26) ($4.75) ($4.18)
Extraordinary gain per common share, basic and diluted 4.11 - - -
----------------- ------------- ----------- -----------
Net income (loss) per common share, basic and diluted $2.08 ($0.26) ($4.75) ($4.18)
================= ============= =========== ===========
Weighted average number of shares, basic and diluted 18,754,133 10,188,630 10,189,684 10,189,684
================= ============= =========== ===========
The accompanying notes are an integral part of these financial statements
F-4
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
STATEMENTS OF CHANGES IN MANDATORILY REDEEMABLE PREFERRED STOCK
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
- --------------------------------------------------------------------------------
PREDECESSOR COMPANY SUCCESSOR COMPANY
------------------------------ -----------------------------
TEN MONTHS AND ONE MONTH AND
SEVENTEEN DAYS ENDED THIRTEEN DAYS ENDED
NOVEMBER 17, 1999 DECEMBER 31, 1999
------------------------------ ------------------------------
SHARES AMOUNT SHARES AMOUNT
-------------- ------------- -------------- -------------
14% CUMULATIVE
REDEEMABLE CONVERTIBLE
PREFERRED STOCK
Balance, beginning of period 158,527 $9,112 - -
Dividends payable-in-kind 17,234 13 - -
Accretion of carrying value
to amount payable at
redemption on June 30, 2000 - 1,197 - -
Shares exchanged for Common Stock
of Successor Company (175,761) (10,322) - -
-------------- ------------- -------------- -------------
Balance, end of period - - - -
============== ============= ============== =============
SUCCESSOR COMPANY
-------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------------
2000 2001
----------------------------------- -----------------------------------
SHARES AMOUNT SHARES AMOUNT
---------------- ---------------- ---------------- ----------------
14% CUMULATIVE
REDEEMABLE CONVERTIBLE
PREFERRED STOCK
Balance, beginning of period - - - -
Dividends payable-in-kind - - - -
Accretion of carrying value
to amount payable at
redemption on June 30, 2000 - - - -
Shares exchanged for Common Stock
of Successor Company - - - -
---------------- ---------------- ---------------- ----------------
Balance, end of period - - - -
================ ================ ================ ================
The accompanying notes are an integral part of these financial statements.
F-5
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
STATEMENTS OF CHANGES IN NON-MANDATORILY REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
- --------------------------------------------------------------------------------
PREDECESSOR COMPANY SUCCESSOR COMPANY
--------------------------- ------------------------------
TEN MONTHS AND ONE MONTH AND
SEVENTEEN DAYS ENDED THIRTEEN DAYS ENDED
NOVEMBER 17, 1999 DECEMBER 31, 1999
----------------------------- ------------------------------
SHARES AMOUNT SHARES AMOUNT
-------------- ------------ --------------- -------------
SERIES A SPECIAL CONVERTIBLE
PREFERRED STOCK
Balance, beginning of period - - - -
Exercise of warrants 89,912 $18 - -
Conversion to Common Stock
(Predecessor Company) (89,912) (18) - -
-------------- ------------ --------------- -------------
Balance, end of period - - - -
============== ------------ =============== -------------
COMMON STOCK (PREDECESSOR COMPANY)
Balance, beginning of period 18,754,133 188 - -
Conversion of Series A Preferred 1,798,240 18 - -
Exchanged for new Common Stock (20,552,373) (206) - -
-------------- ------------ --------------- -------------
Balance, end of period - - - -
============== ------------ =============== -------------
COMMON STOCK (SUCCESSOR COMPANY)
Balance, beginning of period - - 10,188,630 $102
New Common Stock issued in exchange for:
12% Senior Notes 9,500,000 95 - -
14% Preferred Stock 325,000 3 - -
Old Common Stock 175,000 2 - -
Services 205,000 2 - -
Redemption in settlement of warrant
put obligation-Series A Preferred (16,370) - - -
Other capital transactions - - - -
-------------- ------------ --------------- -------------
Balance, end of period 10,188,630 102 10,188,630 102
============== ------------ =============== -------------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of period 61,233 63,390
New Common Stock issued in exchange for:
12% Senior Notes 58,805 -
14% Preferred Stock 10,102 -
Old Common Stock 87 -
Services 1,269 -
Warrants issued in exchange for old
Common Stock and 14% Preferred 333 -
Excercise of warrants - Series A Preferred (18) -
Put under warrants issued for
Series A Preferred 452 -
Other capital transactions - -
Options granted to officer - -
Fresh start accounting adjustment (68,873) -
------------ -------------
Balance, end of period 63,390 63,390
------------ -------------
ACCUMULATED DEFICIT
Balance, beginning of period (113,019) -
Net income (loss) 40,288 (2,694)
Dividends payable in-kind on 14%
Preferred and accretion (1,210) -
Fresh start accounting adjustment 73,941 -
------------ -------------
Balance, end of period - (2,694)
------------ -------------
TOTAL NON-MANDATORILY REDEEMABLE
PREFERRED STOCK, COMMON STOCK AND
OTHER SHAREHOLDERS' EQUITY (DEFICIT) $63,492 $60,798
============ =============
SUCCESSOR COMPANY
------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------------
2000 2001
---------------------------------- ----------------------------------
SHARES AMOUNT SHARES AMOUNT
--------------- ---------------- --------------- ----------------
SERIES A SPECIAL CONVERTIBLE
PREFERRED STOCK
Balance, beginning of period - - - -
Exercise of warrants - - - -
Conversion to Common Stock
(Predecessor Company) - - - -
--------------- ---------------- --------------- ----------------
Balance, end of period - - - -
=============== ---------------- =============== ----------------
COMMON STOCK (PREDECESSOR COMPANY)
Balance, beginning of period - - - -
Conversion of Series A Preferred - - - -
Exchanged for new Common Stock - - - -
--------------- ---------------- --------------- ----------------
Balance, end of period - - - -
=============== ---------------- =============== ----------------
COMMON STOCK (SUCCESSOR COMPANY)
Balance, beginning of period 10,188,630 $102 10,189,684 $102
New Common Stock issued in exchange for:
12% Senior Notes - - - -
14% Preferred Stock - - - -
Old Common Stock - - - -
Services - - - -
Redemption in settlement of warrant
put obligation-Series A Preferred - - - -
Other capital transactions 1,054 - - -
--------------- ---------------- --------------- ----------------
Balance, end of period 10,189,684 102 10,189,684 102
=============== ---------------- =============== ----------------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of period 63,390 63,429
New Common Stock issued in exchange for:
12% Senior Notes - -
14% Preferred Stock - -
Old Common Stock - -
Services - -
Warrants issued in exchange for old
Common Stock and 14% Preferred - -
Excercise of warrants - Series A Preferred - -
Put under warrants issued for
Series A Preferred - -
Other capital transactions 11 -
Options granted to officer 28 -
Fresh start accounting adjustment - -
----------------
----------------
Balance, end of period 63,429 63,429
---------------- ----------------
ACCUMULATED DEFICIT
Balance, beginning of period (2,694) (51,100)
Net income (loss) (48,406) (42,581)
Dividends payable in-kind on 14%
Preferred and accretion - -
Fresh start accounting adjustment - -
---------------- ----------------
Balance, end of period (51,100) (93,681)
---------------- ----------------
TOTAL NON-MANDATORILY REDEEMABLE
PREFERRED STOCK, COMMON STOCK AND
OTHER SHAREHOLDERS' EQUITY (DEFICIT) $12,431 ($30,150)
================ ================
The accompanying notes are an integral part of these financial statements.
F-6
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
PREDECESSOR
COMPANY SUCCESSOR COMPANY
---------------- ----------------------------------------------
TEN MONTHS ONE MONTH
AND SEVENTEEN AND THIRTEEN
DAYS ENDED DAYS ENDED YEAR ENDED YEAR ENDED
NOVEMBER 17 DECEMBER 31 DECEMBER 31 DECEMBER 31
1999 1999 2000 2001
---------------- --------------- ----------- --------------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) $40,288 ($2,694) ($48,406) ($42,581)
Adjustments to reconcile net income (loss)
to net cash flow from operating activities:
Depreciation and amortization 20,719 2,316 17,469 12,986
Extraordinary gain on extinguishment of debt (77,172) - - -
Provision for uncollectible accounts receivable 345 59 4,944 328
Non-cash interest expense 15,154 407 5,193 11,290
Charges relating to location contracts 864 - 21,205 17,582
Loss (Gain) on disposal of assets (51) (4) (107) 272
Other - - 180 95
Changes in current assets 2,178 438 (1,480) 837
Changes in current liabilities, excluding
reclassification of long-term debt (3,010) (1,374) 2,262 (222)
---------------- ----------- ------------- ----------
(685) (852) 1,260 587
---------------- ----------- ------------- ----------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Purchases of property and equipment (1,538) (139) (1,229) (575)
Proceeds from sale of assets 72 4 126 790
Acquisition of intangible assets (469) (306) (1,231) (575)
Other deferred charges 53 21 (95) (85)
---------------- ----------- ------------- ----------
(1,882) (420) (2,429) (445)
---------------- ----------- ------------- ----------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from debt issuance 96,105 400 - -
Principal payments on borrowings (88,206) (4) (53) (270)
Debt financing costs (3,191) - (64) (72)
Other capital transactions - - 11
Debt restructuring costs (1,333) - - -
---------------- ----------- ------------- ----------
3,375 396 (106) (342)
---------------- ----------- ------------- ----------
Increase (decrease) in cash 808 (876) (1,275) (200)
Cash, beginning of period 5,768 6,576 5,700 4,425
---------------- ----------- ------------- ----------
Cash, end of period $6,576 $5,700 $4,425 $4,225
================ =========== ============= ==========
SUPPLEMENTAL DISCLOSURE:
Interest paid during the period $4,970 $223 $5,928 $565
================ =========== ============= ==========
NON-CASH FINANCING TRANSACTIONS:
Deferred financing costs - $230 $2,300 $4,715
Common Stock (Successor Company)
issued in exchange for:
12% Senior Notes $58,900 - - -
14% Preferred 2,015 - - -
Old Common Stock 1,085 - - -
Services 1,271 - - -
Warrants for Common Stock (Successor Company)
issued in
exchange for old Common Stock and 14% Preferred 333 - - -
Put related to warrants issued for Series A Preferred (452) - - -
Other - - 39 -
---------------- ----------- ------------- ----------
$63,152 $230 $2,339 $4,715
================ =========== ============= ==========
The accompanying notes are an integral part of these financial statements.
F-7
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE TEN MONTHS AND SEVENTEEN DAYS ENDED NOVEMBER 17, 1999 (PREDECESSOR
COMPANY), THE ONE MONTH AND THIRTEEN DAYS ENDED DECEMBER 31, 1999 AND THE YEARS
ENDED DECEMBER 31, 2000 AND 2001 (SUCCESSOR COMPANY) (IN THOUSANDS EXCEPT
INSTALLED PUBLIC PAY TELEPHONES, PER CALL, SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
PhoneTel Technologies, Inc. and its subsidiary, Cherokee
Communications, Inc., (the "Company") operate in a single business segment
within the telecommunications industry. The Company specializes in the business
of installing and operating public pay telephones on a revenue sharing basis and
offering operator assisted long distance services. At December 31, 1999, 2000,
and 2001 the Company operated 36,747, 36,410, and 30,156 public pay telephones,
respectively. The Company's operations are regulated by the Public Service or
Utility Commissions of the various States and the Federal Communications
Commission (the "FCC").
BASIS OF REPORTING
As of November 17, 1999, the date the Company emerged from its Chapter
11 proceedings (see Note 13), the Company adopted fresh start reporting.
Pursuant to the provisions of AICPA Statement of Position 90-7 ("SOP 90-7"),
assets and liabilities were restated to reflect the reorganization value of the
Company, which approximates their fair value at that date. In addition, the
accumulated deficit of the Company through November 17, 1999 was eliminated and
the debt and capital structure of the Company was recast pursuant to the
provisions of the Company's plan of reorganization. Thus, the balance sheets as
of December 31, 2000 and 2001 reflect a new reporting entity (the "Successor
Company") and are not comparable to periods prior to November 17, 1999 (the
"Predecessor Company"). Furthermore, the accompanying consolidated statements of
operations and cash flows of the Predecessor Company report operations prior to
the date of adopting fresh start reporting and are thus not comparable with the
results of operations and cash flows of the Successor Company.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. The financial statements do not
include any adjustments that might result if the Company was unable to continue
as a going concern (see Note 3).
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiary. Intercompany transactions and
balances have been eliminated in consolidation.
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Such estimates, among others, include amounts relating to the
carrying value of the Company's accounts receivable and payphone location
contracts and the related revenues and expenses applicable to dial-around
compensation and asset impairment. Actual results could differ from those
estimates.
F-8
CASH AND CASH EQUIVALENTS
The Company considers all investments with original maturities of three
months or less to be cash equivalents. Cash and cash equivalents includes $1,431
on deposit under an informal arrangement at a bank, which is collateral for
letters of credit issued to suppliers.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost or, if acquired through a
business combination, at the amount established by purchase price allocation.
Depreciation for financial reporting and tax purposes is computed using the
straight-line method and accelerated methods, respectively, over the estimated
useful lives of the assets commencing when the equipment is placed in service.
The Company also capitalizes certain costs related to installing telephones and
depreciates those costs over the estimated useful life of the telephone or the
term of the location contract, whichever is shorter.
INTANGIBLE ASSETS
Intangible assets include costs incurred in obtaining new locations or
in the acquisition of installed public pay telephones through prior business
combinations ("location contracts"), non-compete agreements and deferred
financing costs. Intangible assets are amortized over the estimated economic
life of the respective location contracts or the term of the respective
non-compete or financing agreement.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically evaluates potential impairment of long-lived
assets based upon the cash flows derived from each of the Company's operating
districts, the lowest level for which operating cash flows for such asset
groupings are identifiable. A loss relating to an impairment of assets occurs
when the aggregate of the estimated undiscounted future cash inflows expected to
be generated by the Company's assets groups (including any salvage values) are
less than the related assets' carrying value. Impairment is measured based on
the difference between the higher of the fair value of the assets or present
value of the discounted expected future cash flows and the assets' carrying
value. No impairment was incurred in 1999. In 2000 and 2001, the Company
incurred asset impairment losses relating to its payphone location contracts of
$14,787 and $ 15,830, respectively. (see Note 6).
REVENUE RECOGNITION
Revenues from coin calls, reselling operator assisted and long distance
services, and compensation for dial-around calls are recognized in the period in
which the customer places the related call.
REGULATED RATE ADJUSTMENTS
The FCC has the authority pursuant to the Telecommunications Act of
1996 to effect rates related to revenue from dial-around compensation, including
retroactive rate adjustments and refunds (see Note 4). Rate adjustments arising
from FCC rate actions that require refunds to interexchange or other carriers
are recorded in the first period that they become both probable of payment and
estimable in amount. Rate adjustments that result in payments to the Company by
interexchange or other carriers are recorded when received.
COMPREHENSIVE INCOME
The Company has no items of comprehensive income or expense.
Accordingly, the Company's comprehensive income and net income are equal for all
periods presented.
F-9
STOCK-BASED COMPENSATION
The Company accounts for compensation costs associated with stock
options issued to employees under the provisions of Accounting Principles Board
Opinion No. 25, whereby compensation is recognized to the extent the market
price of the underlying stock at the date of grant exceeds the exercise price of
the options granted. The Company has adopted the disclosure provisions of
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("SFAS No. 123"), which requires disclosure of compensation expense
that would have been recognized if the fair-value based method of determining
compensation had been used for all arrangements under which employees receive
shares of stock or equity instruments. Stock-based compensation to non-employees
is accounted for using the fair-value based method prescribed by SFAS No. 123.
EARNINGS PER SHARE
Basic earnings per share amounts are computed by dividing income or
loss applicable to common shareholders by the weighted average number of shares
outstanding during the period. Diluted earnings per share amounts are determined
in the same manner as basic earnings per share except the number of shares is
increased assuming exercise of stock options and warrants using the treasury
stock method and conversion of the 14% Cumulative Redeemable Convertible
Preferred Stock ("14% Preferred"). In addition, income or loss applicable to
common shareholders is not adjusted for dividends and other transactions
relating to preferred shares for which conversion is assumed. Diluted earnings
per share amounts are the same as basic earnings per share because the Company
has a net loss before extraordinary items for all periods presented and the
impact of the assumed exercise of the stock options and warrants and the assumed
conversion of the 14% Preferred is not dilutive. The number of shares of Common
Stock (Successor Company) relating to stock options and warrants that could
potentially dilute basic earnings per share in the future that were not included
in the computation of diluted earnings per share were 1,134,719 shares for the
one month and thirteen days ended December 31, 1999 and 1,422,024 shares for the
years ended December 31, 2000 and 2001.
INCOME TAXES
The Company utilizes the asset and liability method to account for
income taxes whereby deferred tax assets and liabilities are recognized to
reflect the future tax consequences attributable to temporary differences
between the financial reporting basis of existing assets and liabilities and
their respective tax basis. Deferred tax assets and liabilities are measured
using enacted tax rates expected to be recovered and settled. The effect of a
change in tax rates on deferred tax assets and liabilities is recognized in the
period in which the change is enacted. Deferred tax assets are reduced by a
valuation allowance when it is deemed more likely than not that the asset will
not be utilized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of financial instruments are based on a variety of
factors. Where available, fair values represent quoted market prices for
identical or comparable instruments. In other cases, fair values have been
estimated based on assumptions concerning the amount and timing of estimated
future cash flows and assumed discount rates reflecting varying degrees of risk.
Accordingly, the fair values may not represent actual values of the financial
instruments that could have been realized as of December 31, 2000 and 2001, or
that will be realized in the future. At December 31, 2000 and 2001, the
difference between the estimated fair values of financial instruments and their
carrying values was not material due to either short maturity terms or
similarity to terms available to comparable companies in the open market.
F-10
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
which requires companies to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. In 2001, the Company adopted SFAS No. 133 (as amended by SFAS No.
137) which was effective for fiscal years beginning after June 15, 2000. The
adoption of SFAS No. 133 did not have a material effect on the Company's
financial position or results of operations.
In July 2001, the Financial Accounting Standards Board issued SFAS No.
141, `Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interests method of accounting for business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, upon adoption
of SFAS No. 142, that the Company reclassify the carrying amounts of intangible
assets and goodwill based on the criteria in SFAS No. 141.
SFAS No. 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS No. 142 requires that the Company identify reporting units for
the purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
were initially recognized. SFAS No. 142 requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
Company is also required to reassess the useful lives of other intangible assets
within the first interim quarter after adoption of SFAS No. 142.
As of December 31, 2000 and 2001, the net carrying amounts of
intangible assets was $48,374 and $22,770 respectively. Amortization expense
during the ten months and seventeen days ended November 17, 1999, the one month
and thirteen days ended December 31, 1999 and the years ended December 31, 2000
and 2001 was $13,345, $1,623, $12,337 and $8,057, respectively. The Company
does not expect the adoption of SFAS No. 141 and SFAS No. 142 to affect the
classification or useful lives of its intangible assets or the amounts of
amortization expense or impairment losses to be recognized under the new
standards.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets." SFAS No. 144 replaces SFAS No.
121, "Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed of." SFAS No. 144 retains the fundamental provisions of
SFAS No. 121 for the recognition and measurement of the impairment of long-lived
assets to be disposed of by sale. Under SFAS No. 144, long-lived assets are
measured at the lower of the carrying amount or fair value, less cost to sell.
The Company will be required to adopt this statement no later than January 1,
2002. The Company is currently assessing the impact of this statement on its
results of operations, financial condition, and cash flows.
2. PROPOSED MERGER WITH DAVEL COMMUNICATIONS, INC.
On June 13, 2001, PhoneTel Technologies, Inc. ("PhoneTel") announced
that it has signed a letter of intent to merge with Davel Communications, Inc.
("Davel") which is headquartered in Tampa, Florida and operates approximately
54,000 payphones in 44 states and the District of Columbia. On February 19,
2002, the Company executed a definitive merger agreement with Davel (the "Davel
Merger Agreement") which was unanimously approved by the boards of directors of
both companies. In connection with the expected merger, PhoneTel will become a
wholly owned subsidiary of Davel. In addition, in June 2001 the two companies
entered into a servicing agreement designed to commence cost savings initiatives
in advance of the closing of the merger. During the third quarter of 2001, the
two companies implemented the servicing agreement by combining field service
office operation networks on a geographic basis to gain efficiencies resulting
from the increased concentration of payphone service routes.
F-11
In connection with the merger, the existing secured lenders of both
Davel and PhoneTel have agreed to exchange a substantial amount of debt for
equity securities of the respective companies and to restructure the remaining
debt. In addition, on February 19, 2002 Davel and PhoneTel have each executed
amendments to their existing credit agreements and have entered into a new
combined $10,000 senior credit facility.
In connection with PhoneTel's debt exchange, its existing secured
lenders will own 87% of PhoneTel's outstanding common stock immediately prior to
the merger with the remaining secured debt not to exceed $36,500 (compared to
$62,635 outstanding at December 31, 2001, including accrued interest). Existing
holders of PhoneTel common stock will own 9% of PhoneTel's outstanding shares
immediately prior to the merger, and 4% will be reserved for issuance of
post-closing employee options and other stock-based incentives, on a fully
diluted basis. In connection with Davel's debt exchange, its existing secured
lenders will own 93% of Davel's outstanding common stock immediately prior to
the merger, with the remaining secured debt not to exceed $63,500 (compared to
approximately $274,000 outstanding at December 31, 2001, including accrued
interest). Existing shareholders of Davel common stock will own 3% of Davel's
outstanding shares immediately prior to the merger, and 4% of the common stock
will be reserved for issuance of post-closing employee options and other
stock-based incentives, on a fully diluted basis.
Immediately following the merger, current PhoneTel shareholders will
own approximately 3.28% of the shares of Davel common stock and current Davel
shareholders will own approximately 1.91%. Of the remaining shares, 4.00% are
intended to be reserved for issuance of post-closing employee options and other
stock-based incentives, on a fully diluted basis and the companies' existing
lenders will own approximately 90.81%.
Effective with the merger, the then outstanding debt of both entities,
currently in the approximate amount of $337,000, will be reduced to $100,000 in
debt of the merged entity through the debt and equity restructuring outlined
above. Of this $100,000 of restructured debt, $50,000 will be amortizing term
debt with interest and principal payable from operating cash flows. Payment of
the interest and principal on the remaining $50,000 of term debt will be payable
at maturity. Under the commitment letter issued by the existing secured lenders
of both PhoneTel and Davel on February 19, 2002, interest on the term debt will
be payable at a rate of 10% per annum and the debt will mature on December 31,
2005. The commitment is contingent upon the consummation of the merger and
expires on August 31, 2002. Upon consummation of the debt restructuring
described above, the Company estimates, based on the carrying value of its debt
at December 31, 2001, that it will have an extraordinary gain relating to the
restructuring of approximately $6.7 million.
The Davel Merger is subject to approval by the shareholders of both
companies and the receipt of material third party and governmental approvals and
consents. In conjunction with the transaction, PhoneTel will also seek
shareholder approval to increase the number of authorized shares of common stock
from 45,000,000 to approximately 125,000,000 shares. No dates have been set for
the stockholders' meetings.
3. FINANCIAL CONDITION
The Company's working capital deficiency, excluding the current portion
of long-term debt, increased from $2,698 at December 31, 2000 to $3,841 at
December 31, 2001, which represents a decrease in working capital of $1,143. The
Company's cash provided by operating activities decreased from $1,260 for the
year ended December 31, 2000 to $587 for the year ended December 31, 2001. In
addition, the Company has incurred continuing operating losses, was not in
compliance with certain financial covenants under its Exit Financing Agreement
(see Note 7) from December 31, 2000 through December 31, 2001 and has not made
the monthly scheduled interest payments that were originally due on February 1,
2001 through March 1, 2002. As a result of certain amendments to the Company's
Exit Financing Agreement, the lenders have waived all defaults relating to the
Company's failure to comply with certain financial covenants, extended the due
date of the loan, deferred all monthly interest payments to the maturity date of
the loan, and have amended or eliminated certain financial covenants. The
Company's existing lenders have also agreed to restructure this debt in
connection with the Davel Merger as described in Note 2. However, if the Company
is unable to complete the Davel Merger and does not comply with the terms of the
Exit Financing Agreement, as amended, this debt, subject to the rights of the
Senior Lenders, could become immediately due and payable.
F-12
The Company's working capital, liquidity and capital resources may be
limited by its ability to generate sufficient cash flow from its operations or
its investing or financing activities. Cash flow from operations depends on
revenues from coin and non-coin sources, including dial-around compensation, and
management's ability to control expenses. There can be no assurance that coin
and operator service revenues will not decrease, that revenues from dial-around
compensation will continue at the rates anticipated, or that operating expenses
can be maintained at present or reduced to lower levels. In the event that cash
flow from operating activities is insufficient to meet the Company's cash
requirements, there can be no assurance that the Company can obtain additional
or alternative financing to meet its debt service and other cash requirements.
On February 19, 2002, the Company obtained $5,000 of new financing
under the Senior Credit Agreement described in Note 7. The Company also
implemented the servicing agreement with Davel and has begun to achieve the
anticipated efficiencies and cost savings associated with the consolidation of
both companies' field office operations. As part of the Company's ongoing
evaluation of its payphone base, in the third quarter of 2001, the Company
removed approximately 2,000 additional payphones that had become unprofitable.
In addition, the Company is developing alternate sources of revenue. With the
current operational efficiencies and additional cost savings expected in
connection with the Davel Merger and the continued support of its lenders,
management believes, but cannot assure, that cash flow from operations,
including any new sources of revenue, will allow the Company to sustain its
operations and meet its obligations through the remainder of 2002 or until the
proposed merger with Davel is completed.
4. ACCOUNTS RECEIVABLE AND DIAL-AROUND COMPENSATION
A dial-around call occurs when a non-coin call is placed from the
Company's public pay telephone which utilizes any carrier other than the
presubscribed carrier (the Company's dedicated provider of long distance and
operator assisted calls). Dial-around calls include 1 (800) subscriber calls, as
well as 1010xxx calls to access a long distance carrier or operator service
provider selected by the caller. The Company receives revenues from such
carriers and records those revenues from dial-around compensation based upon the
per-phone or per-call rate in effect under orders issued by the FCC. Retroactive
changes in the dial-around compensation rate pursuant to orders issued by the
FCC are accounted for as changes in accounting estimates and are recorded as
adjustments to revenue at the beginning of the most recent period prior to the
announcement of such changes by the FCC. At December 31, 2000 and 2001, accounts
receivable included $6,561 and $5,291, respectively arising from dial-around
compensation. Payments related to such receivables are received on a quarterly
basis at the beginning of the second quarter following the quarter in which such
revenues are recognized.
Net revenue from dial-around compensation was $13,325, $1,655, $13,442,
and $9,877 for the ten months and seventeen days ended November 17, 1999, the
one month and thirteen days ended December 31, 1999 and the years ended December
31, 2000 and 2001, respectively. As further discussed below, the amount recorded
as revenue in 2000 reflects a reduction in revenues in the fourth quarter to
more closely reflect the actual number of calls for which the Company expects to
be compensated.
Effective November 6, 1996, pursuant to the rules and regulations
promulgated by the FCC under section 276 of the Telecommunications Act ("Section
276"), the FCC issued an order to achieve fair compensation for dial-around
calls placed from pay telephones (the "1996 Payphone Order"). Among other
things, the 1996 Payphone Order prescribed compensation payable to the payphone
providers by certain interexchange carriers ("IXCs") for dial-around calls
placed from payphones and, to facilitate per-call compensation, the FCC required
the payphone providers to transmit payphone specific coding digits that would
identify each call as originating from a payphone ("Flex Ani"). The FCC required
local exchange carriers ("LECs") to make such coding available to the payphone
providers as a transmit item included in the local access line service. The 1996
Payphone Order set an initial monthly rate of $45.85 per pay telephone for the
November 6, 1996 to October 7, 1997 period (the "Interim Period"), an increase
from the monthly per pay telephone rate of $6.00 in periods prior to its
implementation. Thereafter, the FCC set dial-around compensation on a per-call
basis, at the assumed deregulated coin rate of $0.35. The Interim Period monthly
rate was arrived at by the product of the assumed deregulated coin rate ($0.35)
and the then monthly average compensable dial-around calls per payphone. A
finding from the record established at the time that the monthly average
compensable calls were 131 per phone.
F-13
The 1996 Payphone Order was appealed by various parties, including the
IXCs, to the United States Court of Appeals for the District of Columbia Circuit
(the "Appeals Court"). Among other items, the Appeals Court found that the FCC
erred in using a market-based method for calculating the amount of dial-around
compensation and further determined that the method of allocating payment among
IXCs was erroneous. In July 1997, the Appeals Court vacated the 1996 Payphone
Order and remanded it to the FCC for further consideration. As a result of this
ruling by the Appeals Court, certain IXCs discontinued or reduced the amount of
dial-around compensation actually paid to payphone service providers for the
Interim Period.
In response to the remand by the Appeals Court, in October 1997 the FCC
issued a new order implementing Section 276 (the "1997 Payphone Order"). The FCC
utilized a market-based method to arrive at a per call compensation rate and
then reduced it by certain costs attributable to a coin call which it did not
believe applied to a dial-around call, and adjusted the per-call rate from $0.35
to $0.284 (the "Default Rate"). The FCC concluded that the Default Rate should
be retroactively utilized in determining compensation during the Interim Period
and reiterated that payphone providers were entitled to compensation for every
call pursuant to the provisions of Section 276; however, the FCC deferred for
later decision the method of allocation of the payment among the IXCs.
The 1997 Payphone Order was subsequently appealed by various parties.
In May 1998, the Appeals Court again remanded the per-call compensation rate to
the FCC for further explanation, without vacating the Default Rate, indicating
that the FCC had failed to adequately explain its derivation of the Default
Rate.
In response to the remand of the 1997 Payphone Order, on February 4,
1999 the FCC issued its Third Report and Order, and Order on Reconsideration of
the Second Report and Order (the "1999 Payphone Order") wherein it adjusted the
Default Rate to $0.238, (the "Adjusted Default Rate) retroactive to October 7,
1997. In adjusting the rate, the FCC shifted its methodology from the
market-based method utilized in the 1996 and 1997 Payphone Orders to a
cost-based method citing technological impediments that it viewed as inhibiting
the marketplace and the unreliability of certain assumptions underlying the
market-based method as a basis for altering its analysis. In setting the
Adjusted Default Rate, the FCC incorporated its prior treatment of certain
payphone costs and examined new estimates of payphone costs submitted as part of
the proceeding. Pursuant to the 1999 Payphone Order, the $0.24 amount ($0.238
plus $0.002 for amounts charged by LECs for providing Flex Ani) became the
Adjusted Default Rate for coinless payphone calls through January 31, 2002.
The 1999 Payphone Order deferred a final ruling on the treatment of
dial-around compensation during the Interim Period to a later order; however, it
appeared from the 1999 Payphone Order that the Adjusted Default Rate would be
applied to the Interim Period. The FCC further ruled that a true-up will be made
for all payments or credits, together with applicable interest due and owing
among the IXCs and the payphone service providers for the payment period
November 7, 1996 through April 20, 1999. In the fourth quarter of 1998, the
Company recorded an adjustment to reduce revenues previously recognized for the
period from November 7, 1996 to September 30, 1998 due to the decrease in the
per-call compensation rate to the Adjusted Default Rate.
The 1999 Payphone Order was appealed by various parties and in June
2000, the Appeals Court issued its ruling on the matter. The Appeals Court
denied all petitions for review of the per-call compensation rate and kept in
place the Adjusted Default Rate mandated by the 1999 Payphone Order. Due to the
lack of progress by the FCC in ordering a true-up for underpayments by IXCs
during the Interim Period and a true-up for overpayments by IXCs to the Adjusted
Default Rate for the payment period October 7, 1997 to April 20, 1999, (the
"Intermediate Period") as well as the Company's historical collection
experience, the Company recorded a bad debt loss of $4,944 in 2000. Of this
amount, $4,429 applicable to amounts previously recognized as revenue for the
period November 1996 to September 2000 was recorded in the fourth quarter of
2000. In the fourth quarter of 2000, the Company began reporting revenues from
dial-around compensation based on $0.24 per call and the Company's current
estimate of the average monthly compensable calls per phone to more closely
reflect the Company's historical collection experience and expected future call
volume.
On January 31, 2002, the FCC released its Fourth Order on
Reconsideration and Order on Remand (the "2002 Payphone Order") that provides a
partial decision on how retroactive dial-around compensation adjustments for the
Interim Period and Intermediate Period may apply. The 2002 Payphone Order
increases the flat monthly dial-around compensation rate for true-ups between
individual IXCs and PSPs during the Interim Period from
F-14
$31.178 to $33.892 (the "New Default Rate"). The New Default Rate is based on
148 calls per month at $0.229 per call. The New Default Rate also applies to
flat rate dial-around compensation during the Intermediate Period when the
actual number of dial-around calls for each payphone is not available. The 2002
Payphone Order excludes resellers but expands the number of IXCs required to pay
dial-around compensation during the Interim and Intermediate Periods. It also
prescribes the Internal Revenue Service interest rate for refunds as the
interest rate to be used to calculate overpayments and underpayments of
dial-around compensation for the Interim Period and Intermediate Period.
The 2002 Payphone Order kept in place the Adjusted Default Rate for
per-call compensation during the Intermediate and subsequent periods. However,
the FCC deferred to a later, as yet unreleased order, the method of allocating
dial-around compensation among the IXCs responsible for paying fixed rate
per-phone compensation. At the present time, the Company is unable to determine
the effect of the final implementation of the 2002 Payphone Order. However, it
is possible that any retroactive adjustments for the Interim Period and
Intermediate Period could have a material adverse effect on the Company.
On April 5, 2001, the FCC issued an order which makes the first
switched based carrier that issues toll-free numbers to resellers, including
prepaid calling card companies, responsible for paying dial-around compensation
on coinless calls placed from payphones by individuals utilizing such toll-free
numbers. Previously, these carriers were were not required to pay dial-around
compensation on such calls and were not required to disclose the identity of
resellers responsible for payment. The FCC order became effective on November
27, 2001. Although the Company expects this FCC order to improve its ability to
identify and collect amounts relating to dial-around calls that would otherwise
become uncollectible, the amount of the increase in revenues from dial-around
compensation, if any, cannot be determined at this time.
5. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2000 and 2001 consisted of the
following:
Estimated
Useful Lives
(in years) 2000 2001
---------- ---------------- ----------------
Telephone boards, enclosures and cases 3-10 $ 23,544 $ 23,228
Furniture, fixtures and other equipment 3-5 827 856
Leasehold improvements 2-5 241 241
---------------- --------------
24,612 24,325
Less - accumulated depreciation (5,754) (10,342)
---------------- --------------
$ 18,858 $ 13,983
================ ==============
Under fresh start reporting, the carrying values of property and equipment
have been restated as of November 17, 1999 to reflect the reorganization value
of the Company and accumulated depreciation amounts have been eliminated.
Depreciation expense was $7,374, $693, $5,132 and $4,929 for the ten months and
seventeen days ended November 17, 1999, the one month and thirteen days ended
December 31, 1999 and the years ended December 31, 2000 and 2001, respectively.
On December 7, 2001, the Company sold approximately 1,080 payphones and
related operating assets for two of its district operations facilities located
in Montana for $648. The Company incurred a $378 loss on the sale of these
assets which is included in interest and other income (expense) in the
accompanying consolidated statements of operations.
F-15
6. INTANGIBLE ASSETS
Intangible assets at December 31, 2000 and 2001 consisted of the following:
Amortization
Period 2000 2001
-------------- ---------------- ----------------
Location contracts 48-120 months $ 56,101 $ 30,478
Deferred financing costs 24-120 months 5,027 9,814
Non-compete agreements 24-60 months 1,099 1,099
Other 120 months 22 22
---------------- --------------
62,249 41,413
Less: accumulated amortization (13,875) (18,643)
---------------- --------------
$ 48,374 $ 22,770
================ ==============
</Table>
Under fresh start reporting, the carrying values of intangible assets were
restated as of November 17, 1999 to reflect the reorganization value of the
Company and accumulated amortization amounts have been eliminated. Amortization
of intangible assets, other than deferred financing costs, amounted to $13,345,
$1,623, $12,337 and $8,057 for the ten months and seventeen days ended November
17, 1999, the one month and thirteen days ended December 31, 1999, and the years
ended December 31, 2000 and 2001, respectively. Amortization of deferred
financing costs is included as a component of interest expense in the
accompanying consolidated statements of operations.
As part of the Company's continuing program to evaluate the profitability
of its pay telephones, the Company wrote-off the carrying value of location
contracts for 1,839, 3,376 and 1,960 pay telephones removed from service in
1999, 2000, and 2001 respectively. The Company recorded losses of $864 in the
ten months and seventeen days ended November 17, 1999, $6,418 in the year ended
December 31, 2000 and $1,752 in the year ended December 31, 2001 relating to the
write-off of these abandoned location contracts. The Company also evaluated the
carrying value of its remaining payphones and location contracts in each of the
Company's operating districts. In certain operating districts, the carrying
value of the Company's payphone assets exceeded the estimated undiscounted
future cash inflows and the Company recorded impairment losses of $14,787 and
$15,830 to reduce the carrying value of such assets to its fair value during the
years ended December 31, 2000 and 2001, respectively. Fair value was determined
based on the estimated market value of such payphone assets. The asset
impairment losses and the write-off of abandoned location contracts are included
in charges relating to locations contracts in the accompanying consolidated
statements of operations.
7. LONG-TERM DEBT
Long-term debt at December 31, 2000 and 2001 consisted of the following:
2000 2001
---------- -----------
Exit Financing Agreement, due August 31, 2002
with interest payable monthly at 10.75%
(or at 3% above the base rate, if greater) at December 31, 2001 $ 51,611 $ 62,635
Warrant Put Obligation and Note Payable 1,062 1,116
Other notes payable 36 -
---------- -----------
52,709 63,751
Less current portion of long-term debt (51,647) (62,635)
---------- -----------
$ 1,062 $ 1,116
========== ===========
Maturities of long-term debt for each of the next five years consist of
$62,635 due in 2002 and $1,116 due in 2004.
F-16
RELATED PARTY DEBT AND CREDIT AGREEMENT
On May 30, 1997, the Company entered into an agreement (the "Credit
Agreement") with various lenders (collectively referred to as the "Lenders").
ING (U.S.) Capital Corporation ("ING"), a significant shareholder of the
Company's common equity, was Agent for the Lenders. On May 8, 1998, the Company
amended the Credit Agreement and Foothill Capital Corporation ("Foothill"), as
replacement Agent and Lender, assumed all of the rights and obligations of the
former Lenders. Under the Credit Agreement, the revolving credit commitment was
$20,000 and the expansion loan commitment was $20,000. Interest was payable
monthly in arrears at 2% above the Lender's reference rate and the maturity date
of the Credit Agreement was extended to May 8, 2001.
In April 1999, the Company received a commitment from Foothill to provide
$45,900 in debtor-in-possession financing ("D.I.P." financing) in anticipation
of the Case described in Note 13. The Company incurred $250 in fees relating to
an additional advance and a $250 fee for the D.I.P. financing commitment. On
July 21, 1999, the outstanding balance of the Credit Agreement was paid from the
proceeds of the D.I.P. financing, the terms of which are described below. The
Company incurred an extraordinary loss from extinguishment of debt of $2,095 due
to the write-off of deferred financing costs related to the Credit Agreement in
1999.
DEBTOR-IN-POSSESSION LOAN AGREEMENT
On July 14, 1999, the Company entered into a D.I.P. financing agreement
("D.I.P. Agreement") with Foothill. The D.I.P. Agreement provided a $45,900
revolving credit commitment, which was used to pay the outstanding balance due
under the Credit Agreement, including accrued interest on July 21, 1999. The
Company also received advances totaling $2,649 for working capital purposes.
Interest on the D.I.P. Agreement was payable monthly in arrears at 3% above
the base rate (as defined therein) through November 12, 1999 and 3.75% above the
base rate thereafter. The loan was secured by substantially all of the assets of
the Company. The D.I.P. Agreement included covenants, which limited the
incurrence of additional debt, capital leases, liens and the disposition of
assets. On November 17, 1999, the Company refinanced the D.I.P. Agreement from
the proceeds of the post reorganization loan described below.
POST REORGANIZATION LOAN AGREEMENT
The Company executed an agreement with Foothill for post reorganization
financing ("Exit Financing Agreement") on November 17, 1999. The Exit Financing
Agreement provides for a $46,000 revolving credit commitment (the "Maximum
Amount"), excluding interest and fees capitalized as part of the principal
balance. The Exit Financing Agreement is secured by substantially all of the
assets of the Company and was originally scheduled to mature on November 16,
2001.
The Exit Financing Agreement provides for various fees aggregating $9,440
over the original term of the loan, including a $1,150 deferred line fee, which
was originally payable one year from the date of closing, together with interest
thereon, and a $10 servicing fee which is payable each month. The Exit Financing
Agreement, as amended, also provides for an additional fee of $575 per month for
each month after the original maturity date of the loan. At the option of the
Company, payment of other fees, together with interest due thereon, may be
deferred and added to the then outstanding principal balance. Fees due pursuant
to the Exit Financing Agreement were subject to certain reductions for early
prepayment, providing the Company was not in default on the Exit Financing
Agreement.
The Exit Financing Agreement provides for interest on the outstanding
principal balance at 3% above the base rate (as defined in the Exit Financing
Agreement) or 10.75%, whichever is greater, with interest on the Maximum Amount
payable monthly in arrears. The Exit Financing Agreement, as amended on December
31, 1999, includes covenants, which among other things, require the Company to
maintain ratios as to fixed charges, debt to earnings, current ratio, interest
coverage and minimum levels of earnings, payphones and operating cash (all as
defined in the Exit Financing Agreement). Other covenants limit the incurrence
of long-term debt, the level of capital expenditures, the payment of dividends,
and the disposal of a substantial portion of the Company's assets.
F-17
From December 31, 2000 through December 31, 2001, the Company was not in
compliance with certain financial covenants under the Exit Financing Agreement.
In addition, the Company did not pay the monthly interest payments that were
originally due on February 1, 2001 through March 1, 2002 nor the deferred line
fee that was originally due on November 17, 2000. Effective November 13, 2000,
February 1, March 1, April 1, May 1 and August 13, 2001, and February 19, 2002,
the Company executed amendments to the Exit Financing Agreement (the
"Amendments") which extended the due date of the deferred line fee and the
maturity date of the Exit Financing Agreement to August 31, 2002. The Amendments
provide for the capitalization of monthly interest that was originally due on
February 1, 2001 through August 1, 2002 as part of the principal balance and
waives defaults through December 31, 2001 for the Company's failure to comply
with certain financial covenants. The Amendments also amended or eliminated
certain financial covenants and permits the Company to incur the debt under the
Senior Credit Agreement described below, which debt is senior in right of
payment to Company's Exit Financing Agreement. Although the lenders have waived
defaults by the Company through December 31, 2001, there can be no assurances
that the Company will be able to comply with its financial covenants through the
remainder of 2002. If a default occurs with respect to the Company's Exit
Financing Agreement, this obligation, subject to the rights of the Senior
Lenders, could become immediately due and payable.
On February 19, 2002, PhoneTel's and Davel's existing secured lenders,
including Foothill, consented to the Davel Merger, agreed to exchange a
substantial amount of debt for equity securities, and committed to restructure
the remaining debt. The Company previously received consent from Foothill to
enter into the servicing agreement with Davel (see Note 2).
SENIOR CREDIT AGREEMENT
On February 19, 2002, in connection with the Davel Merger Agreement,
PhoneTel and Davel jointly entered into a new $10,000 senior secured credit
facility (the "Senior Credit Agreement") with Madeleine L.L.C. and ARK CLO
2000-1, Limited (the "Senior Lenders"). Under the Senior Credit Agreement,
PhoneTel and Davel each received $5,000 of loan proceeds and will each pay 50%
of the interest, fees and principal due thereunder. The companies have joint and
several liability for this obligation and each would be responsible for the
entire obligation in the event of default by the other party.
The Senior Credit Agreement is secured by substantially all of the assets
of PhoneTel and Davel and provides for the payment of monthly interest at 15%
per annum and, beginning July 31, 2002, monthly principal payments of $833
through the earlier of June 30, 2003, the maturity date of the loan, or the
termination of the Davel Merger Agreement (which will occur on August 31, 2002
if not extended by the Lenders). If the Davel Merger Agreement is not
consummated by August 31, 2002, all outstanding amounts will become immediately
due and payable. The Senior Credit Agreement also provides for the payment of a
1% loan fee, loan costs incurred by the Senior Lenders, and advanced payments of
principal from excess cash flow or certain types of cash receipts. The Company
incurred $190 for its share of costs and loan fees. The Senior Credit Agreement
also requires PhoneTel and Davel to maintain a minimum level of combined
earnings (as defined in the Senior Credit Agreement) and limits the incurrence
of cash expenditures and indebtedness, the payment of dividends, and certain
asset disposals.
WARRANT PUT OBLIGATION AND NOTE PAYABLE
On October 18, 1999, in connection with the Prepackaged Plan, the Company
reached an agreement with a former lender to settle a claim for the purported
exercise of a put right relating to warrants to purchase shares of Series A
Special Convertible Preferred Stock ("Series A Preferred"). The Series A
Preferred was convertible into Common Stock. The claim was settled for $1,000 in
the form of a note payable, subject to certain reductions for early payment,
together with deferred interest at 5% per annum, in five years. In addition, the
former lender agreed to forfeit its shares of Common Stock (Successor Company)
and New Warrants which were issued pursuant to the Prepackaged Plan and
immediately canceled. The adjustment to reduce the amount of the warrant put
obligation to $1,000, to record a note payable for this obligation and to credit
additional paid-in capital was recorded by the Company as of November 17, 1999.
The note is secured by substantially all of the assets of the Company and is
F-18
subordinate in right of payment to the Company's Exit Financing Agreement. The
note includes a cross of default provision which permits the holder to declare
the note immediately due and payable if payment of amounts due under the Exit
Financing Agreement is accelerated as a result of default.
8. INCOME TAXES
No provisions for income tax were required and no income taxes were paid
for the years ended December 31, 1999, 2000 and 2001 because of operating losses
generated by the Company. In 1999, the Company had a taxable loss of
approximately $23,000 as a result of the Federal tax exclusion relating to the
extraordinary gain recognized upon conversion of the Senior Notes to Common
Stock (Successor Company) pursuant to the Prepackaged Plan. Special tax rules
apply to cancellation of indebtedness income ("COD Income") arising in
bankruptcy. COD Income of $79,267 is excluded from taxation but must be applied
to reduce the 1999 taxable loss, tax net operating loss carryforwards and other
tax attributes of the Company. Accordingly, no provisions for income tax were
required and no income taxes were payable for the year ended December 31, 1999.
Deferred tax assets and (liabilities) at December 31, 2000 and 2001 are as
follows:
2000 2001
---------------- --------------
Federal net operating loss carryforward $ 6,476 $ 12,497
Depreciation and amortization 6,842 7,777
Allowance for doubtful accounts receivable 28 140
Other - 113
---------------- --------------
Gross deferred tax assets 13,346 20,527
Valuation allowance on deferred tax assets (13,346) (20,527)
---------------- --------------
Net deferred tax assets $ - $ -
================ ==============
A valuation allowance equal to the net deferred tax assets has been
provided because management cannot predict, based on the weight of available
evidence, that it is more likely than not that such assets will be ultimately
realized. The tax net operating loss carryforward of approximately $36,756 will
expire in the years 2018 through 2021. The tax benefit of any preconfirmation
net operating loss carryforward, if utilized, will be reported as an increase in
additional paid-in capital.
Internal Revenue Code Section 382 provides for an annual limitation on the
use of net operating loss carryforwards in years subsequent to significant
changes in ownership. As a result of the Company's Restructuring in 1999, a
change in ownership has occurred resulting in an annual limitation which exceeds
the amount of the Company's net operating loss carryforward from years prior to
the Restructuring. In addition, any significant change in ownership that occurs
within two years after the November 17, 1999 ownership change will result in a
loss of tax benefits relating to the then existing tax net operating loss
carryforwards. The tax benefit as a percentage of the loss before taxes differs
from the statutory tax rate due primarily to the amortization and write-off of
certain intangibles, which is not deductible for tax purposes, and the valuation
allowance on deferred tax assets.
9. 14% CUMULATIVE CONVERTIBLE PREFERRED STOCK MANDATORILY REDEEMABLE
(PREDECESSOR COMPANY)
At December 31, 1998, the Predecessor Company had 107,918 shares of 14%
Preferred issued and outstanding and cumulative dividends issuable of 50,609
shares (valued at $1,118). The Company recorded dividends, declared and
undeclared, at their fair market value and recognized the difference between the
carrying value of the 14% Preferred and the mandatory redemption amount ($9,512
at December 31, 1998) through monthly accretions using the interest method. The
carrying value of the 14% Preferred was increased by $1,197 in the first ten
months and seventeen days of 1999 through accretions. Each share of 14%
Preferred was entitled to receive a quarterly dividend of 0.035 shares of 14%
Preferred. Each share of 14% Preferred was convertible into 10 shares of Common
Stock (Predecessor Company) and was subject to mandatory redemption on June 30,
2000.
F-19
As discussed in Note 13, the Successor Company issued 325,000 shares of
Common Stock and 722,200 New Warrants in exchange for the 14% Preferred.
10. COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY
Under the Amended and Restated Articles of Incorporation confirmed as part
of the Company's Prepackaged Plan, the total authorized capital stock of the
Successor Company was 15,000,000 shares of Common Stock. On July 18, 2000, the
shareholders approved an amendment to the Amended and Restated Articles of
Incorporation to increase the total authorized capital stock of the Successor
Company to 45,000,000 shares of Common Stock.
Effective November 17, 1999, the Company issued 10,205,000 shares of
Common Stock (Successor Company) upon consummation of the Company's Prepackaged
Plan. Prior to the Consumation Date, the Predecessor Company was authorized to
issue up to 50,000,000 shares of Common Stock, $0.01 par value, and had
18,754,133 shares issued and outstanding. As discussed in Note 13, the Successor
Company issued 175,000 shares of Common Stock and 388,900 New Warrants in
exchange for the Common Stock (Predecessor Company). The Predecessor Company was
also authorized to issue up to 250,000 shares of Series A Special Convertible
Preferred Stock, $0.20 par value, $0.20 stated value, none of which were
outstanding as of the Consumation Date.
STOCK WARRANT ACTIVITY
Activity for warrants exercisable into Common Stock during 1999,
2000 and 2001 was as follows:
Number Weighted Average
Predecessor Company of Shares Exercise Price
------------------- ---------- --------------
Balance, December 31, 1998 1,235,357 $ 2.54
Canceled upon expiration or consummation
of the Company's Prepackaged Plan (1,235,357) 2.54
----------
Balance, November 17, 1999 - -
===========
Successor Company
-----------------
November 17, 1999 - Granted pursuant
to Prepackaged Plan 1,111,100 10.50
Canceled - settlement of
warrant put obligation for Series A Preferred (36,379) 10.50
-----------
Balance, December 31, 1999 1,074,721
Exercised and other capital transactions 2,303 10.50
-----------
Balance, December 31, 2000 and 2001 1,077,024 10.50
===========
All warrants outstanding at each period end were exercisable.
At December 31, 1998, there were 89,912 warrants which were exercisable
into Series A Preferred. These warrants were canceled in 1999 in connection with
the settlement of the warrant put obligation discussed in Note 7.
On November 17, 1999, the Company granted New Warrants to purchase
1,111,100 shares of Common Stock (Successor Company) at an exercise price of
$10.50 per share to the holders of the 14% Preferred and Common Stock of the
Predecessor Company upon consummation of the Prepackaged Plan. Each New Warrant
is exercisable through November 17, 2002. New Warrants to purchase 36,379 shares
of Common Stock (Successor Company) were forfeited and immediately canceled on
the date of grant in connection with the settlement of the warrant put
obligation for the Series A Preferred.
F-20
STOCK OPTION ACTIVITY
On February 4, 1997, the Company's Board of Directors adopted and its
shareholders ratified the Company's 1997 Stock Incentive Plan (the "1997 Plan").
The 1997 Plan provided for the issuance of incentive and non-qualified stock
options to purchase up to 2,000,000 shares of Common Stock (Predecessor Company)
by officers, directors, employees and independent contractors of the Company. In
1997, the Company granted 1,592,400 incentive and non-qualified stock options at
exercise prices equal to the market value of the Company's Common Stock
(Predecessor Company) on the dates of grant to substantially all officers and
employees. The options granted provided for graduated vesting, one-third each
year on the anniversary of the date of grant, and had a term of eight years.
Other options to purchase Common Stock (Predecessor Company) were
granted by the Company at the discretion of the Board of Directors to employees,
officers, directors and others, and generally were exercisable immediately upon
issuance, had terms of three to five years and were issued with exercise prices
at or slightly below quoted market value of the Company's Common Stock on the
date of grant. All outstanding options to purchase Common Stock (Predecessor
Company) that were not previously canceled or exercised were canceled in 1999 in
connection with the Prepackaged Plan.
On November 17, 1999, pursuant to the terms of the Prepackaged Plan,
the Company adopted the 1999 Management Incentive Plan (the "1999 Plan"). The
1999 Plan provides for the issuance of incentive and non-qualified stock
options, stock appreciation rights and other awards to purchase up to 391,647
shares of Common Stock (Successor Company) by officers, directors and management
employees. The 1999 Plan will continue in effect until December 31, 2009.
On December 27, 1999, the Company granted options to purchase 85,000
shares of Common Stock (Successor Company) with an exercise price of $1.14 per
share to four non-employee directors of the Company pursuant to the 1999 Plan.
Such options became vested on the date of grant and expire December 26, 2002. On
March 9, 2000, pursuant to the 1999 Plan, the Company granted options to
purchase 193,000 shares of Common Stock (Successor Company) to certain
management employees at an exercise price of $1.56 per share. On April 1, 2000,
options to purchase an additional 50,000 shares at an exercise price of $1.16
per share were granted to an officer of the company pursuant to the 1999 Plan.
No compensation expense was recorded because the exercise prices of these
options were equal to the market value of the Company's shares on the respective
dates of grant. Such options vest equally over a three-year period beginning one
year from the date of grant and expire after five years.
On May 23, 2000, the Company granted options to purchase 75,000 shares
of Common Stock (Successor Company) to an officer of the Company pursuant to an
employment agreement. Such options vest immediately, have an exercise price of
$0.01 per share, and expire three years after the date of grant. The Company
recorded $28 of compensation expense under the intrinsic value method of
accounting relating to these options.
F-21
Activity for stock options exerciseable into Common Stock during 1999, 2000
and 2001 was as follows:
Number Weighted Average
Predecessor Company of Shares Exercise Price
------------------- ---------- --------------
Balance, December 31, 1998 1,916,735 $ 2.87
Granted to former executive 35,000 0.81
Canceled upon expiration, termination
or consummation of the Company's
Prepackaged Plan (1,951,735) 2.83
-----------
Balance, November 17, 1999 -
==========
Successor Company
-----------------
Granted to Directors 85,000 1.14
-----------
Balance, December 31, 1999 85,000 1.14
Granted:
1999 Management Incentive Plan 243,000 1.48
To officer 75,000 .01
-----------
Total options granted 318,000 1.13
Canceled (2,000) 1.56
-----------
Balance, December 31, 2000 401,000 1.13
Canceled (56,000) 1.37
-----------
Balance, December 31, 2001 345,000 1.09
===========
STOCK BASED COMPENSATION
Under SFAS No. 123 "Accounting for Stock-Based Compensation", the fair
value of each option and warrant granted is estimated on the grant date using
the Black-Scholes option pricing model. The fair value of options and warrants
issued to non-employees is charged to operations over the periods such options
and warrants vest. The Company recognizes compensation expense for options or
warrants issued to employees and directors using the intrinsic value method.
Under that method, compensation expense is charged for the excess of the market
value of the Company's shares over the exercise price of the options or
warrants, if any, on the date of grant. The following assumptions were made in
estimating fair value: (i) dividend yield of 0%; (ii) risk-free interest rates
of 6.29% for 1999 and 6.57% for 2000; (iii) expected life equal to the period of
time remaining in which the options or warrants can be exercised; and (iv)
expected volatility of 74% in 1999 and 72% in 2000. There were no compensation
costs charged to operations in 1999 or 2001 for stock options issued to
employees. In 2000, the Company recorded $28 of compensation expense using the
intrinsic value method of accounting. Had compensation cost been determined on
the basis of fair value pursuant to SFAS No. 123, net income (loss) and the
income (loss) per share would have been as follows:
Ten Months One Month and
and Seventeen Thirteen Days
Days Ended Ended Year Ended December 31
November 17 December 31 --------------------------
1999 1999 2000 2001
----------- ------------ ---- ----
Net income (loss):
As reported $ 40,288 ($2,694) ($48,406) ($42,581)
Pro forma 43,302 (2,745) (48,520) (42,639)
Net income (loss) per share
(basic and diluted):
As reported 2.08 (0.26) (4.75) (4.18)
Pro forma 2.24 (0.27) (4.76) (4.18)
F-22
The weighted average fair value of options and warrants granted to
employees and directors was $0.03 in the ten months and seventeen days ended
November 17, 1999, $0.60 in the one month and thirteen days ended December 31,
1999 and $0.79 in 2000. All options and warrants that were outstanding prior to
November 17, 1999 were canceled pursuant to the Company's Prepackaged Plan.
Under SFAS No. 123, the pro forma net income and net income per share amounts
for the ten months and seventeen days ended November 17, 1999 reflect the
reversal of compensation expense from prior years due to the cancellation of
such options.
The following is a summary of the status of options and warrants outstanding at
December 31, 2001:
Options and Warrants Outstanding Options and Warrants Exercisable
-------------------------------------------------------------------- ---------------------------------
Weighted Average
Exercise Price Remaining Weighted Average Weighted Average
Range Number Contractual Life Exercise Price Number Exercise Price
----- ------ ---------------- -------------- ------ --------------
$0.00-$0.01 75,000 1.4 years $0.01 75,000 $0.01
1.14-1.56 270,000 2.7 years 1.39 130,000 1.31
10.50 1,077,024 0.9 years 10.50 1,077,024 10.50
11. COMMITMENTS AND CONTINGENCIES
The Company leases its corporate offices and other locations, office
equipment and field operations service vehicles under noncancellable operating
leases expiring at various times through 2006.
Future minimum noncancellable payments under operating leases are as
follows:
2002 $ 968
2003 596
2004 105
2005 23
2006 21
---------------
$ 1,713
Rent expense under all operating leases was $2,269, $299, $2,514 and $1,961
for the ten months and seventeen days ended November 17, 1999, the one month and
thirteen days ended December 31, 1999 and the years ended December 31, 2000 and
2001, respectively. The Company, in the course of its normal operations, is
subject to regulatory matters, disputes, claims and lawsuits. In management's
opinion all such outstanding matters of which the Company has knowledge, have
been reflected in the financial statements or will not have a material adverse
effect on the Company's financial position, results of operations or cash flows.
In January 2001, the Tennessee Regulatory Authority (the "TRA") denied a
petition for stay of its prior order, which required certain LECs to refund to
payphone service providers amounts billed since April 1997 for local line access
in excess of the applicable LEC's cost plus a reasonable profit (the "New
Services Test"). In February 2001, the Company received a refund of
approximately $500 from Bell South Telecommunications, Inc. who has appealed the
TRA's order. The Company has not recognized this refund as a reduction in
expense in 2001 due to the appeal which is currently pending. The Company has
recorded this refund in accounts payable at December 31, 2001. The Company
expects to receive additional refunds under the New Services Test and will
recognize such refunds as a reduction in line and transmission charges during
the period in which such refunds are received.
On June 11, 1998, the Company entered into an Agreement and Plan of Merger
and Reorganization (the "Original Davel Merger Agreement") with Davel
Communications Group, Inc. On July 5, 1998, Peoples Telephone Company, Inc., a
publicly held, independent pay telephone provider ("Peoples"), also entered into
a merger agreement (the "Peoples Merger Agreement") with Davel.
F-23
On September 29, 1998, the Company received a letter from Davel purporting
to terminate the Original Davel Merger Agreement. Thereafter, a complaint
against the Company was filed in the Court of Chancery of New Castle County,
Delaware by Davel, which was subsequently amended, alleging, among other things,
equitable fraud and breach of contract relating to the Original Davel Merger
Agreement. On October 27, 1998, the Company filed its answer to the amended
complaint denying the substantive allegations contained therein and filed a
counterclaim against Davel for breach of contract. At the same time, PhoneTel
filed a third party claim against Peoples (acquired by Davel on December 23,
1998) for tortuous interference with contract alleging that Peoples induced
Davel to not comply with the terms of the Original Davel Merger Agreement. The
counterclaim and third party claim seek specific performance from Davel, which
would require Davel to comply with the terms of the Original Davel Merger
Agreement or, alternatively, for compensatory damages and costs of an
unspecified amount. On February 19, 2002, the Company and Davel entered into a
settlement agreement which provides for the dismissal of each company's claims
at the time the current merger of the companies is completed.
12. OTHER REVENUES AND EXPENSES AND EXTRAORDINARY ITEMS
The Company's President and Chief Executive Officer is a Director,
Executive Vice President and a 40% shareholder of Urban Telecommunications, Inc.
("Urban"). During the years ended December 31, 2000 and 2001, other revenues
include $81 and $507, respectively, from various telecommunication contractor
services provided to Urban, principally residence and small business facility
provisioning and inside wiring. Accounts receivable include $38 at December 31,
2000 and $188 at December 31, 2001 due from Urban.
Other revenues also include $240 of income in both 2000 and 2001 relating
to the amortization of deferred revenue resulting from a signing bonus received
in connection with a services agreement with an operator service provider.
Other unusual charges (income) and contractual settlements is comprised of:
Predecessor
Company Successor Company
----------------- ---------------------------------------------
One Month
Ten Months and and
Seventeen Days Thirteen Days
Ended Ended Year Ended December 31
November 17 December 31 ----------------------------
1999 1999 2000 2001
------------- --------------- ------------- -------------
Professional fees and other
costs related to the Prepackaged Plan $ 852 $ 31 $ 78
Settlement of employee
contractual obligations - - - $ 108
Costs relating to Davel Merger Agreement - - - 650
Settlement - professional fees - (364) -
Other contractual settlements - - 284 21
Other 178 - 217 83
---------- ----------- --------- ----------
$ 1,030 $ (333) $ 579 $ 862
========== =========== ========= ==========
F-24
The Company did not pay the semiannual interest payments which were due
December 15, 1998 and June 15, 1999 on its $125,000 aggregate principal amount
12% Senior Notes, due 2006, and, pursuant to the terms of the indenture, the
Company was in default on this debt. As discussed in Note 13, the Company
converted the Senior Notes and accrued interest to Common Stock (Successor
Company) on November 17, 1999 and recognized an extraordinary gain on
extinguishment of this debt, determined as follows:
Senior Notes $ 125,000
Accrued Interest (from June 16, 1998 to November 17, 1999) 21,458
Deferred financing costs, net (5,556)
Debt restructuring costs (including $1,271 of Common Stock
(Successor Company) issued for services) (2,735)
-------------
Net carrying value of Senior Notes 138,167
Fair value of 9,500,000 Common Shares (Successor Company)
at $6.20 per share 58,900
-------------
Extraordinary gain on extinguishment of debt $ 79,267
=============
The extraordinary gain on extinguishment of debt of $77,172 for the ten
months and seventeen days ended November 17, 1999 consisted of the gain on
conversion of Senior Notes to Common Stock (Successor Company) of $79,267 less
the loss of $2,095 due to the write-off of deferred financing costs upon
refinancing of the Company's Credit Agreement on July 21, 1999.
13. CHAPTER 11 BANKRUPTCY FILING AND RESTRUCTURING
In January 1999, the Company announced that it had reached an agreement
in principle with an unofficial committee of Senior Noteholders (the "Unofficial
Committee") of its $125,000 aggregate principal amount 12% Senior Notes, due
2006 (the "Senior Notes") providing for the conversion, through a prepackaged
plan of reorganization (the "Prepackaged Plan"), of the Senior Notes and accrued
interest thereon into 95% of a new issue of common stock, $0.01 par value per
share ("Common Stock (Successor Company)") of the reorganized Company (the
"Restructuring").
The Company solicited and received acceptances of the Prepackaged Plan from
the holders of the Senior Notes and its 14% Preferred in anticipation of the
commencement of a case under chapter 11 of the Bankruptcy Code (the "Case"). On
July 14, 1999, the Company commenced the Case in the U.S. Bankruptcy Court in
the Southern District of New York (the "Court") and thereafter continued to
operate its business as a debtor-in-possession.
On October 20, 1999, the Court confirmed the Prepackaged Plan. On November
17, 1999, the Company executed a post reorganization loan agreement ("Exit
Financing Agreement") and consummated the Prepackaged Plan. Pursuant to the
terms of the Prepackaged Plan, claims of employees, trade and other creditors of
the Company, other than holders of the Senior Notes were paid in full in the
ordinary course, unless otherwise agreed. Holders of the Senior Notes received
9,500,000 shares of the Common Stock (Successor Company) in exchange for the
Senior Notes. In addition, the Unofficial Committee representing a majority in
principal amount of the Senior Notes appointed four of the five members of the
Board of Directors of the Company (the "New Board"). The former Chairman and
Chief Executive Officer continues to serve as a Director on the New Board.
Holders of the 14% Preferred received 325,000 shares of Common Stock
(Successor Company) and warrants to purchase up to 722,200 shares of Common
Stock (Successor Company) at an exercise price of $10.50 per share which expire
three years from the date of grant ("New Warrants"). Holders of existing Common
Stock received 175,000 shares of Common Stock (Successor Company) and New
Warrants to purchase up to 388,900 shares of Common Stock (Successor Company).
Options and warrants to purchase existing common stock were extinguished
pursuant to the Prepackaged Plan.
F-25
The equity interests issued in connection with the Prepackaged Plan were
subject to dilution by certain other equity issuances, including the issuance of
205,000 shares of Common Stock (Successor Company) to certain financial advisors
for services rendered in connection with the reorganization, and issuances
resulting from the exercise of certain options to purchase up to 5% of Common
Stock (Successor Company) to be issued by the New Board pursuant to the terms of
a management incentive plan ("1999 Management Incentive Plan") and other awards
included as part of the Prepackaged Plan.
As of November 17, 1999 (the "Consummation Date"), the total amount of
Common Stock (Successor Company) outstanding, after giving effect to the Common
Stock (Successor Company) and New Warrants forfeited in connection with the
warrant put obligation settlement described in Note 7, was 10,188,630 shares. In
addition, 1,074,721 shares of Common Stock (Successor Company) are reserved for
future issuance upon the exercise of the New Warrants, and an amount equal to 5%
of the shares of Common Stock (Successor Company) is reserved for issuance
pursuant to the terms of the 1999 Management Incentive Plan.
The Company recorded the effects of fresh start reporting as of November
17, 1999, the Consummation Date of the Company's Prepackaged Plan. In accordance
with SOP 90-7, assets and liabilities were restated as of November 17, 1999 to
reflect the reorganization value of the Company, which approximated their fair
value at the Consummation Date. In addition, the accumulated deficit of the
Company through the Consummation Date was eliminated and the debt and capital
structure of the Company was recast pursuant to the provisions of the
Prepackaged Plan.
The reorganization value of the Company's common equity of approximately
$63,500 was determined by the Company with the assistance of its financial
advisor. This advisor (1) reviewed certain historical information for recent
years and interim periods; (2) reviewed certain internal financial and operating
data; (3) met with senior management to discuss operations and future prospects;
(4) reviewed publicly available financial data and considered the market values
of public companies deemed generally comparable to the operating business of the
Company; (5) considered certain economic and industry information relevant to
the operating business; (6) reviewed a four year forecast prepared by the
Company; and (7) conducted such other analysis as appropriate. Based upon the
foregoing, the financial advisor determined a range of values for the Company as
of the Consummation Date. In developing this range of values the advisor, using
rates of 15% to 20%, discounted the Company's four year forecasted free cash
flows and an estimate of sales proceeds which would be received if the Company
was sold at the end of the four year period within a range of comparable company
multiples. A portion of the reorganization value of the Company's common equity
was assigned to the New Warrants issued to holders of the 14% Preferred and
Common Stock of the Predecessor Company based upon the fair value of the New
Warrants ($333 or $0.30 per warrant) with the remaining amount assigned to the
Common Stock of the Successor Company (approximately $6.20 per share).
Under fresh start reporting, the accumulated deficit of the Company at
November 17, 1999 of approximately $73,941, which included the effects of the
reorganization adjustments and the extraordinary gain on extinguishment of debt,
was eliminated. In addition, the accumulated depreciation and accumulated
amortization balances relating to the Company's property and equipment and
intangible assets were reduced to zero as part of the fresh start reporting
adjustment recognized to restate assets and liabilities to reflect the
reorganization value of the Company.
F-26
The effects of the Company's Prepackaged Plan and fresh start reporting
on the Company's condensed consolidated balance sheet at November 17, 1999 are
as follows.
PROFORMA CONDENSED CONSOLIDATED BALANCE SHEET
November 17, 1999
Predecessor
Company (a) (b) Successor
Pre-emergence Reorganization Fresh Start Company
Balance Sheet Adjustments Adjustment Balance Sheet
--------------- --------------- -------------- --------------
Assets
Current assets:
Cash $6,576 $6,576
Accounts receivable, net 11,179 11,179
Other current assets 1,708 1,708
--------------- --------------- -------------- --------------
Total current assets 19,463 - - 19,463
Property and equipment, net 21,979 $1,315 23,294
Intangible assets, net 80,762 3,753 84,515
Other assets 532 532
--------------- --------------- -------------- --------------
$122,736 - $5,068 $127,804
=============== =============== ============== ==============
Liabilities and Shareholders' Equity (Deficit)
Current liabilities:
Current portion of long-term debt $1,159 $1,159
Accounts payable 9,174 9,174
Accrued expenses 5,987 5,987
--------------- --------------- -------------- --------------
Total current liabilities 16,320 - - 16,320
12% Senior Notes, net 139,438 ($139,438) -
Other long-term debt 47,992 47,992
14% Preferred 10,322 (10,322) -
Shareholders' Equity (Deficit):
Series A Preferred - -
Common Stock (Predecessor Company) 188 (188) -
Common Stock (Successor Company) - 102 102
Additional Paid-in Capital 61,684 70,579 ($68,873) 63,390
Accumulated Deficit (153,208) 79,267 73,941 -
--------------- --------------- -------------- --------------
Shareholders' Equity (Deficit) (91,336) 149,760 5,068 63,492
--------------- --------------- -------------- --------------
$122,736 $ - $5,068 $127,804
=============== =============== ============== ==============
(a) To record the issuance of Common Stock (Successor Company) in exchange for
the Senior Notes, 14% Preferred, Common Stock (Predecessor Company) and
services rendered by certain financial advisors in connection with the
Restructuring, less Common Stock (Successor Company) and New Warrants
forfeited upon settlement of the warrant put obligation and the
extraordinary gain on extinguishment of debt.
(b) To record assets and liabilities at their fair value pursuant to fresh
start reporting and eliminate the existing accumutated deficit.
F-27
14. QUARTERLY RESULTS (UNAUDITED)
The following is a summary of unaudited results of operations for the years
ended December 31, 2000 and 2001.
Quarter Ended 2000 March 31 June 30 September 30 December 31
- ------------------ -------- ------- ------------ -----------
Revenues $14,549 $15,361 $16,017 $12,917
Net loss (5,492) (4,914) (7,814) (30,186)
Net loss per common share,
basic and diluted (0.54) (0.48) (0.77) (2.96)
Quarter Ended 2001
------------------
Revenues 11,356 12,280 11,817 9,518
Net loss (6,217) (12,786) (7,367) (16,211)
Net loss per common share,
basic and diluted (0.61) (1.25) (0.72) (1.59)
Loss per share amounts for each quarter are required to be computed
independently and, therefore, may not equal amounts computed on an annual basis.
During the fourth quarter of 2000 and the second and fourth quarters of
2001, the Company recorded losses on asset impairment relating to location
contracts of $14,787, $6,323 and $9,507 ($1.45, $0.62 and $0.93 per share),
respectively. The Company also wrote-off the carrying value of abandoned
location contracts of $2,880, $3,538 and $1,752 ($0.28, $0.35 and $0.17 per
share) during the quarters ended September 30, 2000, December 31, 2000 and
September 30, 2001, respectively (see Note 6). In the fourth quarter of 2000,
the Company recorded a provision for uncollectible accounts receivable relating
to dial-around compensation of $4,429 ($0.43 per share) to more closely reflect
the actual number of dial-around calls for which the Company expects to be
compensated.
F-28
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
------------------ ------------------- ------------------------ -------------------
Balance Additions Deductions for
at charged (credited) write-offs and Balance
beginning to costs, expenses fresh start at end
of period or tax benefit reporting of period
------------------ ------------------- ------------------------ -------------------
TEN MONTHS AND SEVENTEEN DAYS
ENDED NOVEMBER 17, 1999
Allowances deducted from related
balance sheet accounts:
Accounts Receivable 935 345 1,280
Deferred Tax Assets 22,629 (15,506) ($447) 6,676
Intangible Assets 42,852 15,279 (58,131) -
ONE MONTH AND THIRTEEN DAYS
ENDED DECEMBER 31, 1999
Allowances deducted from related
balance sheet accounts:
Accounts Receivable 1,280 59 1,339
Deferred Tax Assets 6,676 (2,114) 4,562
Intangible Assets - 1,993 1,993
YEAR ENDED DECEMBER 31, 2000
Allowances deducted from related
balance sheet accounts:
Accounts Receivable 1,339 4,944 (6,199) 84
Deferred Tax Assets 4,562 8,784 13,346
Intangible Assets 1,993 16,920 (5,038) 13,875
YEAR ENDED DECEMBER 31, 2001
Allowances deducted from related
balance sheet accounts:
Accounts Receivable 84 328 412
Deferred Tax Assets 13,346 7,181 20,527
Intangible Assets 13,875 12,845 (8,077) 18,643
F-29
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PHONETEL TECHNOLOGIES, INC.
March 29, 2002 By:/s/ John D. Chichester
--------------------------
John D. Chichester
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
Name Title Date
/s/ John D. Chichester President, March 29, 2002
- ----------------------------- Chief Executive Officer,
John D. Chichester and Director
/s/ Richard P. Kebert Chief Financial Officer, March 29, 2002
- ----------------------------- Treasurer and Secretary
Richard P. Kebert
/s/ Eugene I. Davis Director March 29, 2002
- -----------------------------
Eugene I. Davis
/s/ Peter G. Graf Director March 29, 2002
- -----------------------------
Peter G. Graf
/s/ Kevin Schottlaender Director March 29, 2002
- -----------------------------
Kevin Schottlaender
/s/ Bruce Ferguson Director March 29, 2002
- -----------------------------
Bruce Ferguson
</Table>
EXHIBIT INDEX
10.23 Amendment to Employment Agreement dated February 28, 2002 by and between
PhoneTel Technologies, Inc. and John D. Chichester.
21 Subsidiaries of PhoneTel Technologies, Inc.
- ----------------