1
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, 1998
[ ] 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 22, 1999 was $924,000.
The number of shares outstanding of the registrant's Common Stock, $.01 par
value, as of March 22, 1999 was 18,754,133.
Documents Incorporated by Reference
Portions of the Registrant's Proxy Statement for use at the 1999 Annual Meeting
of Shareholders are incorporated by reference in Part III hereof.
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PART I
ITEM 1. BUSINESS
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
office of the Company's Chief Executive Officer and Chairman of the Board is
located at 6 East 43rd Street, New York, New York 10017. In addition, The
Company maintains certain administrative offices 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 42,685 at February 28, 1999. 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 the past several years, the Company's objective had been to expand
its payphone base through acquisitions as well as through internal growth,
thereby achieving economies of scale while implementing cost savings. The
Company's management believes that there is a significant opportunity to
consolidate the highly fragmented independent segment of the public payphone
industry. Selective acquisitions have enabled PhoneTel to expand its geographic
presence and further its strategy of clustering its public payphones more
rapidly than would have been possible with new installations.
The Company has sought to install new public payphones and 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"), principally U.S. Long Distance Communications, Inc. ("USLD").
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 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 their occurrence.
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
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accounts and encouraging the use of its public payphones in locations where
consumers have multiple payphone options.
As discussed in Note 2 to the consolidated financial statements and Item 7,
Liquidity and Capital Resources, the Company was not in compliance with certain
financial covenants under its Credit Agreement at December 31, 1998 and is in
default on this debt. Further, the Company was unable to make the interest
payment due on December 15, 1998 under the Company's 12% Senior Notes and is in
default on this debt.
INDUSTRY OVERVIEW
Public payphones are primarily owned and operated by RBOCs, other LECs and
Independent Payphone Providers ("IPPs"). Of the approximately 2.5 million public
payphones operated in the United States in 1995, the Multimedia
Telecommunications Association estimated that approximately 87% were operated by
RBOCs and other LECs and approximately 13% were operated by IPPs. Within the
United States, the Multimedia Telecommunications Association estimates that
there were approximately 342,000 public payphones owned by IPPs in 1995. 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 transit 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. Long distance companies,
(referred to as interexchange carriers or "IXCs"), such as AT&T and MCI
Communications Corporation ("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 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
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calls and to offer IPPs companies 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 (both of which
were recently enacted) 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 recent years the Company has sought to grow its payphone base through
acquisitions. The following table summarizes in reverse chronological order
PhoneTel's significant acquisitions in 1996, 1997 and 1998.
NUMBER OF
DATE OF INSTALLED PRIMARY
COMPANY ACQUIRED ACQUISITION PAYPHONES AREAS SERVED
---------------- ----------- --------- ------------
TDS Telecommunications Corporation May 18, 1998 3,407 Tennessee,
("TDS") Wisconsin, Maine,
Michigan, Minnesota
London Communications, Inc. ("London") June 10, 1997 2,519 Georgia, North
Carolina, South
Carolina
American Public Telecom, Inc. May 30, 1997 859 Michigan
("American")
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. January 1, 1997 3,949 Texas, New Mexico,
("Cherokee") Colorado, Utah,
Montana
Amtel Communications Services ("Amtel") September 13, 1996 6,872 California,
Washington, Oregon,
Colorado
Payphones of America, Inc. ("POA") August 1, 1996 3,115 Missouri, Illinois,
Virginia
International Pay Phones, Inc. of South March 15, 1996 2,101 North Carolina,
Carolina and International Pay Phones, Inc. South Carolina,
of Tennessee ("International Pay Phone") Tennessee
Paramount Communications Systems, Inc. March 15, 1996 2,528 Florida
("Paramount") ------
Total installed public payphones acquired
in the three year period ended December 31, 1998 38,091
======
Total installed public payphones at February 28, 1999* 42,685
======
* Includes 558 "dumb" payphones acquired from TDS in 1998 which are
currently being converted into "smart" payphones.
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
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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 obtain contracts, either through
acquisitions or internal growth, from Location Owners to install and operate
public payphones on a revenue sharing basis. 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 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 and 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."
Traditionally, local coin calls have been provided for an unlimited
duration, 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 USLD, 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."
TELEPHONE EQUIPMENT SUPPLIERS
The Company purchases the majority of its payphones from two manufacturers
of public payphones, 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 it easier to stock
appropriate spare parts. It is the Company's policy to place the Company name on
telephones that it acquires or installs.
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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 trade publications, 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 95% of
such public payphones are located in 27 states) 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, 1996, 1997, or 1998.
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 thereof.
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.
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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) have publicly announced or implemented an increase in the local coin
rate to $0.35 per call in most 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. In the first phase, November 1996 to October 1997, the
FCC prescribed flat-rate compensation payable to the payphone providers by the
IXCs in the amount of $45.85 per month per payphone. This rate was arrived at by
determining that the deregulated local coin rate was a valid market based
surrogate for dial-around calls. The FCC applied a market-based, deregulated
coin rate of $0.35 per call to a finding from the record that there were a
monthly average of 131 compensable dial-around calls per payphone. This total
included both carrier access code calls dialed for the purpose of reaching a
long distance company other than the one designated by the payphone provider as
well as 800 subscriber calls. The monthly per phone flat-rate compensation of
$45.85 was to be assessed only against IXCs with annual toll-call revenues in
excess of $100 million and allocated among such IXCs in proportion to their
gross long-distance revenues. During the second phase of the transition to
deregulation and market-based compensation (initially from October 1997 to
October 1998, but subsequently extended in a later order by one year to October
1999), the FCC directed the IXCs to pay payphone service providers (such as
PhoneTel), on a per-call basis for dial-around calls at the assumed deregulated
coin rate of $0.35 per call. At the conclusion of the second phase, the FCC set
the market-based local coin rate, determined on a payphone-by-payphone basis, as
the default per-call compensation
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rate in the absence of a negotiated agreement between the payphone provider and
the IXC. 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 and required the LECs to make such coding
available to the payphone providers as a transmit item included in the local
access line service.
In July 1997, the United States Court of Appeals for the District of
Columbia Circuit ("the Court") responded to an appeal of the 1996 Payphone
Order, finding that the FCC erred in (1) setting the default per call rate at
$0.35 without considering the differences in underlying costs between
dial-around calls and local coin calls, (2) assessing the flat-rate compensation
against only the carriers with annual toll-call revenues in excess of $100
million, and (3) allocating the assessment of the flat-rate compensation based
on gross revenues rather than on a factor more directly related to the number of
dial-around calls processed by the carrier. The Court also assigned error to
other aspects of the 1996 Payphone Order concerning inmate payphones and the
accounting treatment of payphones transferred by an RBOC to a separate
affiliate.
In response to the remand by the Court, the FCC issued a new order
implementing section 276 in October 1997 (the "1997 Payphone Order"). The FCC
determined that distinct and severable costs of $0.066 were attributable to a
coin call that did not apply to the costs incurred by the payphone providers in
providing access for a dial-around call. Accordingly, the FCC adjusted the per
call rate during the second phase of interim compensation to $0.284 (which is
$0.35 less $0.066). While the FCC tentatively concluded that the $0.284 default
rate should be utilized in determining compensation during the first phase and
reiterated that payphone providers were entitled to compensation for each and
every call during the first phase, it deferred for later decision the precise
method of allocating the initial interim period flat-rate payment obligation
among the IXCs and the number of calls to be used in determining the total
amount of the payment obligation.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC 98-48
1, which extended and waived certain requirements concerning the provision by
the LECs of payphone-specific coding digits, which identify a call as
originating from a payphone. Without the transmission of payphone-specific
coding digits some of the IXCs have claimed they are unable to identify a call
as a payphone call eligible for dial-around compensation. With the stated
purpose of ensuring the continued payment of dial-around compensation the FCC,
by Memorandum and Order issued on April 3, 1998, left in place the requirement
for payment of per-call compensation for payphones on lines that do not transmit
the requisite payphone-specific coding digits, but gave the IXCs a choice for
computing the amount of compensation for payphones on LEC lines not transmitting
the payphone-specific coding digits of either accurately computing per-call
compensation from their databases or paying per-phone, flat-rate compensation
computed by multiplying the $0.284 per call rate by the nationwide average
number of 800 subscriber and access code calls placed from RBOC payphones for
corresponding payment periods. Accurate payments made at the flat rate are not
subject to subsequent adjustment for actual call counts from the applicable
payphone.
On May 15, 1998, the Court again remanded the per-call compensation rate to
the FCC for further explanation without vacating the $0.284 per call rate. The
Court opined that the FCC had failed to explain adequately its derivation of the
$0.284 default rate. The Court stated that any resulting overpayment would be
subject to refund and directed the FCC to conclude its proceedings within a
six-month period ending on November 15, 1998. On June 19, 1998, the FCC
solicited comment from interested parties on the issues remanded. In initial and
reply comments certain IXCs and members of the paging industry had urged the FCC
to abandon its efforts to derive a market-based rate from surrogates and either
require the caller to pay dial-around compensation by coin deposit or adopt a
cost-based rate at levels substantially below the $0.284 rate.
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 from $0.284 to $0.238, retroactive to
October 7, 1997. In adjusting the default rate, the FCC shifted its methodology
from the market-based method utilized in the 1997 Payphone Order to a cost-based
method citing technologic 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
cost-based default rate, the FCC incorporated its prior treatment of certain
payphone costs and reexamined new estimates of payphone costs submitted as part
of the proceeding. Pursuant to the 1999 Payphone Order, the $0.24 amount ($0.238
plus 0.2 cents for FLEX ANI costs, amounts charged by LECs for providing
payphone specific coding digit technology) will serve as the default per-call
compensation rate for coinless payphone calls through January 31, 2002, at which
time, parties may petition the FCC regarding the default amount, related issues
pursuant to technological advances, and the expected resultant market changes.
- 7 -
9
The 1999 Payphone Order has been appealed by various parties, including but
not limited to, the trade association which represents the interests of various
pay telephone providers throughout the United States.
EFFECT OF FEDERAL REGULATION OF LOCAL COIN AND DIAL-AROUND CALLS
DIAL-AROUND CALLS. The payments for dial-around calls prescribed in the
1999 Payphone Order 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) the possibility of subsequent court appeals relating
to the 1999 Payphone Order, (2) resolution by the FCC of the method of
allocating the initial interim period flat-rate assessment among the IXCs and
the number of calls to be used in determining the amount of the assessment, (3)
the possibility of other litigation seeking to modify or overturn the 1999
Payphone Order or portions thereof, (4) pending litigation in the federal courts
concerning the constitutionality or validity of the Telecommunications Act, (5)
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 (6) 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 with the fourth
quarter of 1998, PhoneTel has 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 March 1999, the per-call compensation rate will include 0.2 cents
for FLEX ANI costs and become $0.24 per call (or $31.44 per payphone, per month
based upon 131 calls per month).
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 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.
- 8 -
10
OTHER PROVISIONS OF THE TELECOMMUNICATIONS ACT AND FCC RULES
As a whole, the Telecommunications Act and FCC Rules should significantly
alter the competitive framework of the payphone industry. PhoneTel believes that
implementation of the Telecommunications Act and FCC Rules will address certain
historical inequities in the payphone marketplace and 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:
o 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.
o 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.
o 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 new 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.
o 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 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.
o 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 previously 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. The majority 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
current or future operations or results.
- 9 -
11
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 USAC. In February 1998, the USAC issued its first monthly
assessment, which applied to January 1998. The FCC 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. These factors were set at 0.0075 and 0.0318, respectively, for the
fourth quarter of 1998. The universal service assessments, if not modified, may
increase monthly costs by as much as $56,000. PhoneTel is currently paying the
assessments under protest.
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" of up to $2.75 per line per month 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 pre-subscribed 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, but no assurances can be given as to the
actual net impact of these actions.
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. The 49 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.
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 careers. 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
- 10 -
12
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.
PhoneTel 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. PhoneTel believes
that 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.
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.
Some of the other public payphone companies, such as Davel Communications
Group, Inc. ("Davel"), 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; and (iii)
the quality of service provided to Location Owners and public payphone users.
EMPLOYEES
PhoneTel had 439 employees as of February 28, 1999. 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 four acquisitions that added approximately 14,600
telephones during the first nine months of 1996, 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.
- 11 -
13
ITEM 2. PROPERTIES
The Company's administrative offices are located at North Point Tower,
7th Floor, 1001 Lakeside Avenue, Cleveland, Ohio 44114-1195, where the
Company initially leased approximately 20,000 square feet of space at a
monthly rental of $24,167 subject to certain adjustments. The leased area
increased to 39,919 square feet on November 1, 1998 with corresponding
increases in monthly rent to $39,777 per month on November 1, 1998 and to
$41,148 per month on November 1, 2000. The lease expires on October 31,
2003. The Company also leases approximately 40 district operations
facilities with lease terms that are generally three years or less. The
Company considers its facilities adequate for its purposes.
ITEM 3. LEGAL PROCEEDINGS
On September 29, 1998, PhoneTel received a letter from Davel purporting to
terminate the Davel Merger Agreement. On October 1, 1998, a complaint against
PhoneTel under Civil Action No. 16675 was filed in the Court of Chancery of New
Castle County, Delaware by Davel, which was subsequently amended on October 9,
1998, alleging among other things, equitable fraud and breach of contract
relating to the Davel Merger Agreement. Davel is seeking a declaratory judgement
terminating the Davel Merger Agreement or, alternatively, an order to rescind
the merger agreement, and compensatory damages and costs of an amount in excess
of $1,000,000.
On October 27, 1998, PhoneTel filed its answer to the amended complaint
denying the substantive allegations contained therein and filed a counterclaim
against Davel for breach of contract. On the same date, PhoneTel filed a third
party claim against Peoples for tortuous interference with contract alleging
that Peoples induced Davel not to comply with the terms of the Davel Merger
Agreement.
PhoneTel is seeking specific performance from Davel, which would require
Davel to comply with the terms of the Davel Merger Agreement or, alternatively,
for compensatory damages and costs of an unspecified amount. PhoneTel is also
seeking injunctive relief enjoining Peoples from further tortuous interference
with contract and for compensatory damages and costs of an unspecified amount.
Management believes the claims against PhoneTel are without merit and is
vigorously pursuing its claim against Davel and Peoples.
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, 1998, no
matters were submitted to a vote of the Company's shareholders.
- 12 -
14
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Effective February 16, 1999, following the decision by the American
Stock Exchange ("AMEX") to strike the Company's Common Stock from listing and
registration on the exchange, the Company's Common Stock, $0.01 par value, has
traded over the counter and is quoted on the National Quotation Service Pink
Sheets under the symbol "PHNT". Prior to February 12, 1999, the Company's Common
Stock was listed on the AMEX under the symbol "PHN". The following table sets
forth on a per share basis, for the periods indicated, the high and low sales
prices of the Common Stock as reported by the AMEX or other quotation services,
as applicable.
Price Range
High Low
---- ---
1997:
First Quarter ................................. $ 4 5/8 $ 3
Second Quarter ................................ 3 7/16 1 7/8
Third Quarter ................................. 2 7/8 1 13/16
Fourth Quarter ................................ 3 3/8 2 3/8
1998:
First Quarter ................................. 2 15/16 1 5/8
Second Quarter ................................ 2 9/16 1 1/16
Third Quarter ................................. 2 5/8 1/16
Fourth Quarter ................................ 9/32 1/16
1999:
Through March 22, 1999 ........................ 5/16 3/64
As of February 26, 1999, there were 1,943 shareholders of record.
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. The Company cannot pay any dividends on its
Common Stock unless dividends are paid to the holders of the Series A Preferred
(as defined herein) in an amount equal to that which such holders would have
been entitled to receive if such holders had converted their shares of Series A
Preferred (as defined herein) into Common Stock prior to the record date used by
the Board of Directors for determining the holders of Common Stock entitled to
receive such dividends. Any future declaration of dividends will be subject to
the discretion of the Board of Directors of the Company. The timing, amount and
form of dividends (other than with respect to the holders of the 14% Preferred
(as defined herein) which are only entitled to receive dividends payable in
kind), 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.
- 13 -
15
SALES AND ISSUANCES OF COMMON STOCK
Sales and issuances of the Company's Common Stock during 1997 and 1998
were as follows:
Number of Average
Common Price Per
Shares Share
------ -----
1997: Company Equity Offering (registered) 1,012,500 2.79
Exercise of nominal value
warrants by Directors 221,125 .01
Other exercises of nominal value warrants 88,629 .01
Exercise of stock options 100,000 1.02
Issued to Directors for services 75,000 2.78
Conversion of Series A Preferred 250,000 .01
Issued to executive upon conversion of
debt and accrued interest 124,747 3.00
---------
Total issuances of Common Stock in 1997 1,872,001
=========
1998: Exercise of nominal value warrants by Directors 89,998 .01
Other exercises of nominal value warrants 275,124 .01
Exercise of other warrants 10,682 2.34
Conversion of Series A Preferred 2,017,500 .01
---------
Total issuances of Common Stock in 1998 2,393,304
=========
PREFERRED STOCK
On February 23, 1996, the Company created three new classes of preferred
stock: (i) Series A Special Convertible Preferred Stock, $0.20 par value, $0.20
Stated Value, 250,000 authorized shares, with each share immediately convertible
into 20 shares of Common Stock, and non-voting ("Series A Preferred"); (ii)
Series B Special Convertible Preferred Stock, $0.20 par value, $120 Stated
Value, 250,000 authorized shares, with each share immediately convertible into
20 shares of Common Stock, and non-voting ("Series B Preferred"); and (iii) 14%
Convertible Cumulative Redeemable Preferred Stock, without par value, $60 Stated
Value, non-voting, 200,000 authorized shares, and with each share immediately
convertible into 10 shares of Common Stock ("14% Preferred"). Each share of the
14% Preferred is entitled to receive a quarterly dividend of 0.035 shares of 14%
Preferred.
On February 7, 1997, a former lender to the Company exercised options for
12,500 shares of Series A Preferred which were immediately converted into
250,000 shares of Common Stock. On October 13, 1998, the Company received notice
from this former lender which purported to exercise its put right as defined in
the agreement for the Series A Warrants (the "Warrant Agreement"), with respect
to 89,912 Series A Warrants and 124,300 Common Shares. The Warrant Agreement
specifies that the Company is to redeem Series A Warrants that are convertible
into shares of Common Stock (or shares of Common Stock obtained from such
conversion) at a value determined by a formula, subject to certain limitations,
set forth therein. In 1998, the Company recorded an accrued liability and a
charge to additional paid-in-capital of $1,452,000 relating to this put. The
Company is not permitted to make payment pursuant to this purported exercise of
a put right under the indenture for the Company's 12% Senior Notes. To make such
a payment would constitute a breach of the indenture. The Company intends to
engage in further negotiations with said former lender regarding such notice. On
November 13, 1998, another former lender exercised options to purchase 100,875
shares of Series A Preferred, net of stock not issued in lieu of cash payment,
which were immediately converted into 2,017,500 shares of Common Stock.
At December 31, 1998, the total amount of preferred stock that remained
outstanding was 158,527 shares of 14% Preferred.
- 14 -
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.
STATEMENT OF OPERATIONS DATA:
(In thousands except share and per share amounts) YEAR ENDED DECEMBER 31
-----------------------------------------------------------------------------
1994 1995 1996 1997 1998
-------------- -------------- -------------- -------------- --------------
REVENUES:
Coin calls $8,421 $12,130 $26,212 $58,520 $52,544
Non-coin telecommunication services 7,176 6,458 17,649 50,624 42,432
Dial-around compensation adjustment (1) - - - (395) (3,733)
Other 269 130 943 500 143
-------------- -------------- -------------- -------------- --------------
15,866 18,718 44,804 109,249 91,386
-------------- -------------- -------------- -------------- --------------
COSTS AND EXPENSES:
Line and transmission charges 4,135 5,149 11,153 24,518 29,607
Telecommunication and validation fees 1,390 1,258 5,608 11,599 11,344
Location commissions 3,391 3,468 6,072 16,628 14,179
Field operations (1) 3,565 4,934 8,733 21,100 22,009
Selling, general and administrative (1) 2,463 2,645 4,381 10,713 12,354
Depreciation and amortization 2,236 4,383 12,800 22,798 25,583
Other unusual charges and contractual settlements - 2,170 6,072 9,095 2,762
-------------- -------------- -------------- -------------- --------------
17,180 24,007 54,819 116,451 117,838
-------------- -------------- -------------- -------------- --------------
Loss from operations (1,314) (5,289) (10,015) (7,202) (26,452)
-------------- -------------- -------------- -------------- --------------
OTHER INCOME (EXPENSE):
Interest expense - related parties - - (5,235) (1,431) (1,036)
Interest expense - others (388) (837) (1,504) (15,181) (17,876)
Interest income 7 16 182 560 547
-------------- -------------- -------------- -------------- --------------
(381) (821) (6,557) (16,052) (18,365)
-------------- -------------- -------------- -------------- --------------
Loss before extraordinary item (1,695) (6,110) (16,572) (23,254) (44,817)
Extraordinary item:
Loss on early extinguishment of debt - - (10,077) - -
-------------- -------------- -------------- -------------- --------------
NET LOSS ($1,695) ($6,110) ($26,649) ($23,254) ($44,817)
============== ============== ============== ============== ==============
Net loss applicable to common shareholders ($1,987) ($6,420) ($29,090) ($24,262) ($46,213)
Net loss per common share, basic and diluted (2) ($1.35) ($3.29) ($5.29) ($1.51) ($2.73)
Weighted average number of shares, basic and diluted 1,470,188 1,950,561 5,494,011 16,040,035 16,923,499
EBITDA (3) $922 $1,264 $8,857 $24,691 $1,893
Cash flow provided by (used in):
Operating activities $2,380 ($580) ($269) ($4,720) ($6,470)
Investing activities (3,214) (2,354) (63,062) (57,197) (6,763)
Financing activities 1,229 3,168 109,056 21,998 12,482
BALANCE SHEET DATA:
Total assets $10,158 $28,917 $159,770 $169,826 $150,674
Long-term debt and mandatorily redeemable preferred
stock, less current portion of debt (4) 2,272 12,563 132,086 157,938 9,118
Shareholders' equity (deficit) 2,648 9,711 16,705 (4,042) (51,598)
Cash dividends per common share - - - - -
15
17
(1) Certain costs and expenses for prior years have been reclassified to
conform to the current year presentation. The reclassifications have
had no impact on net loss as previously reported.
(2) Net loss per common share and weighted average number of common shares
outstanding in all periods have been adjusted to reflect the one for
six (1:6) reverse stock split which was effective December 26, 1995.
(3) EBITDA represents earnings before interest income and expense,
depreciation, amortization, other unusual charges and contractual
settlements, and the extraordinary loss. EBITDA 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 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.
(4) At December 31, 1998, long-term debt has been classified as current
because the Company is in default on such debt.
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 1999 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, and regulations and policies regarding the
telecommunications industry; (ii) the ability of the Company to accomplish its
strategic objectives with respect to external expansion through selective
acquisitions and internal expansion; and (iii) changes in the dial-around
compensation rate and the coin drop rate. 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 in the
form of commissions from its presubscribed long distance provider and OSPs
based on the volume of calls carried by the OSP and the amount of revenue
generated by the calls. The Company also receives dial-around compensation
(revenues from non-coin calls placed from the Company's payphones utilizing
a carrier other than the Company's presubscribed long distance providers
and OSPs). Net revenues from dial-around compensation was $3,219,000,
$18,705,000 and $12,454,000 for the years ended December 31, 1996, 1997 and
1998, respectively.
- 16-
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, as 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 telephone per month, applicable to the November 6, 1996 to September
30, 1997 period. The third quarter 1997 adjustment included a charge of $395,000
applicable to the November 6 to December 31, 1996 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 current year charge of $3,733,000 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. Additionally, the 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. Substantially all of the Company's
pay telephones currently have a local coin rate of $0.35. However, there can be
no assurance as to the ultimate effect that the rules and policies adopted by
the FCC on its own or after any judicial review will have on the Company's
business, results of operations or financial condition. 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 the respective location providers; (iii)
telecommunication and validation fees; and (iv) field service and collection
costs which are principally comprised of personnel costs for collecting coins
from and maintaining the Company's public pay telephones. The Company pays
monthly line and usage charges to RBOCs and other LECs for interconnection to
the local network for local calls, which are computed on a flat monthly charge
plus either a per message or per minute 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.
Notwithstanding the aforementioned anticipated benefits of section 276 and
the implementing regulations, as a result of the provisions permitting RBOCs and
other LECs to negotiate with location providers and select interLATA long
distance carriers for their public pay telephones, it is anticipated that
section 276 and the implementing regulations may also result in increased
competition for public pay telephone locations and an accompanying increase in
the commissions payable to location providers. Moreover, revenues may be
diminished if the FCC prescribes lower benchmark rates for interstate operator
long distance calls. See "Business --Governmental Regulations."
- 17 -
19
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
information from the Company's Consolidated Statements of Operations, included
elsewhere in this Form 10-K, expressed as a percentage of total revenues.
Certain of the following information for the year ended December 31, 1997 has
been reclassified to conform to the presentation for the year ended December 31,
1998. The reclassifications had no impact on total revenues or total expenses as
previously reported.
YEAR ENDED DECEMBER 31
----------------------------------------
1996 1997 1998
----- ----- -----
REVENUES:
Coin calls 58.5% 53.6% 57.5%
Non-coin telecommunication services 39.4 46.3 46.4
Dial-around compensation adjustment - (0.4) (4.1)
Other 2.1 0.5 0.2
----- ----- -----
Total revenues 100.0 100.0 100.0
----- ----- -----
COSTS AND EXPENSES:
Line and transmission charges 24.9 22.4 32.4
Telecommunication and validation fees 12.5 10.6 12.4
Location commissions 13.6 15.2 15.5
Field operations 19.5 19.3 24.1
Selling, general and administrative expenses 9.7 9.8 13.5
Depreciation and amortization 28.6 20.9 28.0
Other unusual charges and
contractual settlements 13.6 8.3 3.0
----- ----- -----
Total operating expenses 122.4 106.6 128.9
----- ----- -----
Loss from operations (22.4) (6.6) (28.9)
----- ----- -----
OTHER INCOME (EXPENSE):
Interest expense - related parties (11.7) (1.3) (1.1)
Interest expense - others ( 3.3) (13.9) (19.6)
Interest and other income 0.4 0.5 0.6
----- ----- -----
Total other income (expense) ( 14.6) (14.7) (20.1)
----- ----- -----
Loss before extraordinary item (37.0) (21.3) (49.0)
Extraordinary item (22.5) - -
----- ----- -----
NET LOSS (59.5)% (21.3)% (49.0)%
===== ===== =====
CASH FLOW PROVIDED BY (USED IN):
Operating activities (0.6)% (4.4)% (7.1)%
Investing activities (140.8)% (52.4)% (7.4)%
Financing activities 243.4% 20.1% 13.7%
EBITDA (1) 19.8% 22.6% 2.1%
(1) See Item 6, Selected Financial Data for definition of EBITDA.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES
Total revenues decreased by $17,863,000 or 16.4% from $109,249,000 for
the year ended December 31, 1997 to $91,386,000 for the year ended December
31, 1998. This decrease is primarily due to a decline in call volume,
offset in part by the increase in the local coin call rate from $0.25 to
$0.35, and the decrease in revenues from non-coin telecommunication
services, including dial-around compensation, as discussed below. The
average number of installed pay telephones increased from 42,590 for the
year ended December 31, 1997 to 43,282 for the year ended December 31,
1998, an increase of 692 or 1.6%. This increase was principally due to
acquisitions in the second quarter of 1997 and in 1998 offset by decreases
in pay telephones resulting from expired location contracts.
- 18 -
20
Revenues from coin calls decreased by $5,976,000 or 10.2%, from $58,520,000
for the year ended December 31, 1997 to $52,544,000 for the year ended December
31, 1998. The decrease is primarily due to a decline in the number of local coin
calls which historically represents approximately 70% of total coin revenue.
During the fourth quarter of 1997, the Company increased its local coin call
rate from $0.25 to $0.35 and, as initially expected, experienced a reduction in
call volume. In addition, 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. To a
lesser extent, coin revenues have been adversely affected by changes in customer
and geographic mix and adverse weather conditions in the first quarter of 1998.
There can be no assurance that coin call volumes will return to historical
levels or that coin revenue per phone will increase in excess of historical
levels.
Revenues from non-coin telecommunication services decreased by $8,912,000
or 16.2%, from $50,624,000 for the year ended December 31, 1997 to $42,432,000
for the year ended December 31, 1998. Of this decrease, long distance revenues
from operator service providers decreased by $5,280,000 or 16.7% principally due
to a reduction in the number of operator service calls as a result of continuing
aggressive dial-around advertising by long distance carriers such as AT&T and
MCI Communications Corporation. Long distance revenues from operator service
providers have also been adversely affected by the growth in wireless
communications. In addition, revenues from dial-around compensation decreased by
$2,913,000 or 15.3% compared to 1997 primarily due to the decrease in the
dial-around compensation rate as a result of regulatory changes discussed below.
Net revenues from dial-around compensation consists of:
1997 1998
---- ----
Amount included in revenue from
non-coin telecommunication services $ 19,100,000 $ 16,187,000
Retroactive adjustment for changes in
accounting estimates of revenues
recorded in prior years (395,000) (3,733,000)
------------- -------------
Net revenue from dial-around compensation $ 18,705,000 $ 12,454,000
============= =============
Of the amount recorded as a retroactive adjustment to dial-around
compensation in 1998, $3,222,000 relates to the Company's 1997 fiscal year and
$511,000 relates to the Company's 1996 fiscal year. The retroactive adjustment
to dial-around compensation of $395,000 in 1997 relates to the Company's 1996
fiscal year. If revenues from dial-around compensation had been recorded at the
current rate ($0.238 per call or $31.18 per month based on 131 calls) the net
revenue would have been $15,878,000 in 1997 and $16,187,000 in 1998.
Effective November 6, 1996, pursuant to the rules and regulations
promulgated by the FCC under section 276 of the Telecommunications Act (the
"1996 Payphone Order"), the FCC directed a two-phase transition to achieve fair
compensation for dial-around calls through deregulation and competition. In the
first phase, November 6, 1996 to October 6, 1997, the FCC prescribed flat-rate
compensation payable to the payphone providers by the interexchange carriers
("IXCs") in the amount of $45.85 per month per payphone (as compared with a fee
of $6.00 per installed payphone per month in periods prior to November 6, 1996).
This rate was arrived at by determining that the deregulated local coin rate was
a valid market based surrogate for dial-around calls. The FCC applied a
market-based, deregulated coin rate of $0.35 per call to a finding from the
record that there were a monthly average of 131 compensable dial-around calls
per payphone. This total included both carrier access code calls dialed for the
purpose of reaching a long distance company other than the one designated by the
payphone provider as well as 800 subscriber calls. The monthly per phone
flat-rate compensation of $45.85 was to be assessed only against IXCs with
annual toll-call revenues in excess of $100 million and allocated among such
IXCs in proportion to their gross long-distance revenues. During the second
phase of the transition to deregulation and market-based compensation (initially
from October 1997 to October 1998, but subsequently extended in a later order by
one year to October 1999), the FCC directed the IXCs to pay payphone service
providers (such as PhoneTel), on a per-call basis for dial-around calls at the
assumed deregulated coin rate of $0.35 per call. At the conclusion of the second
phase, the FCC set the market-based local coin rate, determined on a
payphone-by-payphone basis, as the default per-call compensation rate in the
absence of a negotiated agreement between the payphone provider and the IXC. To
facilitate per-call compensation, the FCC required the payphone providers to
transmit payphone specific coding
- 19 -
21
digits that would identify each call as originating from a payphone and required
the LECs to make such coding available to the payphone providers as a transmit
item included in the local access line service.
In July 1997, the United States Court of Appeals for the District of
Columbia Circuit ("the Court") responded to an appeal of the 1996 Payphone
Order, finding that the FCC erred in (1) setting the default per call rate at
$0.35 without considering the differences in underlying costs between
dial-around calls and local coin calls, (2) assessing the flat-rate compensation
against only the carriers with annual toll-call revenues in excess of $100
million, and (3) allocating the assessment of the flat-rate compensation based
on gross revenues rather than on a factor more directly related to the number of
dial-around calls processed by the carrier. The Court also assigned error to
other aspects of the 1996 Payphone Order concerning inmate payphones and the
accounting treatment of payphones transferred by a Regional Bell Operating
Company ("RBOC") to a separate affiliate.
In response to the remand by the Court, the FCC issued a new order
implementing section 276 in October 1997 (the "1997 Payphone Order"). The FCC
determined that distinct and severable costs of $0.066 were attributable to a
coin call that did not apply to the costs incurred by the payphone providers in
providing access for a dial-around call. Accordingly, the FCC adjusted the per
call rate during the second phase of interim compensation to $0.284 (which is
$0.35 less $0.066). While the FCC tentatively concluded that the $0.284 default
rate (or $37.20 per payphone per month based on 131 calls per month) should be
utilized in determining compensation during the first phase and reiterated that
payphone providers were entitled to compensation for each and every call during
the first phase, it deferred for later decision the precise method of allocating
the initial interim period flat-rate payment obligation among the IXCs and the
number of calls to be used in determining the total amount of the payment
obligation. In the third quarter of 1997, the Company recorded an adjustment of
$2,361,000 to reduce dial-around compensation recorded in prior quarters for the
decrease in rate from $45.85 to $37.20 per payphone per month. Of this
adjustment amount, $395,000 related to the prior year.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC 98-48
1, which extended and waived certain requirements concerning the provision by
the local exchange carriers ("LECs") of payphone-specific coding digits, which
identify a call as originating from a payphone. Without the transmission of
payphone-specific coding digits some of the IXCs have claimed they are unable to
identify a call as a payphone call eligible for dial-around compensation. With
the stated purpose of ensuring the continued payment of dial-around compensation
the FCC, by Memorandum and Order issued on April 3, 1998, left in place the
requirement for payment of per-call compensation for payphones on lines that do
not transmit the requisite payphone-specific coding digits, but gave the IXCs a
choice for computing the amount of compensation for payphones on LEC lines not
transmitting the payphone-specific coding digits of either accurately computing
per-call compensation from their databases or paying per-phone, flat-rate
compensation computed by multiplying the $0.284 per call rate by the nationwide
average number of 800 subscriber and access code calls placed from RBOC
payphones for corresponding payment periods. Accurate payments made at the flat
rate are not subject to subsequent adjustment for actual call counts from the
applicable payphone.
On May 15, 1998, the Court again remanded the per-call compensation rate to
the FCC for further explanation without vacating the $0.284 per call rate. The
Court opined that the FCC had failed to explain adequately its derivation of the
$0.284 default rate. The Court stated that any resulting overpayment would be
subject to refund and directed the FCC to conclude its proceedings within a
six-month period ending on November 15, 1998. On June 19, 1998, the FCC
solicited comment from interested parties on the issues remanded. In initial and
reply comments, certain IXCs and members of the paging industry had urged the
FCC to abandon its efforts to derive a market-based rate from surrogates and
either require the caller to pay dial-around compensation by coin deposit or
adopt a cost-based rate at levels substantially below the $0.284 rate.
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 from $0.284 to $0.238, retroactive to
October 7, 1997. In adjusting the default rate, the FCC shifted its methodology
from the market-based method utilized in the 1997 Payphone Order to a cost-based
method citing technologic 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
cost-based default rate, the FCC incorporated its prior treatment of certain
payphone costs as well as reexamined new estimates of payphone costs submitted
as part of the proceeding. Pursuant to the 1999 Payphone Order, the $0.24 amount
($0.238 plus 0.2 cents for FLEX ANI costs, amounts charged by LECs for providing
payphone specific coding digit technology) will serve as the default per-call
compensation rate for coinless payphone calls through January 31, 2002, at which
time, parties may petition the
- 20 -
22
FCC regarding the default amount, related issues pursuant to technological
advances, and the expected resultant market changes. In the fourth quarter of
1998, the Company again recorded an adjustment to reduced revenues previously
recognized for the period November 7, 1996 to September 30, 1998 due to the
further decrease in the dial-around compensation rate from $0.284 to $0.238 per
call. This adjustment for $6,075,000 included an adjustment of $3,733,000
recorded as revenue in prior years.
The 1999 Payphone Order has been appealed by various parties,
including but not limited to, the trade association which represents the
interests of various pay telephone providers throughout the United States.
Based on the information available, the Company believes that the minimum
amount it is entitled to as fair compensation under the Telecommunications
Act for the period from November 7, 1996 through December 31, 1998 is
$31.18 per pay telephone per month based on $0.238 per call and 131 calls
per pay telephone per month. Further, the Company does not believe that it
is reasonably possible that the amount will be materially less than $31.18
per pay telephone per month.
Other revenues decreased $357,000 from $500,000 for the year ended December
31, 1997 to $143,000 for the year ended December 31, 1998. This decrease was
primarily due to revenues recognized in 1997 for the remaining portion of a
deferred operator services bonus received in 1996.
OPERATING EXPENSES
Total operating expenses increased $1,387,000, or 1.2%, from
$116,451,000 for the year ended December 31, 1997 to $117,838,000 for the
year ended December 31, 1998. The increase was due to increases in line and
transmission charges, selling, general and administrative expenses ("SG&A
expense"), and depreciation and amortization. Such increases were due in
part to increases in amounts charged by LECs for the provision of local
telephone service, the increase in the average number of installed pay
telephones, and the increase in the number of sales and administrative
personnel added as a result of acquisitions in the first and second
quarters of 1997. These increases were offset in part by the decreases in
location commissions and other unusual charges and contractual settlements
as explained below.
Line and transmission charges increased $5,089,000, or 20.8%, from
$24,518,000 for the year ended December 31, 1997 to $29,607,000 for the year
ended December 31, 1998. Line and transmission charges represented 22.4% of
total revenues for the year ended December 31, 1997 and 32.4% of total revenues
for the year ended December 31, 1998, an increase of 10.0%. The dollar increase
was due to the increase in the average number of installed pay telephones and
the increase in the average line and transmission charge per phone. The average
line and transmission charge per phone increased as a result of the increased
charges by LECs for end user common line charges, Preferred Interexchange
Carrier charges ("PICC"), "FLEX ANI" charges for implementation of ANI
Identification, and to a more limited extent, state Universal Service Fund fees
("USF") passed through to users such as independent public pay telephone
providers. The increase as a percentage of revenues also reflects the effect of
the decrease in revenues discussed above.
Telecommunication and validation fees which consist primarily of
processing costs relating to operator services decreased by $255,000, or
2.2%, from $11,599,000 for the year ended December 31, 1997 to $11,344,000
for the for the year ended December 31, 1998. Telecommunication and
validation fees represented 10.6% of total revenues for the year ended
December 31, 1997 and 12.4% for the year ended December 31, 1998, an
increase of 1.8%. The dollar decrease was primarily the result of the
decrease in operator service calls in 1998 compared to 1997. The percentage
increase was mostly the result of changes in the mix and call volumes
processed by various operator service providers pursuant to contracts with
different rates for providing such services.
Location commissions decreased $2,449,000, or 14.7%, from $16,628,000
for the year ended December 31, 1997 to $14,179,000 for the year ended
December 31, 1998. Location commissions represented 15.2% of total revenues
for the year ended December 31, 1997 and 15.5% for the year ended December
31, 1998, an increase of 0.3%. The dollar decrease reflects the effect of
the decrease in revenues and the increase in line and transmission charges
which enter into the calculation of commissions. The percentage increase is
due to the increase in commission rates in response to competitive demands
for new location providers as well as renewal of location contracts with
existing location providers. Higher commission rates on location contracts
relating to acquisitions completed at the end of the second quarter of 1997
also contributed to the increase.
- 21 -
23
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, increased $909,000, or 4.3%, from
$21,100,000 for the year ended December 31, 1997 to $22,009,000 for the year
ended December 31, 1998. Field operations represented 19.3% of total revenues
for the year ended December 31, 1997 and 24.1% of total revenues for the year
ended December 31, 1998. The dollar increase in 1998 compared to 1997 was
primarily due to the increase in service vehicle costs and Universal Service
Fees, offset in part by efficiencies achieved in integrating the operations of
companies previously acquired. The Company incurred $627,000 for Universal
Service Fees for the first time in 1998 which the Company is paying under
protest. The percentage increase was a result of the lower revenues during 1998.
SG&A expenses increased $1,641,000, or 15.3%, from $10,713,000 for the year
ended December 31, 1997 to $12,354,000 for the year ended December 31, 1998.
SG&A expenses represented 9.8% of total revenues for the year ended December 31,
1997 and 13.5% of total revenues for the year ended December 31, 1998, an
increase of 3.7%. The dollar and percentage increases were primarily due to an
expansion of the sales force, the transfer of technical support and other
personnel from the Company's Jacksonville, Texas (former Cherokee headquarters)
local service facility to the Company's headquarters in the second quarter of
1997, and an increase in telephone expense. The personnel increases at the
Company's headquarters following the acquisitions in 1997 were later reduced at
the end of 1998 in an effort to reduce costs.
Depreciation and amortization increased $2,785,000, or 12.2%, from
$22,798,000 for the year ended December 31, 1997 to $25,583,000 for the year
ended December 31, 1998. Depreciation and amortization represented 20.9% of
total revenues for the year ended December 31, 1997 and 28.0% of total revenues
for the year ended December 31, 1998, an increase of 7.1%. The dollar and
percentage increases were primarily due to the acquisitions previously completed
and expansion of the Company's public pay telephone base. The percentage
increase was also due to the reduction in total revenues.
Other unusual charges and contractual settlements decreased $6,333,000, or
69.6% from $9,095,000 for the year ended December 31, 1997 to $2,762,000 for the
year ended December 31, 1998. For the year ended December 31, 1998, other
unusual charges and contractual settlements consisted of: (i) costs incurred
in connection with the Davel Merger Agreement which has been terminated,
$1,426,000; (ii) certain fees relating to amendments to the Company's Credit
Agreement, $328,000; (iii) legal and professional fees relating to the
settlement of litigation relating to a former operator services agreement,
$545,000; and (iv) settlement of other contractual obligations and other
matters, $463,000. Other unusual charges and contractual settlements represented
8.3% of total revenue in 1997 and 3.0% of total revenue in 1998, a decrease of
5.3%.
OTHER INCOME (EXPENSE)
Other income (expense) is comprised principally of interest expense
incurred on debt and interest income. Total interest expense increased
$2,300,000, or 13.8%, from $16,612,000 for the year ended December 31, 1997 to
$18,912,000 for the year ended December 31, 1998. Interest expense represented
15.2% of total revenues for the year ended December 31, 1997 and 20.7% of total
revenues for the year ended December 31, 1998, an increase of 5.5%. The dollar
and percentage increases were a result of the additional borrowings under the
Company's Credit Agreement in 1997 and 1998 and the increase in the interest
rate under the Third Amendment to the Credit Agreement in the second quarter of
1998. Interest and other income decreased $13,000, from $560,000 in 1997 to
$547,000 in 1998. This decrease consists of a $351,000 decrease in interest
income due to lower cash balances available for investment in 1998, offset by a
$338,000 increase in other income. The increase in other income was primarily
due to the sale of the Company's Jacksonville, Texas land and building in 1998.
EBITDA
EBITDA (income before interest income, interest expense, taxes,
depreciation and amortization, and other unusual charges and contractual
settlements) decreased $22,798,000, or 92.3%, from $24,691,000 for the year
ended December 31, 1997 to $1,893,000 for the year ended December 31, 1998.
EBITDA represented 22.6% of total revenues for the year ended December 31, 1997
and 2.1% of total revenues for the year ended December 31, 1998, a decrease of
20.5%. The dollar and percentage decreases are primarily due to the decreases in
coin and non-coin telecommunication revenues (including dial-around
compensation), and the increases in costs and expenses from operations. EBITDA
is not intended to represent an alternative to operating income (as de-
- 22 -
24
fined 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 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, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Total revenues increased $64,445,000, or 143.8%, from $44,804,000 for the
year ended December 31, 1996 to $109,249,000 for the year ended December 31,
1997. This increase was attributable primarily to an increase in the number of
installed public pay telephones, which increased by 18,818, or 75.2%, from
25,029 at December 31, 1996 to 43,847 at December 31, 1997, with the majority of
the increase occurring in the first quarter of 1997 due to acquisitions
completed in that quarter.
Revenues from coin calls increased $32,308,000, or 123.3%, from $26,212,000
for the year ended December 31, 1996 to $58,520,000 for the year ended December
31, 1997. This increase was primarily due to the acquisition and installation of
public pay telephones which produced additional revenues and the increase in the
local coin rate from $0.25 to $0.35 in a majority of the Company's pay
telephones effective October 7, 1997. Such increases were offset in part by a
reduction in average coin revenue per installed pay telephone due to a decrease
in call volume.
Revenues from non-coin telecommunication services increased by $32,975,000
or 186.8%, from $17,649,000 in 1996 to $50,624,000 in 1997. The increase was due
to the increase in the number of installed pay telephones relating to the
acquisition and installation of public pay telephones, and the increase in gross
revenue from dial-around compensation. Dial-around compensation revenue
increased $15,881,000, from $3,219,000 in 1996 to $19,100,000 in 1997 due to
regulatory changes that initially increased the dial-around compensation rate
from $6.00 to $45.85 per payphone per month. Based on the FCC's tentative
conclusions in the 1997 Payphone Order, in the third quarter of 1997, the
Company adjusted the amount of dial-around compensation recorded in prior
quarters from the initial $45.85 rate to $37.20 (based on 131 calls per
installed pay telephone per month). Included in this adjustment was a net charge
of $395,000 for dial-around compensation relating to the period of November 6,
1996 to December 31, 1996. This adjustment amount is presented separately as a
reduction in revenue in the Company's consolidated financial statements.
The increase in revenue from non-coin telecommunication services was offset
in part by a reduction in operator assisted calls as a result of aggressive
dial-around advertising by long distance carriers such as AT&T and MCI
Communications Corporation.
Other revenues decreased $443,000 or 47.0% from $943,000 in 1996 to
$500,000 in 1997. This decrease was primarily due to the reduction in revenue
relating to the $1,200,000 signing bonus received in 1996 upon execution of a
new operator service agreement, which was being recognized as income on a pro
rata basis over the twelve month period ended March 1997.
OPERATING EXPENSES
Total operating expenses increased $61,632,000 or 112.4%, from $54,819,000
for the year ended December 31, 1996 to $116,451,000 for the year ended December
31, 1997. Operating expenses represented 122.4% of total revenues in 1996 and
106.6% of total revenues in 1997, a decrease of 15.8%. The percentage decrease
was due in part to the reductions in depreciation and amortization expense and
in other unusual charges and contractual settlements as a percentage of total
revenues, as well as the increase in total revenues attributable to the increase
in dial-around compensation.
Line and transmission charges increased $13,365,000 or 119.8%, from
$11,153,000 in 1996 to $24,518,000 in 1997. Line and transmission charges
represented 24.9% and 22.4% of total revenues for the years ended December 31,
1996 and 1997, respectively, a decrease of 2.5%. The increase in amount was
primarily due to the increase in the number of pay telephones due to
acquisitions. The decrease in expense as a percentage of total revenue was
primarily due to the increase in dial-around compensation.
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Telecommunication and validation fees (consisting primarily of processing
costs relating to operator services) increased from $5,608,000 in 1996 to
$11,599,000 or 106.8%. Telecommunication and validation fees represented 12.5%
of total revenue in 1996 and 10.6% of total revenue in 1997. The increase in
amount was primarily due to the increase in the number of installed pay
telephones. The decrease, as a percentage of total revenue, was primarily due to
the increase in dial-around compensation.
Location commissions increased $10,556,000, or 173.8%, from $6,072,000 for
the year ended December 31, 1996 to $16,628,000 for the year ended December 31,
1997. As a percentage of total revenues, location commissions increased from
13.6% in 1996 to 15.2% in 1997, an increase of 1.6%. The dollar and percentage
increases are due to the increase in the number of pay telephones resulting from
acquisitions and installations and the increase in commission rates on new
location contracts. The commission rate increase also reflects the increased
competition in certain geographic areas from local exchange carriers and other
independent public pay telephone service providers in renewing existing
contracts and obtaining new contracts with location providers.
Field operations consist principally of personnel costs, rents and
utilities of the district service facilities, repairs and maintenance of the
public pay telephones, and sales and property taxes. Field operations expense
increased from $8,733,000 in 1996 to $21,100,000 in 1997, an increase of
$12,367,000 or 141.6%. The dollar increase was primarily due to the increase in
personnel costs, rent and service related expenses relating to the acquisition
of Cherokee, Amtel, POA and London. Field operations expenses as a percentage of
total revenues decreased slightly from 19.5% in 1996 to 19.3% in 1997.
Sales, general and administrative expenses increased $6,332,000 or 144.5%,
from $4,381,000 for the year ended December 31, 1996 to $10,713,000 for the year
ended December 31, 1997. The dollar increase was primarily due to the increase
in personnel cost, travel, telephone and insurance resulting from acquisitions
and other business expansion. As a percentage of total revenue, SG&A expenses
were comparable in 1996 and 1997.
Depreciation and amortization increased $9,998,000 or 78.1% from
$12,800,000 for the year ended December 31, 1996 to $22,798,000 for the year
ended December 31, 1997. Depreciation and amortization represented 28.6% of
total revenues in 1996 and 20.9% of total revenues in 1997, a decrease of 7.7%.
The dollar increase was primarily due to the increase in depreciation and
amortization relating to 1997 business acquisitions and to a lesser extent 1996
acquisitions. The decrease as a percentage of total revenue was due to the
longer useful lives used for amortizing location contracts relating to
acquisitions based on a study performed by the Company and the effect of the
revenue increase relating to dial-around compensation.
Other unusual charges and contractual settlements increased $3,023,000 or
49.8% from $6,072,000 in 1996 to $9,095,000 in 1997. For the year ended December
31, 1997, the unusual charges and contractual settlements consisted of: (i) a
forfeited deposit, professional fees and related expenses applicable to the
termination of the proposed acquisition of Communications Central Inc.,
$7,771,000; (ii) legal and note holder consent solicitation fees relating to the
amendment to the indenture for the 12% Senior Notes, $761,000; (iii) settlement
of other contractual obligations and other items totaling $563,000. For the year
ended December 31, 1996, other unusual charges and contractual settlements
consists primarily of: (i) the settlement of contractial obligations under
certain employment contracts, $342,000; (ii) the settlement of other contractual
obligations, $211,000; (iii) losses recognized on the early pay-off of
obligations under capital leases and other debt concurrent with the debt
restructurings completed on March 15 and December 18, 1996, $631,000; (iv) the
estimated fair market value of the Nominal Value Warrants issued pursuant to the
debt restructuring completed on March 15, 1996, $3,886,000; (v) the write-off of
certain receivables and deposits relating to terminated employees, former
vendors and operator service providers, $436,000; (vi) relocation and employment
related costs associated with acquisitions, $429,000; and (vii) other costs,
$137,000. Other unusual charges and contractual settlements represented 13.6% of
total revenue in 1996 and 8.3% of total revenue in 1997, a decrease of 5.3%.
OTHER INCOME (EXPENSE)
Other income (expense) consisted of interest expenses incurred on debt
with related parties, the 12% Senior Notes and others, and interest income
(earned primarily from the proceeds of the 12% Senior Notes before such
proceeds were used for acquisitions). Total other income (expense)
increased $9,495,000, or 144.8%, from $6,557,000 in 1996 to $16,052,000 in
1997. Other income (expense) represented 14.6% of total revenue in 1996 and
1997. The dollar increase was due to the increase in long-term debt
relating to the issuance of the 12%
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Senior Notes in December 1996 and borrowings under the related party debt
agreement entered into in May 1997. Proceeds from the 12% Senior Notes, among
other things, were used to repay the outstanding balance under the former debt
agreement with the related party at the end of 1996.
EXTRAORDINARY ITEM
The Company recorded extraordinary losses of $10,077,000, representing
22.5% of total revenues for the year ended December 31, 1996. The extraordinary
loss related to non-recurring costs that were incurred in connection with the
restructuring of the Company's long-term debt on March 15, 1996 and December 18,
1996.
EBITDA
EBITDA (income before interest income, interest expense, depreciation,
amortization, other unusual charges and contractual settlements, and the
extraordinary losses on debt restructuring) increased $15,834,000 from
$8,857,000 for the year ended December 31, 1996 to $24,691,000 for the year
ended December 31, 1997. EBITDA represented 19.8% of total revenues for the year
ended December 31, 1996 and 22.6% for the year ended December 31, 1997, an
increase of 2.8%. See "Liquidity and Capital Resources" for a discussion of cash
flows from operating, investing and financing activities.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash used in operating activities during the fiscal years ended
December 31, 1996, 1997 and 1998 was $269,000, $4,720,000 and $6,470,000,
respectively. Net cash used in operating activities consisted primarily of the
funding of operating losses, increases in current assets in 1996 and 1997
(including the increase in accounts receivable from dial-around compensation),
offset by the issuance of the Nominal Value Warrants (as defined herein),
depreciation and amortization, increases in current liabilities, and the
non-cash portion of the loss associated with the debt restructuring.
CASH FLOWS FROM INVESTING ACTIVITIES
Cash used in investing activities during the fiscal years ended December
31, 1996, 1997 and 1998 was $63,062,000, $57,197,000 and $6,763,000,
respectively. Cash used in investing activities consisted primarily of payments
to acquire companies (including the Cherokee acquisition deposit of $37,110,000
at December 31, 1996) and capital expenditures primarily due to the purchase and
installation of new pay telephone equipment.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash provided by financing activities during the fiscal years ended
December 31, 1996, 1997 and 1998 was $109,056,000, $21,998,000 and $12,482,000,
respectively, which consisted primarily of net proceeds from the Company Debt
Offering, the Company Equity Offering and from other borrowings offset by
redemptions and repurchases of preferred stock, repayments of debt and payment
of debt financing costs.
CREDIT FACILITY
On March 15, 1996, the Company entered into a credit agreement (the "Credit
Facility"), with ING (U.S.) Capital Corporation ("ING") and Cerberus Partners,
L.P. ("Cerberus" and, together with ING, the "Lenders"), pursuant to which the
Lenders agreed to lend the Company up to $37,250,000. On March 15, 1996, the
Company borrowed $30,531,000 pursuant to the Credit Facility. During the second
quarter of 1996, the Company borrowed an additional $1,693,000 pursuant to the
Credit Facility. The initial borrowings under the Credit Facility were used to
complete the Paramount and IPP acquisitions, to repay $8,503,000 of outstanding
debt and $3,174,000 of outstanding obligations under capital leases, to redeem
the 10% Preferred, 8% Preferred and 7% Preferred, to pay related transaction
fees, to fund the Amtel acquisition deposit of $1,300,000 and for working
capital.
In connection with the execution of the Credit Facility on March 15, 1996,
ING and Cerberus each received 102,412 warrants (204,824 warrants in total and
referred to herein as the "Lenders' Warrants"), which would collectively allow
them to purchase up to 204,824 shares of Series A Preferred at an exercise price
of $0.20 per share. Each share of Series A Preferred is convertible into 20
shares of the Company's Common Stock. The debt under the Credit Facility was
initially recorded net of an allocation of the fair value of the Lenders'
Warrants, such fair value being determined using the Black-Scholes valuation
model. ING and Cerberus may separately exercise their warrants without any
action of the other party.
On September 13, 1996, concurrent with the acquisition of Amtel, the
Lenders amended the Credit Facility to increase the maximum borrowings available
under the Credit Facility to $41,000,000. The Company then borrowed an
additional $8,777,000 and used $5,950,000 of the proceeds to complete the Amtel
and POA acquisitions. The remainder of the proceeds were used for working
capital and payment of certain related acquisition expenses. On November 22,
1996, the Lenders amended the Credit Facility to permit the incurrence of
additional borrowings of up to $2,000,000 to fund the deposits required in
connection with the Cherokee and the Texas Coinphone acquisitions and
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for working capital purposes, thereby increasing the
maximum borrowings available under the Credit Facility to $43,000,000.
On December 18, 1996, the Company repaid all of the indebtedness under the
Credit Facility with a portion of the proceeds from the Company Equity Offering
and the Company Debt Offering, and the Credit Facility was terminated. The
Company realized an extraordinary loss of $9,810,000 consisting primarily of the
write-off of the remaining value assigned to the Series A Preferred warrants and
related unamortized deferred financing costs.
THE COMPANY EQUITY OFFERING AND THE COMPANY DEBT OFFERING
On December 18, 1996, the Company closed the following publicly
underwritten offerings: (i) the sale of 6,750,000 shares of Common Stock (the
"Company Equity Offering"), at a price to the public of $3.00 per share, for net
proceeds to the Company therefrom of $18,295,000 and (ii) the sale of
$125,000,000 aggregate principal amount of its 12% Senior Notes due 2006 (the
"Notes" or the "Company Debt Offering"), for net proceeds to the Company
therefrom of $119,149,000. In connection with the Company Equity Offering, the
Company also granted the underwriters a 45-day option to purchase up to
1,012,500 additional shares of Common Stock, at $3.00 per share (less an
underwriting discount of $0.21 per share), solely to cover over-allotments (the
"Over-Allotment Option"). The Company received $2,825,000 at the time the
underwriters exercised their Over-Allotment Option on January 29, 1997.
The Company used the net proceeds from the Company Equity Offering to repay
approximately $8.0 million of debt outstanding under the Credit Facility and the
balance for working capital and other general corporate purposes. The Company
used a portion of the net proceeds from the Company Debt Offering to repay all
of the remaining outstanding debt under the Credit Facility, to repay certain
capital lease obligations and other indebtedness and to finance the Cherokee and
Texas Coinphone acquisitions.
The 12% Senior Notes are general unsecured obligations of the Company
limited in aggregate principal amount to $125,000,000 and will mature on
December 15, 2006. Interest on the Notes accrues at the rate of 12% per annum
and is payable semi-annually in arrears on June 15 and December 15 in each year
commencing June 15, 1997. The Notes rank senior in right of payment to all
indebtedness of the Company that is expressly subordinated and are pari passu in
right of payment with all other senior indebtedness of the Company. The Notes
are guaranteed jointly and severally and fully and unconditionally on a senior
unsecured basis by all current and all future subsidiaries of the Company
("Subsidiary Guarantors").
The Notes are redeemable, in whole or in part, at the option of the Company
at any time on or after December 15, 2001, at the redemption prices set forth in
the indenture, plus accrued and unpaid interest to the date of redemption. In
addition, at any time or from time to time prior to December 15, 1999, the
Company may redeem up to 40% of the aggregate principal amount of the Notes
originally issued with the net cash proceeds to the Company of one or more
public equity offerings or equity private placements (other than the Company
Equity Offering) at a redemption price equal to 112% of the principal amount
thereof, plus accrued and unpaid interest to the date of redemption provided
that at least $75,000,000 principal amount of the Notes remains outstanding
immediately after any such redemption.
The indenture imposes certain limitations on the ability of the Company and
the Subsidiary Guarantors to, among other things, incur additional indebtedness,
pay dividends or make certain other restricted payments, consummate certain
asset sales, enter into certain transactions with interested persons, incur
liens, impose restrictions on the ability of a Subsidiary Guarantor to pay
dividends or make certain payments to the Company, conduct business other than
the pay telephone and ancillary businesses, merge or consolidate with any other
person or sell, assign, transfer, lease, convey or otherwise dispose of all or
substantially all of the assets of the Company.
The indenture contains customary events of default, including, without
limitation, the following: (i) the failure to pay principal or interest when due
on the Notes; (ii) certain defaults under agreements relating to other
indebtedness; (iii) the breach of any covenant in the indenture; (iv) the levy
of certain judgments; and (v) certain bankruptcy, reorganization and insolvency
events. The occurrence of an event of default under the indenture permits the
holders of the Notes to accelerate the Notes and to pursue other remedies.
In addition, upon a "change of control" (as defined in the indenture), the
Company has the obligation to offer to repurchase all outstanding Notes from the
holders thereof at a price equal to 101% of the outstanding principal balance,
plus accrued and unpaid interest to the date of repurchase. On December 30,
1997, the Company solicited and received the consent from its Noteholders to
amend the indenture to increase the limit of permitted
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indebtedness and to modify the definition of consolidated net income to exclude
certain non-recurring expenses and non-operating charges when calculating
certain restrictive covenants. The Company incurred $625,000 in deferred
financing costs to the Noteholders and $761,000 in fees relating to the
solicitation of the Noteholders' consent to amend the indenture.
The Company has not paid the semiannual interest payment which was due
December 15, 1998 on the 12% Senior Notes and, pursuant to the terms of the
indenture, the Company is in default on this debt. Under certain circumstances,
such obligations could become immediately due and payable. As of December 31,
1998, the principal balance due has been classified as a current liability in
the Company's consolidated balance sheets. As discussed below, the Company plans
to solicit the consent of the Noteholders to convert the 12% Senior Notes and
accrued interest to Common Stock. There can be no assuance that the requisite
consent can be obtained or that conversion of the Notes to Common Stock will
occur.
NEW 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 was Agent for the Lenders and Transamerica Business Credit Corporation and
Finova Capital Corporation were Co-Agents for the Lenders. ING is a significant
shareholder of the Company's common equity. The Credit Agreement provided a
$75,000,000 commitment of which $60,000,000 was to be utilized for future
acquisitions ("Expansion Loan Commitment"), and $15,000,000 was to be utilized
for general working capital requirements. Borrowings accrued interest at the ING
Alternate Base Rate (as defined in the Credit Agreement) plus 1.50%. The Credit
Agreement was originally scheduled to mature on May 20, 2000 and all the
Company's installed public pay telephones are pledged as collateral. The Company
borrowed $17,700,000 under the Expansion Loan Commitment to complete the
acquisitions of Advance, American, and London and to pay related acquisition and
credit facility fees. The Company also borrowed $7,300,000 of the Revolving
Credit Commitment for interest payments due under the $125,000,000 12% Senior
Notes and for general working capital purposes. Subsequent to the September 16,
1997 Court ruling which vacated dial-around compensation, and pursuant to
certain terms of the Credit Agreement, the Agent gave notice to the Company that
it was prohibited from making additional borrowings under the Credit Agreement,
without prior approval from the Lenders.
The Credit Agreement includes covenants which, among other things, require
the Company to maintain ratios as to fixed charges, debt to earnings, current
ratio and interest coverage (all as defined in the Credit Agreement). Other
covenants limit incurrence of additional long-term debt, the level of capital
expenditures, the incurrence of lease obligations and permitted investments.
On February 24, 1998, the Credit Agreement was amended to increase the
Revolving Credit Commitment to $20,000,000 and to decrease the Expansion Loan
Commitment to $55,000,000 (the "First Amendment"). The amount available for
letters of credit under the working capital commitment was reduced from
$5,000,000 to $3,000,000 and certain of the covenants therein were modified. On
the same date, the Company was permitted to borrow and additional $3,000,000 for
working capital purposes under the Revolving Credit Commitment. On March 31,
1998, the Credit Agreement was further amended (the "Second Amendment") to
modify certain financial covenants.
On May 8, 1998, the Company amended the Credit Agreement (the "Third
Amendment") and Foothill Capital Corporation, as replacement Agent and Lender,
assumed all of the rights and obligations of the former Lenders. Under the Third
Amendment, the Revolving Credit Commitment remained at $20,000,000 and the
Expansion Loan Commitment was reduced to $20,000,000. Interest is payable
monthly in arrears at 2% above the Lender's reference rate (as defined in the
Third Amendment) and the maturity date of the Credit Agreement was extended to
May 8, 2001. Certain financial covenants under the Credit agreement were also
modified. The Company incurred $1,174,000 in fees and expenses in connection
with the Third Amendment of which $328,000 is included in other unusual charges
and contractual settlements in the Company's consolidated statements of
operations.
During the second quarter of 1998, the Company borrowed $10,547,000 under
the Revolving Credit Commitment for interest payments due under the Company's
$125,000,000, 12% Senior Notes, to fund acquisition and financing costs for
working capital. On July 3, 1998, the Company borrowed an additional $1,453,000,
the remaining amount available under the Credit Agreement, to finance the cost
of equipment
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upgrades relating to the pay telephones acquired as result of the TDS
acquisition.
At December 31, 1998, the Company was not in compliance with certain
financial covenants and was in default under its Credit Agreement. Under certain
circumstances, such obligations could become immediately due and payable.
Accordingly, the Company has classified the amounts due under the Credit
Agreement as a current liability in its consolidated balance sheet as December
31, 1998. The Company has had discussions with the Agent and has requested an
additional advance for working capital purposes. There can be no assurance that
the Agent will advance the additional funds requested. Further, there can be no
assurance that the Agent will not take such other action that it deems necessary
to collect the balance due on the debt.
OTHER
The redemption price for the 10% Preferred, 8% Preferred and 7% Preferred
consisted of cash payments aggregating $1,117,000 and 34,436 shares of 14%
Preferred. In the aggregate, $6,475,000 of the Company's outstanding
obligations, including portions of the purchase price for the IPP and Paramount
acquisitions, was liquidated by issuing 107,918 shares of 14% Preferred. The
$2,002,000 excess of the redemption price of the preferred issues redeemed over
their aggregate carrying value was recorded as a reduction of earnings available
to common shareholders on March 15, 1996.
On March 15, 1996, warrants to purchase 2,018,942 shares of Common Stock at
an exercise price of $.01 per share ("Nominal Value Warrants") were issued in
conjunction with the acquisitions of IPP and Paramount, redemption of the 10%
Preferred, 8% Preferred and 7% Preferred, and conversion of certain related
party debt of the Company to the 14% Preferred. Certain holders of the 14%
Preferred are deemed related parties. See "Item 13 Certain Relationships and
Related Transactions." The warrants expire on March 13, 2001. The Company has
estimated the fair market value of the Nominal Value Warrants to be $4,975,000,
using the Black-Scholes valuation model, of which $3,886,000 (the amount
attributable to the warrants provided to related parties in connection with the
redemption of the preferred shares and the conversion of certain debt) was
recorded in the caption "other unusual charges and contractual settlements" in
the Company's consolidated statement of operations.
The Company's working capital, excluding the reclassification of long-term
debt to current liabilities, declined from $7,839,000 at December 31, 1997 to
($6,976,000) at December 31, 1998, a decrease of $14,815,000. This decrease was
primarily due to the increase in accrued interest resulting from the default in
payment on the Company's 12% Senior Notes and increases in other current
liabilities. Cash flows used in operating activities increased from $4,720,000
in 1997 to $5,018,000 in 1998, an increase of $298,000. At December 31, 1998,
the Company had a deficit of $51,598,000 in stockholders equity (excluding
mandatorily redeemable preferred stock) as a result of the current year loss of
$44,817,000 and a loss of $23,254,000 in 1997. The Company was not in compliance
with certain financial covenants under the Credit Agreement at December 31, 1998
and is in default on this debt. Further, the Company was unable to make the
interest payment due on December 15, 1998 under the Company's 12% Senior Notes
and is in default on that debt. Under certain circumstances, the debt that is in
default could become immediately due and payable. As a result, the reports of
the Company's independent accountants refer to the substantial doubt regarding
the Company's ability to continue as a going concern.
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 investment 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
revenues will increase, that revenues from dial-around compensation will
continue at the rates anticipated or that they will be received by the Company
in the amounts the Company has recorded as receivable as they become due, or
that operating expenses can be maintained at present or reduced to lower levels.
To the extent that cash flow from operating activities is insufficient to meet
the Company's cash requirements, there can be no assurance that the Company's
lender will grant additional advances under the Credit Agreement for working
capital or business expansion purposes or that the Company can obtain additional
financing to meet its debt service and other cash requirements.
In January 1999, the Company reached an agreement in principle with the
Unofficial Committee of Noteholders of its 12% Senior Notes, subject to a number
of conditions including satisfactory documentation and the Company obtaining a
revised working capital facility, which provides for the conversion of the Notes
plus accrued interest into 95% of the Company's Common Stock (the
"Restructuring"). At that date the Unofficial Committee of Noteholders
represented approximately 63% of the principal amount of the Notes. The
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Restructuring further contemplates that existing preferred and common
shareholders will receive the remaining 5% of the Company's Common Stock (as
well as warrants to purchase approximately 11% of the Company's Common Stock) at
an exercise price of $10.50 per share (assuming 10,000,000 Common Shares
outstanding after the conversion). These equity interests would be subject to
dilution upon the exercise of certain warrants and awards under a new management
incentive plan being considered as part of the Restructuring.
The Company is reviewing various alternative methods of implementing the
Restructuring. Among the alternatives presently under consideration by the
Company and its professional advisors is the possibility of seeking confirmation
of a prepackaged plan of reorganization (the "Prepackaged Plan") in connection
with commencing a case under chapter 11 of the United States Bankruptcy Code
(the "Case"). Commencing the Case seeking confirmation of the Prepackaged Plan
would require, among other things, that consent to the Restructuring be obtained
from holders of two-thirds of the principal amount of the Notes and 50% of the
Noteholders actually voting. Under the Prepackaged Plan, claims of creditors of
the Company, other than the holders of Notes, generally would be paid in full in
the ordinary course, with the Company retaining its rights and defenses with
respect to such claims.
The Company believes, but cannot assure, that it will be able to implement
the Restructuring with the consent of the holders of the Notes. In the event
that the Company and the holders of the Notes are unable to implement the
Restructuring and the Company is unable to obtain a revised working capital
facility, the Company will be forced to evaluate other available options.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board 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. SFAS No. 133 is effective
for fiscal years beginning after June 15, 1999. The Company does not presently
enter into any transactions involving derivative financial instruments and,
accordingly, does not anticipate the new standard will have any effect on its
financial statements.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather that the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send commissions,
or engage in similar normal business activities.
The Company has completed a detailed assessment of the Year 2000 Issue and
has developed a plan for compliance. In the fourth quarter of 1998, the Company
began to implement its plan relating to its accounting, business operations and
corporate telephone systems. Complete implementation of the Company's plan is
dependent, among other things, upon receiving updated versions of proprietary
software from pay telephone manufacturers, confirmation from other third parties
that information and software supplied by them will be in compliance and
replacement of the Company's central office telephone switch. Although the
Company has not incurred any significant costs to date, the cost to achieve full
compliance is currently estimated to be approximately $500,000.
Management believes the Company will be able to implement its plan and
achieve full Year 2000 compliance before the end of 1999. Management does not
believe the Year 2000 issue will have a material effect on future financial
results or cause reported financial information not to be necessarily indicative
of future operating results or future financial condition.
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ITEM 7A. QUANTITIVE 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 its
$125 million 12% Senior Notes and its $40 million borrowings under the Company's
Credit Agreement.
As discussed in Note 2 to the Company's consolidated financial statements,
the Company plans to solicit the consent of its Noteholders to convert its 12%
Senior Notes to Common Stock. Accordingly, the fair value of such debt is more
dependent upon the value of the Company than it is on changes in interest rates.
The Company does not anticipate that the fair value of this debt will be
materially affected by change in interest rates, if any.
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 $40
million Credit 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 November 9, 1998 under Item 4
reporting that the Company's independent accountants, PricewaterhouseCoopers LLP
("PwC"), had resigned. During the Company's two fiscal years ended December 31,
1997 and through November 9, 1998, there have been no disagreements with PwC 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 PwC, would have caused it to make reference to the subject
matter of the disagreements in connection with its report.
The Company also filed a report on Form 8-K dated January 18, 1999 under
Item 4 reporting that the Company engaged BDO Seidman, LLP as its new
independent public accountants to audit the Company's financial statements for
its fiscal year ended December 31, 1998.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The description of the directors and executive officers of the Registrant
is incorporated herein by reference to the section of the definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders (the "Proxy Statement"),
entitled "Election of Directors", which Proxy Statement is expected to be filed
in April 1999. In addition, the information set forth in the section of the
Proxy Statement entitled "Section 16(a), Beneficial Ownership Reporting
Compliance" is incorporated herein by reference.
- 30 -
32
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the section of the definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders entitled "Executive
Compensation", which Proxy Statement is expected to be filed in April 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the section of the definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders entitled "Security
Ownership of Certain Beneficial Owners and Management", which Proxy Statement is
expected to be filed in April 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the section of the definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders entitled "Executive
Compensation-Certain Transactions", which Proxy Statement is expected to be
filed in April 1999.
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 BDO Seidman, LLP, Independent Accountants ............................... F-1
Report of PricewaterhouseCoopers LLP, Independent Accountants ..................... F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ...................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1997 and 1998 .................................................. F-4
Statements of Changes in Mandatorily Redeemable Preferred Stock for the Years
Ended December 31, 1996, 1997 and 1998 ............................................ F-5
Statements of Changes in Non-mandatorily Redeemable Preferred Stock,
Common Stock and Other Shareholders' Equity (Deficit) for the Years Ended
December 31, 1996, 1997 and 1998 .................................................. F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996,
1997 and 1998 ..................................................................... F-8
Notes to Consolidated Financial Statements for the Years Ended
December 31, 1996, 1997 and 1998 .................................................. F-10
2. FINANCIAL STATEMENT SCHEDULES
Schedule II - Valuation and Qualifying Accounts ................................... F-30
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.
- 31 -
33
3. EXHIBITS
EXHIBIT NO. DESCRIPTION
2.1 Agreement and Plan of Merger and Reorganization, dated June 11, 1998,
by and among Davel Communications Group, Inc., Davel Holdings, Inc.,
D Subsidiary, Inc., PT Merger Corp. and PhoneTel Technologies, Inc.
(26)*
3.1 Articles of Incorporation. (1)*
3.2 Amendment to Articles of Incorporation dated August 30, 1989. (2)*
3.3 Amended and Restated Code of Regulations. (5)*
3.5 Amendment to Articles of Incorporation dated January 3, 1992. (5)*
3.6 Amendment to Articles of Incorporation dated January 20, 1992. (5)*
3.7 Amendment to Articles of Incorporation dated April 9, 1992. (8)*
3.8 Amendment to Articles of Incorporation dated June 18, 1993. (8)*
3.9 Amendment to Articles of Incorporation dated June 30, 1993. (8)*
3.10 Amendment to Articles of Incorporation dated September 22, 1995.
(13)*
3.11 Amendment to Articles of Incorporation dated December 15, 1995. (13)*
3.12 Amendment to Articles of Incorporation dated February 28, 1996. (13)*
4.1 Specimen of Common Stock Certificate. (3)*
4.2 Form of 14% Convertible Preferred Stock. (13)*
4.3 Indenture relating to the Notes offered in the Company Debt Offering
(including the form of Note). (18)*
5.1 Opinion of Tammy L. Martin, Esq. regarding validity of the Notes
registered. (18)*
10.2 Stock Incentive Plan for Key Employees, dated May 5, 1987. (1)*
10.3 Amended and Restated Stock Option Agreement between PhoneTel
Technologies, Inc. and Jerry H. Burger dated July 1, 1993. (8)*
10.4 Stock Option Agreement dated July 1, 1993 between PhoneTel
Technologies, Inc. and Bernard Mandel. (8)*
10.7 Separation Agreement dated September 15, 1995 between PhoneTel
Technologies, Inc. and Jerry Burger, together with amendments
thereto. (13)*
10.8 Separation Agreement dated September 15, 1995 between PhoneTel
Technologies, Inc. and Bernard Mandel, together with amendments
thereto. (13)*
10.10 Registration Rights Agreement dated April 10, 1992 among PhoneTel
Technologies, Inc., George H. Henry, Carl Kirchhoff and Charles
Stuart. (5)*
10.11 Registration Rights Agreement among PhoneTel Technologies, Inc. J & C
Resources, Inc. and Allen Moskowitz. (5)*
- 32 -
34
10.13 Stock Option Agreement and Registration Rights Agreement between
PhoneTel Technologies, Inc. and William D. Moses, Jr. dated May 11,
1992. (5)*
10.14 Assignment Agreement between William D. Moses, Jr. and Edward A.
Moulton transferring the right to receive options to acquire 5,000
shares of Common Stock of PhoneTel Technologies, Inc. (9)*
10.15 Stock Option Agreement and Registration Rights Agreement between
PhoneTel Technologies, Inc. and George H. Henry dated March 24, 1992.
(5)*
10.16 Amendment No. 1 to Amended and Restated Loan Agreement and
Registration Rights Agreement dated October 23, 1992 by and among
PhoneTel Technologies, Inc., J & C Resources, Inc. and Allen
Moskowitz. (6)*
10.18 Master Agreement between The Cafaro Company and PhoneTel
Technologies, Inc. dated December 23, 1992. (6)*
10.19 Operator Subscriber Service Agreement dated March 25, 1994 between
U.S. Long Distance, Inc. and Alpha Pay Phones-IV, L.P. (7)*
10.22 Stock Option Agreement with Allenstown Investments Limited dated on
or about January 10, 1994 relative to grant of an option to purchase
126,000 shares of PhoneTel Technologies, Inc. Common Stock. (8)*
10.23 Stock Option Agreement with Douglas Abrams with respect to 45,000
shares of Common Stock of PhoneTel Technologies, Inc. dated on or
about January 10, 1994. (8)*
10.24 Amendment to Stock Option Agreement dated January 10, 1994 with
Douglas Abrams with respect to 45,000 shares of Common Stock of
PhoneTel Technologies, Inc. (9)*
10.25 Stock Option Agreement with William Moses, Jr. relative to 75,000
shares of Common Stock of PhoneTel Technologies, Inc. dated on or
about January 29, 1993. (8)*
10.26 Agreement dated January 5, 1994 between PhoneTel Technologies, Inc.
and the Estate of William Moses relative to loan in the amount of one
million dollars and providing for warrants to purchase 100,000 shares
and contingent right to acquire warrants to purchase 400,000 shares
of PhoneTel Technologies, Inc. Common Stock. (8)*
10.27 Agreement dated September 13, 1994 between PhoneTel Technologies,
Inc. and the Estate of William Moses relative to restructuring the
repayment schedule of certain monies owed by PhoneTel Technologies,
Inc. and providing for warrants to purchase 45,000 shares of PhoneTel
Technologies, Inc. Common Stock. (9)*
10.28 Loan Agreement dated December 29, 1993 between PhoneTel Technologies,
Inc. and certain lenders identified therein with respect to borrowing
by PhoneTel Technologies, Inc. of $400,000 and the granting of
warrants to purchase, in the aggregate, a total of 62,745 shares of
Common Stock by PhoneTel Technologies, Inc. (8)*
10.29 Letter Agreement dated February 23, 1995 between PhoneTel
Technologies, Inc. and certain lenders identified therein with
respect to the extension of the maturity dates of certain promissory
notes and the granting of additional warrants to purchase Common
Stock of PhoneTel Technologies, Inc. (9)*
10.30 Stock Option Agreement dated March 3, 1994 between PhoneTel
Technologies, Inc. and George H. Henry relative to a grant of an
option to purchase 39,000 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.31 Stock Option Agreements dated in January 1994 between PhoneTel
Technologies, Inc. and George H. Henry granting options to purchase,
in the aggregate, a total of 106,551 shares of PhoneTel Technologies,
Inc. Common Stock. (9)*
- 33 -
35
10.32 Stock Option Agreement with George H. Henry dated in August 1993
relative to a grant of an option to purchase 150,000 shares of
PhoneTel Technologies, Inc. Common Stock. (9)*
10.35 Amendments to Warrant Agreements between PhoneTel Technologies, Inc.
and Richard Thatcher dated March 1995, and related Warrant Agreements
thereto, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 49,412 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.36 Warrant Agreements with Richard Thatcher dated February, March and
April 1995, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 7,500 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.37 Amendments to Warrant Agreements between PhoneTel Technologies, Inc.
and Gerald Waldschutz dated March 1995, and related Warrant
Agreements thereto, issued pursuant to a Letter Agreement dated
February 23, 1995, relative to the grant of warrants, in the
aggregate, to purchase a total of 41,177 shares of PhoneTel
Technologies, Inc. Common Stock. (9)*
10.38 Warrant Agreements with Gerald Waldschutz dated February, March and
April 1995, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 6,250 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.39 Amendments to Warrant Agreements between PhoneTel Technologies, Inc.
and Steven Richman dated March 1995, and related Warrant Agreements
thereto, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 41,177 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.40 Warrant Agreements with Steven Richman dated February, March and
April 1995, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 6,250 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.41 Amendments to Warrant Agreements between PhoneTel Technologies, Inc.
and Janice Fuelhart dated March 1995, and related Warrant Agreements
thereto, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 49,412 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.42 Warrant Agreements with Janice Fuelhart dated February, March and
April 1995, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 1,250 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.43 Amendments to Warrant Agreements between PhoneTel Technologies, Inc.
and Peter Graf dated in March 1995, and related Warrant Agreements
thereto, issued pursuant to a Letter Agreement dated February 23,
1995, relative to the grant of warrants, in the aggregate, to
purchase a total of 148,235 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.44 Warrant Agreements with Peter Graf dated February, March and April
1995, issued pursuant to a Letter Agreement dated February 23, 1995,
relative to the grant of warrants, in the aggregate, to purchase a
total of 28,750 shares of PhoneTel Technologies, Inc. Common Stock.
(9)*
10.45 Stock Option Agreement dated May 24, 1994 between PhoneTel
Technologies, Inc. and the Estate of William D. Moses, and subsequent
assignment thereof dated February 2, 1995, relative to the grant of
an option to purchase 50,000 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.46 Stock Option Agreement dated September 13, 1994 between PhoneTel
Technologies, Inc. and the Estate of William D. Moses, and subsequent
assignment thereof dated February 2, 1995, relative to the grant of
an option to purchase 45,000 shares of PhoneTel Technologies, Inc.
Common Stock. (9)*
10.47 Warrant Agreement dated March 31, 1994 between PhoneTel Technologies,
Inc. and the Estate of William D. Moses, and subsequent assignment
thereof dated February 2, 1995, relative to the grant of warrants to
purchase 200,000 shares of PhoneTel Technologies, Inc. Common Stock.
(9)*
- 34 -
36
10.48 Agreement and Plan of Merger dated September 22, 1995, together with
Exhibits attached thereto, by and among PhoneTel Technologies, Inc.
Phone Tel II, Inc., and World Communications, Inc. (10)*
10.49 Amendment to Agreement and Plan of Merger dated September 22, 1995 by
and among PhoneTel Technologies, Inc., PhoneTel II, Inc., and World
Communications, Inc. (10)*
10.50 Agreement and Plan of Merger dated October 16, 1995, together with
Exhibits attached thereto, by and among PhoneTel Technologies, Inc.,
PhoneTel II, Inc., and Public Telephone Corporation. (11)*
10.51 Agreement and Plan of Merger dated November 22, 1995, between
PhoneTel Technologies, Inc. and International Pay Phones, Inc., South
Carolina corporation, and all amendments thereto. (12)*
10.52 Agreement and Plan of Merger dated November 22, 1995, between
PhoneTel Technologies, Inc. and International Pay Phones, Inc.,
Tennessee corporation, and all amendments thereto. (12)*
10.53 Share Purchase Agreement dated as of November 16, 1995, between
PhoneTel Technologies, Inc. and Paramount Communications Systems,
Inc., and all amendments thereto. (12)*
10.54 Credit Agreement dated as of March 15, 1996 among PhoneTel
Technologies, Inc., Various Lenders and Internationale Nederlanden
(U.S.) Capital Corporation (the "Credit Agreement"). (12)*
10.55 Security Agreement dated as of March 15, 1996 among PhoneTel
Technologies, Inc. Public Telephone Corporation, World
Communications, Inc., Northern Florida Telephone Corporation and
Paramount Communications Systems, Inc. and Internationale Nederlanden
(U.S.) Capital Corporation as Agent for itself and certain other
lenders. (12)*
10.56 Warrant Purchase Agreement dated as of March 15, 1996 between
PhoneTel Technologies, Inc. and Internationale Nederlanden (U.S.)
Capital Corporation and Cerberus Partners, L.P. (12)*
10.57 Registration Rights Agreement dated as of March 15, 1996 between
PhoneTel Technologies, Inc. and Internationale Nederlanden (U.S.)
Capital Corporation and Cerberus Partners, L.P. (12)*
10.58 Warrant Certificate dated as of March 15, 1996 granting
Internationale Nederlanden (U.S.) Capital Corporation the right to
purchase 102,412 shares of Series A Special Convertible Preferred
Stock of PhoneTel Technologies, Inc. (13)*
10.59 Warrant Certificate dated as of March 15, 1996 granting Cerberus
Partners, L.P. the right to purchase 102,412 shares of Series A
Special Convertible Preferred Stock of PhoneTel Technologies, Inc.
(13)*
10.60 Form of Warrant issued on March 15, 1996 to persons listed on
Schedule A to this exhibit. (13)*
10.61 Operator Service Subscriber Agreement dated as of February 29, 1996
by and between Intellicall Operator Services, Inc. and PhoneTel
Technologies, Inc. (13)*
10.62 Intellistar License Agreement dated as of February 29, 1996 by and
between Intellicall, Inc. and PhoneTel Technologies, Inc. (13)*
10.63 Relay Services Agreement dated as of February 29, 1996 by and between
Intellicall, Inc. and PhoneTel Technologies, Inc. (13)*
10.64 Stock Option Agreement dated April 1, 1995 between PhoneTel
Technologies, Inc. and Daniel J. Moos. (13)*
10.65 Separation Agreement dated July 29, 1996 between PhoneTel
Technologies, Inc. and Daniel J. Moos. (15)*
10.66 Employment Agreement dated September 1, 1996 between PhoneTel
Technologies, Inc. and Richard Kebert.(15)*
10.67 First Amendment to Credit Agreement dated as of April 11, 1996. (15)*
- 35 -
37
10.68 Second Amendment to Credit Agreement dated as of June 1996. (14)*
10.69 Third Amendment to Credit Agreement dated as of August 1, 1996. (14)*
10.70 Fourth Amendment to Credit Agreement dated as of September 13, 1996.
(14)*
10.71 Fifth Amendment to Credit Agreement dated as of September 13, 1996.
(14)*
10.72 Sixth Amendment to Credit Agreement dated as of October 8, 1996.
(15)*
10.73 Asset Purchase Agreement among PhoneTel Technologies, Inc., an Ohio
Corporation As Buyer and ACI-HDT Supply Company, a California
corporation, Amtel Communications Services, a California corporation,
Amtel Communications Correctional Facilities, a California
corporation, Amtel Communication, Inc., a California corporation,
Amtel Communications, Inc., a California corporation, and Amtel
Communications Payphones, Inc., a California corporation, as Seller,
dated June 26, 1996, and all amendments thereto. (14)*
10.74 Amended and Restated Share Purchase Agreement among PhoneTel III,
Inc., Payphones of America, Inc. and All of the Shareholders of
Payphones of America, Inc., dated as of August 1, 1996, and all
amendments thereto. (14)*
10.75 Seventh Amendment to Credit Agreement dated as of November 22, 1996.
(16)*
10.76 Agreement and Plan of Merger dated as of November 21, 1996 among
PhoneTel Technologies, Inc., PhoneTel CCI, Inc., Cherokee
Communication, Inc. and all of the shareholders of Cherokee
Communications, Inc. (the "Cherokee Merger Agreement") (16)*
10.77 Escrow Agreement dated as of November 21, 1996 among Comerica
Bank-Texas, as escrow agent, Cherokee Communications, Inc., Bill H.
Bailey, Jr. and J. Bruce Duty, as duly authorized agents for all of
the shareholders of Cherokee Communications, Inc., PhoneTel
Technologies, Inc. and Bill H. Bailey, Jr., Jerry T. Beddow and
Edward L. Marshall, individually. (16)*
10.78 Amendment dated as of December 31, 1996 to the Cherokee Merger
Agreement. (17)*
10.79 Asset Purchase Agreement dated January 13, 1997, among PhoneTel
Technologies, Inc., an Ohio Corporation, Texas Coinphone, a Texas
general partnership, Pete W. Catalena and Dennis H. Goehring. (17)*
10.80 Agreement and Plan of Merger by and among PhoneTel Technologies,
Inc., PhoneTel Acquisition Corp. and Communications Central Inc.
dated as of March 14, 1997. (19)*
10.81 First Supplemental Indenture, dated as of January 3, 1997,
supplementing the Indenture, Dated as of December 18, 1996, among
PhoneTel Technologies, Inc., the Subsidiary Guarantors named on
Schedule I thereto and Marine Midland Bank, as Trustee, $125,000,000
12% Senior Notes Due 2006. (20)*
10.82 Second Supplemental Indenture, dated as of May 29, 1997,
supplementing the Indenture, Dated as of December 18, 1996, as
supplemented by the First Supplemental Indenture dated as of January
3, 1997, among PhoneTel Technologies, Inc., the Subsidiary Guarantors
named on Schedule I thereto and Marine Midland Bank, as Trustee,
$125,000,000 12% Senior Notes Due 2006. (20)*
10.83 First Amendment to Agreement and Plan of Merger by and among PhoneTel
Technologies, Inc., PhoneTel Acquisition Corp. and Communications
Central Inc. dated as of May 15, 1997. (20)*
10.84 $75,000,000 Credit Agreement dated as of May 30, 1997 among PhoneTel
Technologies, Inc., as the Borrower, Various Lenders and ING (U.S.)
Capital Corporation, as the Agent for the Lenders and Transamerica
Business Credit Corporation and Finova Capital Corporation, as
Co-Agents for the Lenders. (20)*
- 36 -
38
10.85 Settlement Agreement as of August 8, 1997 together with the Release
and Termination of escrow agent between PhoneTel Technologies, Inc.
and Bill H. Bailey, Jr. and J. Bruce Duty, as duly authorized agents
on behalf of Bill H. Bailey, Jr., Edward L. Marshall, Jerry T.
Beddow, C. Nelson Trimble, Berthel Fisher & Company Investments,
Inc., Capital Southwest Corporation, Capital Southwest Venture
Corporation, and Bank One Capital Partners, L.P., and Comerica
Bank-Texas as escrow agent. (21)*
10.86 Third Supplemental Indenture, dated as of December 30, 1997,
supplementing the Indenture, dated as of December 18, 1996, as
supplemented by the First Supplemental Indenture, dated as of January
3, 1997, and the Second Supplemental Indenture, dated as of May 29,
1997, among PhoneTel Technologies, Inc., the Subsidiary Guarantors
named on Schedule I thereto and Marine Midland Bank, as Trustee,
$125,000,000 12% Senior Notes due 2006. (23)*
10.87 First Amendment to Credit Agreement, dated as of February 24, 1998,
amending the $75,000,000 Credit Agreement dated as of May 30, 1997
among PhoneTel Technologies, Inc. as the Borrower, Various Lenders
and ING (U.S.) Capital Corporation, as Agent for the Lenders and
Transamerica Business Credit Corporation and Finova Capital
Corporation, as Co-Agents for the Lenders.
10.88 PhoneTel Technologies, Inc. 1997 Stock Incentive Plan (22) *
10.89 Second Agreement to Credit agreement and Waiver, dated as of March
31, 1998, amending the $75,000,000 Credit Agreement dated as of May
30, 1997, among PhoneTel Technologies, Inc. as the Borrower, various
Lenders and ING (U.S.) Capital Corporation, as Agent for the Lenders
and Transamerica Business Credit Corporation and Finova Capital
Corporation, as Co-Agents for the Lenders (24)*
10.90 Third Amendment to Credit Amendment, dated as of May 8, 1998, between
PhoneTel Technologies, Inc., as the Borrower, and Foothill Capital
Corporation, as Replacement Agent and Lender, amending the Credit
Agreement dated as of May 30, 1997, as amended, restated,
supplemented, or otherwise modified from time to time, among PhoneTel
Technologies, Inc. as the Borrower, various Lenders and ING (U.S.)
Capital Corporation, as the former Agent of the Lenders. (25)*
10.91 Voting Agreement, dated June 11, 1998, by and between PhoneTel
Technologies, Inc. and Mr. David R. Hill (26)*
10.92 Voting Agreement, dated June 11, 1998, by and between PhoneTel
Technologies, Inc. and Samstock, L.L.C. (26)*
10.93 Voting Agreement, dated June 11, 1998, by an between PhoneTel
Technologies, Inc. and Samstock, L.L.C. (26)*
10.94 Consulting and Non-Competition Agreement, dated June 11, 1998, by and
between PhoneTel Technologies, Inc. and Mr. Peter Graf (26)*
10.95 Employment and Non-Competition Agreement, dated June 11, 1998, by and
between PhoneTel Technologies, Inc. and Ms. Tammy Martin (26)*
10.96 Pay Phone Communications Services Agreement dated as of November 16,
1998 by and between Qwest Communications Corporation and USLD
Communications, Inc. and PhoneTel Technologies, Inc.
99.1 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and Mr. Peter Graf (26)*
99.2 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and Mr. Steven Richman (26)*
99.3 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and Mr. George Henry (26)*
- 37 -
39
99.4 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and Mr. Aron Katzman (26)*
99.5 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and Mr. Joseph Abrams (26)*
99.6 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and ING (U.S.) Investment Corporation
(26)*
99.7 Voting Agreement, dated June 11, 1998, by and between Davel
Communications Group, Inc. and Cerberus Partners, L. P. (26)*
99.8 Joint Press Release of PhoneTel Technologies, Inc. and Davel
Communications Group, Inc. dated June 12, 1998 (26)*
99.9 Press Release of PhoneTel Technologies, Inc. dated September 29, 1998
announcing the termination of merger with Davel Communications Group,
Inc. and notification by AMEX regarding listing requirements. (27)*
21.1 Subsidiaries of PhoneTel Technologies, Inc.
27 Financial Data Schedule for the Year Ended December 31, 1998
- ----------------
* Previously filed.
(1) Incorporated by reference from the Registration Statement on Form
S-18 (Registration No. 33-16962C) of PhoneTel Technologies, Inc. (the
"Company"), filed with the Securities and Exchange Commission on
September 1, 1987.
(2) Incorporated by reference from Amendment No. 1 to the Company's
Registration Statement on Form S-1, Registration No. 33-30428, filed
September 27, 1989.
(3) Incorporated by reference from Amendment No. 1 to the Company's
Registration Statement on Form S-18 (Registration No. 33-16962C),
filed with the Securities and Exchange Commission on October 30,
1987.
(4) Incorporated by reference from the Company's Form 10-K for the year
ended December 31, 1989.
(5) Incorporated by reference from the Company's Form 10-K for the year
ended December 31, 1991.
(6) Incorporated by reference from the Company's Form 10-KSB for the year
ended December 31, 1992.
(7) Incorporated by reference from the Company's Form 8-K dated March 25,
1994.
(8) Incorporated by reference from the Company's Form 10-KSB for the year
ended December 31, 1993.
(9) Incorporated by reference from the Company's Form 10-KSB for the year
ended December 31, 1994.
(10) Incorporated by reference from the Company's Form 8-K dated September
22, 1995.
(11) Incorporated by reference from the Company's Form 8-K dated October
16, 1995.
(12) Incorporated by reference from the Company's Form 8-K dated March 15,
1996.
(13) Incorporated by reference from the Company's Form 10-KSB for the year
ended December 31, 1995.
(14) Incorporated by reference from the Company's Form 8-K dated September
13, 1996.
- 38 -
40
(15) Incorporated by reference from the Company's Form 10-QSB for the
quarter ended September 30, 1996.
(16) Incorporated by reference from Amendment No. 2 to the Company's
Registration Statement on Form SB-2 (Registration No. 333-13767),
filed with the Securities and Exchange Commission on December 12,
1996.
(17) Incorporated by reference from the Company's Form 8-K dated
January 3, 1997.
(18) Incorporated by reference from Amendment No. 2 to the Company's
Registration Statement on Form SB-2 (Registration No. 333-15611),
filed with the Securities and Exchange Commission on December 13,
1996.
(19) Incorporated by reference from the Company's Form 10-KSB for the year
ended December 31, 1996.
(20) Incorporated by reference from the Company's Form 10-QSB for the
quarter ended June 30, 1997.
(21) Incorporated by reference from the Company's Form 10-QSB for the
quarter ended September 30, 1997.
(22) Incorporated by reference from the Company's Proxy Statement for the
1997 Annual Meeting of Shareholders.
(23) Incorporated by reference from the Company's Form 10-K for the year
ended December 31, 1998.
(24) Incorporated by reference from the Company's Form 10-K/A-1 for the
year ended December 31, 1998.
(25) Incorporated by reference from the Company's Form 10-Q for the
quarter ended March 31, 1998.
(26) Incorporated by reference from the Company's Form 8-K dated June 11,
1998.
(27) Incorporated by reference from the Company's Form 8-K dated September
28, 1998.
(B) REPORT ON FORM 8-K
The Company filed a report on Form 8-K under Item 4 dated November 9,
1998 reporting that the Company's independent accountants,
PricewaterhouseCoopers LLP, had resigned and a report on Form 8-K
under Item 4 dated January 18, 1999 reporting that the Company
engaged BDO Seidman, LLP as its new independent public accountants.
(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 SCHEDULE
The Financial Statement Schedules to this Form 10-K are set forth as
Exhibits 21.1 and 27.
- 39 -
41
REPORT OF BDO SEIDMAN, LLP, INDEPENDENT ACCOUNTANTS
To the Board of Directors
PhoneTel Technologies, Inc.
Cleveland, Ohio
We have audited the accompanying consolidated balance sheet of
PhoneTel Technologies, Inc. and subsidiaries as of December 31, 1998 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. We have also audited the financial statement schedule listed in the
accompanying index. These financial statements and schedule are the
responsibility of the Company'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 generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements and
schedule are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and schedule. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements and schedule. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of PhoneTel
Technologies, Inc. and Subsidiaries at December 31, 1998 and the results of its
operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles. Also, in our opinion, the schedule
presents fairly, in all material respects, the information set forth therein.
The accompanying financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
2 to the financial statements, the Company has suffered recurring losses from
operations, has a net capital deficiency and is in default on its long-term
debt. These factors raise substantial doubt about its 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
March 8, 1999
F-1
42
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Shareholders of
PhoneTel Technologies, Inc.
In our opinion, the accompanying consolidated balance sheet and 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 of cash flows present fairly,
in all material respects, the financial position of PhoneTel Technologies, Inc.
and its subsidiaries at December 31, 1997, and the results of their operations
and their cash flows for each of the two years in the period ended December 31,
1997, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raises substantial doubt about its 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/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Cleveland, Ohio
March 31, 1998
F-2
43
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------
DECEMBER 31
---------------------------------------
1997 1998
---------------- ----------------
ASSETS
Current assets:
Cash $6,519 $5,768
Accounts receivable, net of allowance for doubtful accounts
of $507 and $ 935, respectively 16,278 14,021
Other current assets 972 1,389
---------------- ----------------
Total current assets 23,769 21,178
Property and equipment, net 30,109 27,837
Intangible assets, net 115,607 101,073
Other assets 341 586
---------------- ----------------
$169,826 $150,674
================ ================
LIABILITIES AND EQUITY (DEFICIT)
Current liabilities:
Current portion:
Long-term debt $544 $165,216
Obligations under capital leases 92 17
Accounts payable 8,768 11,254
Accrued expenses:
Location commissions 3,142 2,756
Personal property and sales tax 1,927 3,145
Interest 991 8,728
Salaries, wages and benefits 466 335
Other - 1,703
---------------- ----------------
Total current liabilities 15,930 193,154
Long-term debt 150,203 4
Obligations under capital leases 19 2
Commitments and contingencies - -
14% Cumulative Preferred Stock Mandatorily Redeemable
(redemption amount $9,512 due June 30, 2000) 7,716 9,112
Non-mandatorily Redeemable Preferred Stock, Common Stock
and Other Shareholders' Equity (Deficit) (4,042) (51,598)
---------------- ----------------
$169,826 $150,674
================ ================
The accompanying notes are an integral part of these financial statements.
F-3
44
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
- ------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
---------------------------------------------------
1996 1997 1998
---------------- --------------- ----------------
REVENUES:
Coin calls $26,212 $58,520 $52,544
Non-coin telecommunication services 17,649 50,624 42,432
Dial-around compensation adjustment (395) (3,733)
Other 943 500 143
---------------- --------------- ----------------
44,804 109,249 91,386
---------------- --------------- ----------------
COSTS AND EXPENSES:
Line and transmission charges 11,153 24,518 29,607
Telecommunication and validation fees 5,608 11,599 11,344
Location commissions 6,072 16,628 14,179
Field operations 8,733 21,100 22,009
Selling, general and administrative 4,381 10,713 12,354
Depreciation and amortization 12,800 22,798 25,583
Other unusual charges and contractual settlements 6,072 9,095 2,762
---------------- --------------- ----------------
54,819 116,451 117,838
---------------- --------------- ----------------
Loss from operations (10,015) (7,202) (26,452)
---------------- --------------- ----------------
OTHER INCOME (EXPENSE):
Interest expense - related parties (5,235) (1,431) (1,036)
Interest expense - others (1,504) (15,181) (17,876)
Interest and other income 182 560 547
---------------- --------------- ----------------
(6,557) (16,052) (18,365)
---------------- --------------- ----------------
Loss before extraordinary item (16,572) (23,254) (44,817)
Extraordinary item:
Loss on early extinguishment of debt (10,077) - -
---------------- --------------- ----------------
NET LOSS ($26,649) ($23,254) ($44,817)
================ =============== ================
Earnings per share calculation:
Loss before extraordinary item ($16,572) ($23,254) ($44,817)
Preferred dividend payable in kind (337) (514) (268)
Accretion of 14% Preferred to its redemption value (102) (494) (1,128)
Premium on redemption of 10%, 8% and 7% Preferred (2,002) - -
---------------- --------------- ----------------
Loss before extraordinary item applicable to
common shareholders (19,013) (24,262) (46,213)
Extraordinary item:
Loss on early extinguishment of debt (10,077) - -
---------------- --------------- ----------------
Net loss applicable to common shareholders ($29,090) ($24,262) ($46,213)
================ =============== ================
Loss per common share before extraordinary item ($3.46) ($1.51) ($2.73)
================ =============== ================
Net loss per common share, basic and diluted ($5.29) ($1.51) ($2.73)
================ =============== ================
Weighted average number of shares, basic and diluted 5,494,011 16,040,035 16,923,499
================ =============== ================
The accompanying notes are an integral part of these financial statements.
F-4
45
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN MANDATORILY REDEEMABLE PREFERRED STOCK
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
- ----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------------------------------------------------------------------------
1996 1997 1998
---------------------------- ---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
-------------- ------------ -------------- ------------ -------------- -------------
14% CUMULATIVE
REDEEMABLE CONVERTIBLE
PREFERRED STOCK
Balance, beginning of year - - 120,387 $6,708 138,147 $7,716
Redemption of 7%, 8% and
10% Preferred 34,436 $2,066 - - - -
Conversion of debt 59,695 3,581 - - - -
Acquisitions 13,787 622 - - - -
Dividends payable-in-kind 12,469 337 17,760 514 20,380 268
Accretion of carrying value
to amount payable at
redemption on June 30, 2000 - 102 - 494 - 1,128
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year 120,387 $6,708 138,147 $7,716 158,527 $9,112
============== ============ ============== ============ ============== =============
The accompanying notes are an integral part of these financial statements.
F-5
46
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN NON-MANDATORILY REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
- ----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------------------------------------------------------------------------
1996 1997 1998
---------------------------- ---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
-------------- ------------ -------------- ------------ -------------- -------------
7 % CUMULATIVE
CONVERTIBLE REDEEMABLE
PREFERRED STOCK
Balance, beginning of year 2,500 $200 - - - -
Redemption (2,500) (200) - - - -
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year - - - - - -
============== ------------ ============== ------------ ============== -------------
8 % CUMULATIVE REDEEMABLE
PREFERRED STOCK
Balance, beginning of year 12,200 981 - - - -
Redemption (12,200) (981) - - - -
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year - - - - - -
============== ------------ ============== ------------ ============== -------------
10 % CUMULATIVE REDEEMABLE
PREFERRED STOCK
Balance, beginning of year 1,496 - - - - -
Redemption (1,496) - - - - -
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year - - - - - -
============== ------------ ============== ------------ ============== -------------
10 % CUMULATIVE NON-VOTING
REDEEMABLE PREFERRED STOCK
Balance, beginning of year 530,534 5,305 - - - -
Conversion (530,534) (5,305) - - - -
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year - - - - - -
============== ------------ ============== ------------ ============== -------------
SERIES A SPECIAL CONVERTIBLE
PREFERRED STOCK
Balance, beginning of year - - - - - -
Exercise of Warrants - - 12,500 $3 100,875 $20
Conversion to Common Stock - - (12,500) (3) (100,875) (20)
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year - - - - - -
============== ------------ ============== ------------ ============== -------------
COMMON STOCK
Balance, beginning of year 2,855,350 29 14,488,828 145 16,360,829 164
Company Equity Offering 6,750,000 68 1,012,500 10 - -
Exercise of warrants and options 1,035,137 10 409,754 4 375,804 4
Acquisitions 2,860,608 28 - - - -
Conversion of Series A Preferred - - 250,000 3 2,017,500 20
Conversion of 10% Non-voting
Preferred 884,214 9 - - - -
Other issuances of stock 103,519 1 199,747 2 - -
-------------- ------------ -------------- ------------ -------------- -------------
Balance, end of year 14,488,828 145 16,360,829 164 18,754,133 188
============== ------------ ============== ------------ ============== -------------
The accompanying notes are an integral part of these financial statements.
F-6
47
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN NON-MANDATORILY REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
- ----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------------------------------------------------------------------------
1996 1997 1998
---------------------------- ---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
-------------- ------------ -------------- ------------ -------------- -------------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year $16,650 $59,104 $62,600
Company Equity Offering, net 18,228 2,815 -
Exercise of warrants and options - 101 25
Acquisitions 8,010 -
Warrants issued with debt 6,412 - -
Exercise of warrants -
Series A Preferred - - (20)
Put under warrants issued for
Series A Preferred - - (1,452)
Conversion of 10% Non-voting
Preferred 5,296 - -
Issuance of Nominal
Value Warrants 4,241 - -
Other issuances of stock and warrants 267 580 80
------------ ------------ -------------
Balance, end of year 59,104 62,600 61,233
------------ ------------ -------------
ACCUMULATED DEFICIT
Balance, beginning of year (13,454) (42,544) (66,806)
Net loss (26,649) (23,254) (44,817)
Dividends payable in-kind on 14%
Preferred and accretion (439) (1,008) (1,396)
Redemption of stock:
7%, 8% and 10% Preferred (2,002) - -
------------ ------------ -------------
Balance, end of year (42,544) (66,806) (113,019)
------------ ------------ -------------
TOTAL NON-MANDATORILY
REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND
OTHER SHAREHOLDERS' EQUITY (DEFICIT) $16,705 ($4,042) ($51,598)
============ ============ ==============
The accompanying notes are an integral part of these financial statements.
F-7
48
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------------------------------
1996 1997 1998
-------------- -------------- --------------
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss ($26,649) ($23,254) ($44,817)
Adjustments to reconcile net loss to net cash flows
from operating activities:
Depreciation and amortization 12,800 22,798 25,583
Amortization of deferred revenues (900) (300) -
Increase in allowance for doubtful accounts 92 267 428
Issuance of Nominal Value Warrants 3,886 - -
Stock in lieu of cash payments 21 - -
Accretion of related party debt 1,605 - -
Loss on debt restructuring 9,628 - -
Gain on disposal of assets - - (335)
Other non-cash charges 156 2 -
Changes in current assets, net of assets acquired (2,531) (4,735) 1,413
Change in current liabilities, net of liabilities assumed and
reclassification of long - term debt 1,623 502 11,258
-------------- -------------- --------------
(269) (4,720) (6,470)
-------------- -------------- --------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Acquisitions (22,576) (48,687) (2,669)
Restricted funds (37,110) - -
Acquisition deposits (520) - -
Purchases of property and equipment (2,851) (7,937) (3,580)
Proceeds from sale of assets - 789 468
Deferred revenues - signing bonus 1,200 - -
Aquisition of intangible assets (907) (1,265) (737)
Other deferred charges (298) (97) (245)
-------------- -------------- --------------
(63,062) (57,197) (6,763)
-------------- -------------- --------------
The accompanying notes are an integral part of these financial statements.
F-8
49
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------------------------------
1996 1997 1998
-------------- -------------- --------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from debt issuances $43,000 $110 $12,002
Proceeds from shareholder debt 835 25,000 3,090
Net proceeds from Company Debt Offering 119,149 - -
Net proceeds from Company Equity Offering 18,295 2,825 -
Principal payments on borrowings (66,205) (1,642) (724)
Debt financing costs (4,911) (4,402) (1,915)
Redemption of 10% and 8% Preferred (1,117) - -
Proceeds from warrant and option exercises 10 107 29
-------------- -------------- --------------
109,056 21,998 12,482
-------------- -------------- --------------
Increase (decrease) in cash 45,725 (39,919) (751)
Cash, beginning of period 713 46,438 6,519
-------------- -------------- --------------
Cash, end of period $46,438 $6,519 $5,768
============== ============== ==============
SUPPLEMENTAL DISCLOSURE:
Interest paid during the year $4,465 $16,395 $11,171
============== ============== ==============
NON-CASH TRANSACTIONS:
Acquisitions :
Amtel Communications $5,421 - -
Payphones of America 13,918 - -
International Pay Phones 3,536 - -
Paramount Communications 1,064 - -
Common Stock or warrants for Common Stock issued for services 21 $208 $80
Put under warrants issued for Series A Preferred - - 1,452
Common Stock issued in payment of debt and interest 248 374 -
-------------- -------------- --------------
$24,208 $582 $1,532
============== ============== ==============
The accompanying notes are an integral part of these financial statements.
F-9
50
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(IN THOUSANDS EXCEPT FOR INSTALLED PUBLIC PAY TELEPHONES,
PER CALL, SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
PhoneTel Technologies, Inc. and Subsidiaries (the "Company") operate in
a single business segment within the telecommunications industry. The Company
specializes in the business of installation and operation of public pay
telephones on a revenue sharing basis and offering operator assisted long
distance services. At December 31, 1996, 1997 and 1998, the Company operated
25,029, 43,847 and 43,248 installed 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.
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. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. Intercompany transactions and
balances have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers all investments with original maturities of three
months or less to be cash equivalents.
RESTRICTED CASH EQUIVALENTS
Restricted cash equivalents represent a portion of the net proceeds
realized from the Company's Debt Offering completed on December 18, 1996, which,
pursuant to the terms of the Company's Debt Offering, were restricted to certain
transactions. The funds were used to complete the acquisition of Cherokee
Communications, Inc. on January 1, 1997.
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.
F-10
51
INTANGIBLE ASSETS
Intangible assets include costs incurred in obtaining new locations or
in the acquisition of installed public pay telephones through a business
combination ("location contract"), non-compete agreements, costs associated with
obtaining operating certification in various states and deferred financing
costs. Intangible assets are amortized over the estimated economic life of the
respective location contracts, the term of the respective non-compete or
financing agreement, and five years for state operating certifications.
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 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 recorded in 1996, 1997 or 1998.
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.
COMPREHENSIVE INCOME
The Company has no items of comprehensive income or expense.
Accordingly, the Company's comprehensive income and net income are equal.
EARNINGS PER SHARE
In March 1997, the FASB issued Statement No. 128, "Earnings per Share"
which specifies the computation, presentation, and disclosure requirements for
earnings per share for publicly held entities. This Statement is effective for
financial statements for both interim and annual periods ending after December
15, 1997.
In the fourth quarter of 1997, the Company adopted FASB Statement No.
128 and has applied the provisions of the statement to prior periods. No
restatement of amounts previously reported as loss per share by the Company was
required.
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 7% Cumulative Convertible Redeemable Preferred ("7%
Preferred") in 1996 and the 14% Cumulative Redeemable Preferred ("14%
Preferred") in 1996, 1997 and 1998. 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 have not been reported because the Company has a net loss and
the impact of the assumed exercise of the stock options and warrants and the
assumed conversion of the 7% Preferred and 14% Preferred is not dilutive.
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.
F-11
52
RECLASSIFICATIONS
Certain amounts relating to 1996 and 1997 have been reclassified to
conform to the current year presentation. The reclassifications have had no
impact on total assets, shareholders' equity or net loss as previously reported.
BASIS OF PRESENTATION
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.
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, 1997 and 1998, or
that will be realized in the future. At December 31, 1997 and 1998, 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.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board 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. SFAS No. 133 is
effective for fiscal years beginning after June 15, 1999. The Company does not
presently enter into any transactions involving derivative financial instruments
and, accordingly, does not anticipate the new standard will have any effect on
its financial statements.
F-12
53
2. FINANCIAL CONDITION
The Company's working capital, excluding the reclassification of
long-term debt to current liabilities, declined from $7,839 at December 31, 1997
to ($6,976) at December 31, 1998, a decrease of $14,815. This decrease was
primarily due to the increase in accrued interest resulting from the default in
payment of interest on the Company's 12% Senior Notes and increases in other
current liabilities. Cash flows used in operating activities increased from
$4,720 in 1997 to $5,018 in 1998, an increase of $298. At December 31, 1998, the
Company had a deficit of $51,598 in stockholders equity (excluding mandatorily
redeemable preferred stock) as a result of the current year loss of $44,817 and
a loss of $23,254 in 1997. The Company was not in compliance with certain
financial covenants under the Credit Agreement at December 31, 1998 and is in
default on this debt. Further, the Company was unable to make the interest
payment due on December 15, 1998 under the Company's 12% Senior Notes and is in
default on this debt. Under certain circumstances, the debt that is in default
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 investment 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
revenues will increase, that revenues from dial-around compensation will
continue at the rates anticipated or that they will be received by the Company
in the amounts the Company has recorded as receivable as they become due, or
that operating expenses can be maintained at present or reduced to lower levels.
To the extent that cash flow from operating activities is insufficient to meet
the Company's cash requirements, there can be no assurance that the Company's
lender will grant additional advances under the Credit Agreement for working
capital or business expansion purposes or that the Company can obtain additional
financing to meet its debt service and other cash requirements.
In January 1999, the Company reached an agreement in principle with the
Unofficial Committee of Noteholders of its 12% Senior Notes, subject to a number
of conditions including satisfactory documentation and the Company obtaining a
revised working capital facility, which provides for the conversion of the Notes
plus accrued interest into 95% of the Company's Common Stock (the
"Restructuring"). At that date the Unofficial Committee of Noteholders
represented approximately 63% of the principal amount of the Notes. The
Restructuring further contemplates that existing preferred and common
shareholders will receive the remaining 5% of the Company's Common Stock (as
well as warrants to purchase approximately 11% of the Company's Common Stock) at
an exercise price of $10.50 per share (assuming 10,000,000 Common Shares
outstanding after the conversion). These equity interests would be subject to
dilution upon the exercise of certain warrants and awards under a new management
incentive plan being considered as part of the Restructuring.
The Company is reviewing various alternative methods of implementing
the Restructuring. Among the alternatives presently under consideration by the
Company and its professional advisors is the possibility of seeking confirmation
of a prepackaged plan of reorganization (the "Prepackaged Plan") in connection
with commencing a case under chapter 11 of the United States Bankruptcy Code
(the "Case"). Commencing the Case seeking confirmation of the Prepackaged Plan
would require, among other things, that consent to the Restructuring be obtained
from holders of two-thirds of the principal amount of the Notes and 50% of the
Noteholders actually voting. Under the Prepackaged Plan, claims of creditors of
the Company, other than the holders of Notes, generally would be paid in full
in the ordinary course, with the Company retaining its rights and defenses with
respect to such claims.
The Company believes, but cannot assure, that it will be able to
implement the Restructuring with the consent of the holders of the Notes. In the
event that the Company and the holders of the Notes are unable to implement the
Restructuring and the Company is unable to obtain a revised working capital
facility, the Company will be forced to evaluate other available options.
F-13
54
3. TERMINATION OF MERGER WITH DAVEL COMMUNICATIONS GROUP, INC.
On June 11, 1998, PhoneTel Technologies, Inc. ("PhoneTel") entered into
an Agreement and Plan of Merger and Reorganization (the "Davel Merger
Agreement") with Davel Communications Group, Inc., a publicly held, independent
pay telephone provider ("Davel"). 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, PhoneTel received a letter from Davel purporting
to terminate the Davel Merger Agreement. Thereafter, a complaint against
PhoneTel 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 Davel Merger Agreement. On October
27, 1998, PhoneTel 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 for tortuous interference with contract alleging that Peoples
induced Davel to not comply with the terms of the Davel Merger Agreement.
PhoneTel is seeking specific performance from Davel, which would
require Davel to comply with the terms of the Davel Merger Agreement or,
alternatively, for compensatory damages and costs of an unspecified amount.
PhoneTel is also seeking injunctive relief enjoining Peoples from further
tortuous interference with contract and for compensatory damages and costs of an
unspecified amount. Management believes the claims against PhoneTel are without
merit and is vigorously pursuing its claims against Davel and Peoples.
As of December 31, 1998, the Company has incurred $1,426 of costs relating
to the Davel Merger Agreement and related litigation. Such costs are included in
other unusual charges and contractual settlements in the accompanying
consolidated statements of operations.
4. ACQUISITIONS AND MERGERS
TERMINATION OF PROPOSED ACQUISITION
On March 14, 1997, PhoneTel entered into an Agreement and Plan of
Merger (the "Merger Agreement") to acquire Communications Central Inc. ("CCI"),
pursuant to which on March 20, 1997 a wholly-owned subsidiary of PhoneTel
commenced a tender offer (the "Offer") for all of the outstanding shares of
common stock of CCI ("CCI Shares") at $12.85 per share in cash. The Offer
expired on August 20, 1997. No CCI Shares were purchased and all CCI Shares
tendered and not properly withdrawn at the time of expiration were returned by
the depositary. On August 21, 1997, PhoneTel announced that the Merger Agreement
had been terminated and in connection therewith forfeited a $6,000 deposit that
had been paid to CCI. The Company recorded a charge of $7,818 relating to the
transaction, including the forfeited deposit and $1,818 in professional fees and
related expenses in the third quarter of 1997.
TDS TELECOMMUNICATIONS CORPORATION - MAY 18, 1998 ("TDS")
The Company entered into an asset purchase agreement to acquire
approximately 3,400 installed pay telephones from TDS's network of Local
Exchange Carriers ("LECs") for a purchase price of $851. The majority of the pay
telephones acquired had to be upgraded with the necessary microprocessor
technology needed to operate the pay telephones under the Company's operating
and management information systems. The cost incurred to upgrade these pay
telephones was approximately $1,717. The Company completed the installation of a
majority of the upgrade equipment and began operating these pay telephones
during the last half of 1998.
LONDON COMMUNICATIONS, INC. - JUNE 10, 1997 ("LONDON")
The Company acquired 2,519 installed public pay telephones for $9,514
and incurred related acquisition expenses of $204.
F-14
55
ADVANCE PAY SYSTEMS, INC. - MAY 30, 1997 ("ADVANCE")
The Company acquired 800 installed public pay telephones for $2,709 and
incurred related acquisition expenses of $62.
AMERICAN PUBLIC TELECOM, INC. - MAY 30, 1997 ("AMERICAN")
The Company acquired 859 installed public pay telephones for $3,312 and
incurred related acquisition expenses of $69.
TEXAS COINPHONE - JANUARY 14, 1997 ("TEXAS COINPHONE")
The Company acquired 1,250 installed public pay telephones, parts and
supplies inventories, and certain other assets for $3,660 and incurred related
acquisition expenses of approximately $50.
CHEROKEE COMMUNICATIONS, INC. - JANUARY 1, 1997 ("CHEROKEE")
The Company acquired 13,131 public pay telephones for a purchase price
consisting of: $53,953; $1,250 for non-competition agreements; $4,174 for
acquired outstanding accounts receivable, prepaid expenses, deposits and coin in
the installed pay telephones; and the assumption of $5,443 in liabilities.
Additionally, the Company incurred approximately $1,656 in acquisition related
expenses.
AMTEL COMMUNICATIONS SERVICES - SEPTEMBER 13, 1996 ("AMTEL")
The Company acquired 6,872 installed public pay telephones and
inventory consisting of approximately 728 public pay telephones and related
parts. Amtel's assets were acquired for a purchase price consisting of $7,000
and 2,162,163 shares of Common Stock based on the fair market value of $2.15 per
share, or $4,638. Additionally, the Company incurred approximately $783 in
related acquisition expenses.
PAY PHONES OF AMERICA, INC. - AUGUST 1, 1996 ("POA")
The Company acquired 3,115 installed public pay telephones for a
purchase price consisting of: $500; 166,666 shares of Common Stock based on the
fair market value of $1.87 per share, or $312; assumption of $7,783 in capital
lease obligations; $3,634 in notes payable to the sellers; the assumption of
$1,779 in current liabilities and other debt; and non-competition and consulting
agreements for an aggregate value of $360. Additionally, the Company incurred
approximately $50 in related acquisition expenses.
INTERNATIONAL PAY PHONES, INC. OF SOUTH CAROLINA ("IPP SC") AND
INTERNATIONAL PAYPHONES, INC. OF TENNESSEE ("IPP TN") - MARCH 15, 1996
(REFERRED TO AS "IPP")
The Company acquired 2,101 installed public pay telephones for a
purchase price consisting of: $4,829; 555,589 shares of Common Stock (valued at
$4.51 per share, or $2,506); 5,453 shares of 14% Preferred, valued at $246;
117,785 warrants to purchase shares of Common Stock at a nominal exercise price
("Nominal Value Warrants"), valued at $139; $57 for three five year non-compete
agreements; and the assumption of approximately $588 in liabilities.
PARAMOUNT COMMUNICATIONS, INC. - MARCH 15, 1996 ("PARAMOUNT")
The Company acquired 2,528 installed public pay telephones for a
purchase price consisting of: $10,397; 8,333 shares of 14% Preferred, valued at
$376; 179,996 Nominal Value Warrants, valued at $443; the assumption of $245 in
liabilities; and included a five year consulting and non-compete agreement,
valued at $50.
F-15
56
PURCHASE PRICE ACCOUNTING
The Company recorded each of the above acquisitions as purchases and
has included the operating results of the acquired entities in the statements of
operations from the respective dates of acquisition. The difference between the
total purchase price and the current assets and liabilities assumed has been
allocated to property and equipment, location contracts and non-compete
agreements based on the relative fair values. Fair values of location contracts
are determined using discounted cash flows over the remaining estimated economic
lives of the acquired location contracts. The amount of location contracts
recorded for each acquisition and the estimated economic life of the acquired
location contracts are as follows: London $8,608, 102 months; Advance $2,313,
120 months; American $2,763, 103 months; Texas Coinphone $ 3,097, 101 months;
Cherokee $53,103, 113 months; Amtel $10,136, 99 months; POA $12,054, 103 months;
IPP $6,959, 97 months; Paramount $10,116, 109 months.
PRO FORMA FINANCIAL DATA (UNAUDITED)
Set forth below is the Company's unaudited pro forma condensed
statement of operations data for the years ended December 31, 1996 and 1997, as
though the IPP, Paramount, POA and Amtel acquisitions had occurred at the
beginning of 1996; and the Cherokee, Texas Coinphone, Advance, American and
London acquisitions had occurred at the beginning of 1996 and 1997.
1996 1997
---- ----
Total revenues $ 109,980 $ 114,638
Loss before extraordinary item (26,060) (24,093)
Net loss (36,137) (24,093)
Net loss applicable to common
Shareholders (38,578) (25,101)
Net loss per common share (2.63) (1.56)
The unaudited pro forma data above does not include TDS because the
effect on such operating results would not be significant. The unaudited pro
forma results are not necessarily indicative of either actual results of
operations that would have occurred had the acquisitions been made at the
beginning of 1996 or 1997 or of future results. The pro forma statement of
operations data includes adjustments related to depreciation of property and
equipment, amortization of intangible assets, interest expense on borrowings
used to finance the acquisitions and the weighted average number of common
shares outstanding after giving effect to the acquisitions and excludes the
assets and results of operations not acquired.
5. 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). 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 revenues at the beginning of the most recent period prior to the announcement
of such changes by the FCC. At December 31, 1997 and 1998, accounts receivable
included $12,938 and $13,095, respectively, arising from dial-around
compensation. Such receivables are received on a quarterly basis, two quarters
in arrears. For the years ended December 31, 1996, 1997 and 1998, revenues from
dial-around compensation consisted of:
1996 1997 1998
---- ---- ----
Amount included in revenue from
non-coin telecommunication services $ 3,219 $ 19,100 $ 16,187
Retrocative adjustment for changes in
accounting estimates of revenues
recorded in prior years (395) (3,733)
-------- -------- --------
Net revenue from dial-around compensation $ 3,219 $ 18,705 $ 12,454
======== ======== ========
F-16
57
Of the amount recorded as a retroactive adjustment to dial-around
compensation in 1998, $3,222 relates to the Company's 1997 fiscal year and $511
relates to the Company's 1996 fiscal year. The retroactive adjustment to
dial-around compensation of $395,000 in 1997 relates to the Company's 1996
fiscal year. If revenues from dial-around compensation had been recorded at the
current rate ($0.238 per call or $31.18 per month based on 131 calls), the net
revenue would have been $15,878 in 1997 and $16,187 in 1998.
Effective November 6, 1996, pursuant to the rules and regulations promulgated by
the FCC under section 276 of the Telecommunications Act (the "1996 Payphone
Order"), the FCC directed a two-phase transition to achieve fair compensation
for dial-around calls through deregulation and competition. In the first phase,
November 6, 1996 to October 6, 1997, the FCC prescribed flat-rate compensation
payable to the payphone providers by the interexchange carriers ("IXCs") in the
amount of $45.85 per month per payphone (as compared with a fee of $6.00 per
installed payphone per month in periods prior to November 6, 1996.) This rate
was arrived at by determining that the deregulated local coin rate was a valid
market based surrogate for dial-around calls. The FCC applied a market-based,
deregulated coin rate of $0.35 per call to a finding from the record that there
were a monthly average of 131 compensable dial-around calls per payphone. This
total included both carrier access code calls dialed for the purpose of reaching
a long distance company other than the one designated by the payphone provider
as well as 800 subscriber calls. The monthly per phone flat-rate compensation of
$45.85 was to be assessed only against IXCs with annual toll-call revenues in
excess of $100 million and allocated among such IXCs in proportion to their
gross long-distance revenues. During the second phase of the transition to
deregulation and market-based compensation (initially from October 1997 to
October 1998, but subsequently extended in a later order by one year to October
1999), the FCC directed the IXCs to pay payphone service providers (such as
PhoneTel), on a per-call basis for dial-around calls at the assumed deregulated
coin rate of $0.35 per call. At the conclusion of the second phase, the FCC set
the market-based local coin rate, determined on a payphone-by-payphone basis, as
the default per-call compensation rate in the absence of a negotiated agreement
between the payphone provider and the IXC.
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 and required the LECs to make such coding available
to the payphone providers as a transmit item included in the local access line
service.
In July 1997, the United States Court of Appeals for the District of
Columbia Circuit ("the Court") responded to an appeal of the 1996 Payphone
Order, finding that the FCC erred in (1) setting the default per call rate at
$0.35 without considering the differences in underlying costs between
dial-around calls and local coin calls, (2) assessing the flat-rate compensation
against only the carriers with annual toll-call revenues in excess of $100
million, and (3) allocating the assessment of the flat-rate compensation based
on gross revenues rather than on a factor more directly related to the number of
dial-around calls processed by the carrier. The Court also assigned error to
other aspects of the 1996 Payphone Order concerning inmate payphones and the
accounting treatment of payphones transferred by a Regional Bell Operating
Company ("RBOC") to a separate affiliate.
In response to the remand by the Court, the FCC issued a new order
implementing section 276 in October 1997 (the "1997 Payphone Order"). The FCC
determined that distinct and severable costs of $0.066 were attributable to a
coin call that did not apply to the costs incurred by the payphone providers in
providing access for a dial-around call. Accordingly, the FCC adjusted the per
call rate during the second phase of interim compensation to $0.284 (which is
$0.35 less $0.066). While the FCC tentatively concluded that the $0.284 default
rate (or $37.20 per payphone per month based on 131 calls per month) should be
utilized in determining compensation during the first phase and reiterated that
payphone providers were entitled to compensation for each and every call during
the first phase, it deferred for later decision the precise method of allocating
the initial interim period flat-rate payment obligation among the IXCs and the
number of calls to be used in determining the total amount of the payment
obligation. In the third quarter of 1997, the Company recorded an adjustment of
$2,361 to reduce dial-around compensation recorded in prior quarters for the
decrease in rate from $45.85 to $37.20 per payphone per month. Of this
adjustment amount, $395 related to the prior year.
F-17
58
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC
98-48 1, which extended and waived certain requirements concerning the provision
by the local exchange carriers ("LECs") of payphone-specific coding digits,
which identify a call as originating from a payphone. Without the transmission
of payphone-specific coding digits some of the IXCs have claimed they are unable
to identify a call as a payphone call eligible for dial-around compensation.
With the stated purpose of ensuring the continued payment of dial-around
compensation the FCC, by Memorandum and Order issued on April 3, 1998, left in
place the requirement for payment of per-call compensation for payphones on
lines that do not transmit the requisite payphone-specific coding digits, but
gave the IXCs a choice for computing the amount of compensation for payphones on
LEC lines not transmitting the payphone-specific coding digits of either
accurately computing per-call compensation from their databases or paying
per-phone, flat-rate compensation computed by multiplying the $0.284 per call
rate by the nationwide average number of 800 subscriber and access code calls
placed from RBOC payphones for corresponding payment periods. Accurate payments
made at the flat rate are not subject to subsequent adjustment for actual call
counts from the applicable payphone.
On May 15, 1998, the Court again remanded the per-call compensation rate to
the FCC for further explanation without vacating the $0.284 per call rate. The
Court opined that the FCC had failed to explain adequately its derivation of the
$0.284 default rate. The Court stated that any resulting overpayment would be
subject to refund and directed the FCC to conclude its proceedings within a
six-month period ending on November 15, 1998. On June 19, 1998, the FCC
solicited comment from interested parties on the issues remanded. In initial and
reply comments, certain IXCs and members of the paging industry had urged the
FCC to abandon its efforts to derive a market-based rate from surrogates and
either require the caller to pay dial-around compensation by coin deposit or
adopt a cost-based rate at levels substantially below the $0.284 rate.
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 from $0.284 to $0.238, retroactive to
October 7, 1997. In adjusting the default rate, the FCC shifted its methodology
from the market-based method utilized in the 1997 Payphone Order to a cost-based
method citing technologic 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
cost-based default rate, the FCC incorporated its prior treatment of certain
payphone costs as well as reexamined new estimates of payphone costs submitted
as part of the proceeding.
Pursuant to the 1999 Payphone Order, the $0.24 amount ($0.238 plus 0.2 cents for
FLEX ANI costs, which are amounts charged by LECs for providing payphone
specific coding digit technology) will serve as the default per-call
compensation rate for coinless payphone calls through January 31, 2002, at which
time, parties may petition the FCC regarding the default amount, related issues
pursuant to technological advances, and the expected resultant market changes.
In the fourth quarter of 1998, the Company again recorded an adjustment to
reduce revenues previously recognized for the period from November 7, 1996 to
September 30, 1998 due to the further decrease in the dial-around compensation
rate from $0.284 to $0.238 per call. This adjustment for $6,075 included $3,733
recorded as revenue in prior years.
The 1999 Payphone Order has been appealed by various parties, including but
not limited to, the trade association which represents the interests of various
pay telephone providers throughout the United States. Based on the information
available, the Company believes that the minimum amount it is entitled to as
fair compensation under the Telecommunications Act for the period from November
7, 1996 through December 31, 1998 is $31.18 per pay telephone per month based on
$0.238 per call and 131 calls per pay telephone per month. Further, the Company
does not believe that it is reasonably possible that the amount will be
materially less than $31.18 per pay telephone per month.
F-18
59
6. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
Estimated December 31
Useful Lives ----------------------
(in years) 1997 1998
------------ -------- --------
Telephone boards, enclosures and cases 3-10 $ 41,653 $ 47,518
Furniture, fixtures and other equipment 3-5 3,063 3,138
Leasehold improvements 2-5 424 473
-------- --------
45,140 51,129
Less - accumulated depreciation (15,031) (23,292)
-------- --------
$ 30,109 $ 27,837
======== ========
Depreciation expense, including amortization of assets under capital
leases, was $5,032, $7,270 and $8,451 for the years ended December 31, 1996,
1997 and 1998, respectively.
Effective January 1, 1997, the Company changed the estimated useful life
of new telephones to ten years. The impact on depreciation for 1997 and 1998 was
not material.
7. INTANGIBLE ASSETS
Intangible assets consisted of the following:
December 31
Amortization ------------------------
Period 1997 1998
------------- --------- ---------
Location contracts 60-113 months $ 126,775 $ 127,425
Deferred financing costs 120 months 10,254 12,178
Non-compete agreements 24-60 months 3,731 3,733
State operating certifications 36-60 months 567 589
--------- ---------
141,327 143,925
Less: accumulated amortization (25,720) (42,852)
--------- ---------
$ 115,607 $ 101,073
========= =========
Amortization of intangible assets amounted to $7,768, $15,528 and
$17,132 for the years ended December 31, 1996, 1997 and 1998, respectively.
During the fourth quarter of 1996, the Company performed a study of its
location contracts acquired in business combinations. Generally, location
contracts are written such that they contain an "evergreen" clause which causes
the contract to automatically renew for a like term unless the contract is
canceled, in writing, by the location provider. The Company determined that the
economic life (economic life includes the expected effect of the operation of
the evergreen contract provisions, net of non-renewals) of a contract is greater
than the remaining life based on contractual terms at the time of acquisition.
The Company determined that the average remaining contractually determined life
for a location contract ranged from 30 months to 36 months for its acquisitions.
Based on the study performed, which analyzed historical renewal rates and
contract terms, the economic life of acquired location contracts were determined
to range from 60 months to 113 months. The Company adjusted its amortization
periods for the acquired location contracts as of October 1, 1996. This
adjustment had the effect of decreasing amortization and the net loss by
approximately $663 or $0.12 per share in 1996 and $2,645 or $0.16 per share in
1997.
F-19
60
8. LONG-TERM DEBT
Long-term debt consisted of the following:
December 31
------------------------
1997 1998
--------- ---------
Senior Notes, contractually due December 15, 2006 with interest
at 12% payable semiannually. $ 125,000 $ 125,000
Related Party Debt and Credit Agreement, contractually due May 8, 2001,
with interest payable monthly at 2% above the Lenders' reference
rate (9.75% at December 31, 1998). 25,000 40,014
Other notes payable due in monthly installments of
$26 including interest at rates ranging from 3% to 12%. 747 206
--------- ---------
150,747 165,220
Less current maturities (544) (165,216)
--------- ---------
$ 150,203 $ 4
========= =========
Following are maturities of long-term debt for each of the next five years:
1999 $165,216
2000 4
2001 --
2002 --
2003 --
--------
$165,220
========
SENIOR 12% NOTES
On December 18, 1996, the Company completed a public debt offering of
$125,000 aggregate principal amount 12% Senior Notes, due 2006, with interest
payable semiannually on June 15 and December 15. The net proceeds of $119,149
were used to complete the Cherokee and Texas Coinphone acquisitions in January
1997, and to repay the outstanding indebtedness under the prior Credit Facility,
certain capitalized lease obligations and the sellers' notes incurred in the
acquisition of POA. The remaining proceeds were available for general corporate
purposes and working capital. The 12% Senior Notes contain covenants which,
among other things, limit the Company's ability to incur additional indebtedness
or pay dividends and which require the Company, in the event of a change in
control of the Company, to offer to purchase the 12% Senior Notes for 101% of
their aggregate outstanding principal value plus accrued and unpaid interest. On
December 30, 1997, the Company solicited and received the consent from its
Noteholders to amend the indenture to increase the limit of permitted
indebtedness and to modify the definition of consolidated net income to exclude
certain non-recurring expenses and non-operating charges when calculating
certain restrictive covenants. The Company incurred $625 in deferred financing
costs to the Noteholders and $761 in fees relating to the solicitation of the
Noteholders' consent to amend the indenture.
The Company has not paid the semiannual interest payment which was due
December 15, 1998 on the 12% Senior Notes and, pursuant to the terms of the
indenture, the Company is in default on this debt. Under certain circumstances,
such obligations could become immediately due and payable. As of December 31,
1998, the principal balance due has been classified as a current liability in
the accompanying consolidated balance sheets. As discussed in Note 2, the
Company plans to solicit the consent of the Noteholders to convert the 12%
Senior Notes and accrued interest to Common Stock. There can be no assurance
that the requisite consent can be obtained or that conversion of the Notes to
Common Stock will occur.
F-20
61
RELATED PARTY DEBT AND CREDIT AGREEMENT
On May 30, 1997, the Company entered into an agreement (the "Credit
Agreement") with various lenders which were or may, thereafter, become parties
thereto (collectively referred to as the "Lenders"). ING (U.S.) Capital
Corporation ("ING") was Agent for the Lenders and Transamerica Business Credit
Corporation and Finova Capital Corporation were Co-Agents for the Lenders. ING
is a significant shareholder of the Company's common equity. The Credit
Agreement provided a $75,000 commitment of which $60,000 was to be utilized for
future acquisitions ("Expansion Loan Commitment"), and $15,000 was to be
utilized for general working capital requirements. Borrowings accrued interest
at the ING Alternate Base Rate (as defined in the Credit Agreement) plus 1.50%.
The Credit Agreement was originally scheduled to mature on May 20, 2000 and all
the Company's installed public pay telephones are pledged as collateral. The
Company borrowed $17,700 under the Expansion Loan Commitment to complete the
acquisitions of Advance, American, and London and to pay related acquisition and
credit facility fees. The Company also borrowed $7,300 of the Revolving Credit
Commitment for interest payments due under the $125,000 12% Senior Notes and for
general working capital purposes. Subsequent to the September 16, 1997 Court
ruling which vacated dial-around compensation (see Note 5), and pursuant to
certain terms of the Credit Agreement, the agent gave notice to the Company that
it was prohibited from making additional borrowings under the Credit Agreement,
without prior approval from the Lenders.
The Credit Agreement includes covenants which, among other things,
require the Company to maintain ratios as to fixed charges, debt to earnings,
current ratio and interest coverage (all as defined in the Credit Agreement).
Other covenants limit incurrence of additional long-term debt, the level of
capital expenditures, the incurrence of lease obligations and permitted
investments.
On February 24, 1998, the Credit Agreement was amended to increase the
Revolving Credit Commitment to $20,000 and to decrease the Expansion Loan
Commitment to $55,000 (the "First Amendment"). The amount available for letters
of credit under the working capital commitment was reduced from $5,000 to $3,000
and certain covenants therein were modified. On the same date, the Company was
permitted to borrow an additional $3,000 for working capital purposes under the
Revolving Credit Commitment. On March 31, 1998, the Credit Agreement was further
amended (the "Second Amendment") to modify certain financial covenants.
On May 8, 1998, the Company amended the Credit Agreement (the "Third
Amendment") and Foothill Capital Corporation, as replacement Agent and Lender,
assumed all of the rights and obligations of the former Lenders. Under the Third
Amendment, the Revolving Credit Commitment remained at $20,000 and the Expansion
Loan Commitment was reduced to $20,000. Interest is payable monthly in arrears
at 2% above the Lender's reference rate (as defined in the Third Amendment) and
the maturity date of the Credit Agreement was extended to May 8, 2001. Certain
financial covenants under the Credit Agreement were also modified. The Company
incurred $1,174 in fees and expenses in connection with the Third Amendment, of
which $328 is included in other unusual charges and contractual settlements in
the Company's consolidated statements of operations.
During the second quarter of 1998, the Company borrowed $10,547
under the Revolving Credit Commitment for interest payments due under the
Company's $125,000, 12% Senior Notes, to fund acquisition and financing costs
and for working capital. On July 3, 1998, the Company borrowed an additional
$1,453, the remaining amount available under the Credit Agreement, to finance
the cost of equipment upgrades relating to the pay telephones acquired as result
of the TDS acquisition (See Note 4).
At December 31, 1998, the Company was not in compliance with certain
financial covenants and was in default under its Credit Agreement. Under certain
circumstance, such obligations could become immediately due and payable.
Accordingly, the Company has classified the amounts due under the Credit
Agreement as a current liability in the accompanying consolidated balance sheet
at December 31, 1998. The Company has had discussions with the Agent and has
requested an additional advance for working capital purposes.
There can be no assurance that the Agent will advance the additional funds
requested. Further, there can be no assurance that the Agent will not take such
other action that it deems necessary to collect the balance due on the debt.
F-21
62
CREDIT FACILITY REPAID ON DECEMBER 18, 1996
In a transaction consummated on March 15, 1996, the Company borrowed
$30,531 (out of a total credit facility ("Credit Facility") commitment of
$37,250) from ING (U.S.) Capital Corporation and one other lender (collectively
known as the "Lenders"). The Company used the funds to complete the Paramount
and IPP acquisitions, to repay all outstanding long-term debt and capital lease
obligations which had a secured interest in the Company's installed phones at
March 15, 1996, redeem the 10% Preferred, 7% Preferred and 8% Preferred and to
pay related transaction fees. In connection with the repayments, the Company
recorded an extraordinary loss of $267, or $0.05 per share. All of the Company's
installed phones were pledged as collateral to the Credit Facility. On September
13, 1996, concurrent with the acquisitions of Amtel and POA, the Lenders amended
the Credit Facility, increasing the maximum borrowings available under the
Credit Facility to $41,000. The Company then borrowed an additional $8,777 and
used $5,950 of the proceeds to complete the Amtel and POA acquisitions and the
remaining proceeds for working capital and payment of certain related
acquisition expenses. Subsequently, the Credit Facility was further amended to
$43,000. The Company repaid the Credit Facility on December 18, 1996 and
recognized an extraordinary loss of $9,810, or $1.79 per share, consisting
primarily of the write-off of the remaining unamortized value assigned to the
Nominal Value Warrants and related unamortized deferred financing costs.
A portion of the Credit Facility ($29,000) was convertible into Series B
Preferred at the ratio of 833 shares for each $100 in outstanding debt and
interest. Concurrent with the repayment of the Credit facility on December 18,
1996, the Series B Preferred was canceled. Additionally, the Lenders received
warrants to purchase 204,824 shares of Series A Preferred at an exercise price
of $0.20 per share. The debt under the Credit Agreement was initially recorded
net of an allocation of the fair value of the Lender's Warrants, such fair value
being determined using the Black-Scholes valuation model.
On March 15, 1996, concurrent with the consummation of the Credit
Facility, the Company redeemed the 10%, 8% and 7% Preferred through cash
payments of $1,117 and the issuance of 34,436 shares of 14% Preferred. In the
aggregate, $6,475 of the Company's outstanding obligations, including portions
of the purchase price for the pending acquisitions, was liquidated by issuing
107,918 shares of 14% Preferred. The $2,002 excess of the redemption price of
the preferred issues redeemed over their aggregate carrying value was recorded
as a reduction of earnings available to common shareholders.
9. LEASES
OPERATING LEASES
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 2003.
Future minimum noncancellable payments under operating leases are as
follows:
1999 $2,294
2000 2,127
2001 1,539
2002 835
2003 435
After 2003 --
------
$7,230
======
Rent expense under all operating leases was $474, $1,868 and $2,622 for
the years ended December 31, 1996, 1997 and 1998, respectively.
F-22
63
CAPITAL LEASES
During 1996, as part of the acquisitions of IPP and POA, the Company
assumed capital lease obligations. Leased assets include installed public pay
telephones, office equipment and vehicles. As of December 31, 1996, the Company
had paid off all capital leases secured by installed public pay telephones.
Assets recorded under capital leases are as follows:
December 31
------------------
1997 1998
---- ----
Office Equipment $ 779 $ 779
Less accumulated amortization (466) (602)
----- -----
$ 313 $ 177
===== =====
The Company repaid $130 and $92 of the outstanding obligations under
capital leases during 1997 and 1998, respectively. Following are maturities of
capital lease obligations for each of the next five years:
1999 $17
2000 2
2001 --
2002 --
2003 --
---
$19
===
10. INCOME TAXES
No provisions for income tax were required and no income taxes were paid
for the years ended December 31, 1996, 1997 or 1998 because of operating losses
generated by the Company. Deferred tax assets and (liabilities) are as follows:
December 31
-------------------------
1997 1998
-------- --------
Federal net operating loss carryforward $ 12,073 $ 19,248
Depreciation and amortization 512 3,057
Allowance for doubtful accounts receivable 172 324
-------- --------
Gross deferred tax assets 12,757 22,629
Valuation allowance on deferred tax assets (12,757) (22,629)
-------- --------
Net deferred tax assets $ - $ -
======== ========
A valuation allowance has been provided against the deferred tax assets
since 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 $56,600, if not utilized, will
expire between the years 2002 to 2018. Internal Revenue Code Section 382
provides for the limitation on the use of net operating loss carryforwards in
years subsequent to significant changes in ownership. As a result of the
Company's Initial Public Offering in 1988 and certain other transactions,
including acquisitions utilizing proceeds from the Company's Common Stock and
the Company Equity Offering, changes in ownership have occurred resulting in
limitations on the use of net operating loss carryforwards. The extent of
limitations as a result of significant changes in ownership has not been
determined by the Company. The tax benefit as a percentage of the loss before
taxes differs from the statutory tax rate due primarily to the amortization of
intangibles, which is not deductible for tax purposes, and the valuation
allowance on deferred tax assets.
F-23
64
11. PREFERRED STOCK MANDATORILY REDEEMABLE
Preferred stock mandatorily redeemable consisted of the following:
December 31
-------------
1997 1998
---- ----
14% Cumulative Redeemable Convertible Preferred Stock ($60 stated value -
200,000 shares authorized; 107,918 shares issued and outstanding; cumulative
dividends issuable of 30,229 shares at December 31, 1997 (valued at $851) and
50,609 shares at December 31, 1998 (valued at $1,118); mandatory redemption
amount of $8,289 and $9,512, respectively; due June 30, 2000) $7,716 $9,112
====== ======
The Company records dividends, declared and undeclared, at their fair
market value and recognizes the difference between the carrying value of the 14%
Preferred and the mandatory redemption amount through monthly accretions using
the interest method. The carrying value of the 14% Preferred was increased by
$102 in 1996, $494 in 1997 and $1,128 in 1998 through accretions. Each share of
14% Preferred is entitled to receive a quarterly dividend of 0.035 shares of 14%
Preferred. Each share of 14% Preferred is convertible into 10 shares of Common
Stock.
12. NON-MANDATORILY REDEEMABLE PREFERRED STOCK, COMMON STOCK AND OTHER
SHAREHOLDERS' EQUITY (DEFICIT)
Non-mandatorily Redeemable Preferred Stock, Common Stock and Other
Shareholders' Equity (Deficit) consisted of the following:
December 31
------------------------
1997 1998
---------- ---------
Series A Special Convertible Preferred Stock
($0.20 par value, $0.20 stated value - 250,000
shares authorized; no shares outstanding) -- --
Common Stock
($0.01 par value - 50,000,000 shares authorized;
16,360,829 and 18,754,133 shares issued and
outstanding at December 31, 1997 and 1998, respectively) $ 164 $ 188
Additional paid-in capital 62,600 61,233
Accumulated deficit (66,806) (113,019)
---------- ---------
($ 4,042) ($ 51,598)
========== =========
On February 23, 1996, the Company created three new classes of
preferred stock: (i) Series A Preferred; (ii) Series B Preferred; and (iii) 14%
Preferred.
On March 15, 1996, concurrent with entering into the Company's former
Credit Facility, the Company redeemed its 10%, 8% and 7% Preferred for cash
payments aggregating $1,117 and 34,436 shares of 14% Preferred. In the
aggregate, $6,475 of the Company's outstanding obligations, including portions
of the purchase price for the IPP and Paramount acquisitions, was liquidated by
issuing 107,918 shares of 14% Preferred. The $2,002 excess of the redemption
price of the preferred issues redeemed over their aggregate carrying value was
recorded as a reduction of earnings available to common shareholders.
On June 27, 1996, the shareholders of the Company approved an amendment
to the Articles of Incorporation which authorizes the Company to have
outstanding 60,000,000 shares, of which 50,000,000 shares are to be classified
as Common Stock and 10,000,000 shares as Preferred Stock.
F-24
65
COMPANY EQUITY OFFERING AND OTHER ISSUANCES OF COMMON STOCK
On December 18, 1996, the Company sold 6,750,000 shares of Common Stock
at the price of $3.00 per share and received proceeds, net of offering expenses,
of $18,295. On January 29, 1997, the Company issued an additional 1,012,500
shares of Common Stock at the price of $3.00 per share and received net proceeds
of $2,825.
On December 31, 1996, the Company converted $248 of debt owed to a
related party into 99,119 shares of Common Stock or $2.50 per share,
representing the market price of the Common Stock on the day the Company's Board
of Directors approved the conversion.
On January 2, 1997, an executive officer of the Company converted an
outstanding loan and accrued interest of $374 to 124,747 shares of Common Stock.
On October 23, 1997, the Company issued 75,000 shares of Common Stock to the
five non-employee directors of the Company for services rendered for the two
years ended May 1997.
COMMON STOCK SHARES RESERVED FOR POSSIBLE ISSUANCE
As of December 31, 1998, the Company had reserved 6,535,600 shares of
Common Stock for issuance under the following scenarios: (i) exercise of
warrants to purchase 89,912 shares of Series A Preferred Stock, immediately
convertible into 1,798,240 shares of Common Stock; (ii) conversion of 158,527
shares of 14% Preferred into 1,585,268 shares of Common Stock; (iii) exercise of
308,929 Nominal Value Warrants; (iv) exercise of 926,428 warrants; (v) the
exercise of 789,496 stock options; and (vi) the exercise of 1,127,239 options
under the 1997 Stock Incentive Plan. Substantially all of the shares reserved
for future issuance, other than the shares issued under the 1997 Stock Incentive
Plan, were registered on January 24, 1997.
PREFERRED STOCK DIVIDENDS
On December 31, 1995, the Company had dividends in arrears payable to
preferred shareholders in the aggregate amount of $827. On March 15, 1996, the
10%, 8% and 7% Preferred, including dividends in arrears, were either paid or
converted to 14% Preferred.
STOCK WARRANT ACTIVITY
Activity for warrants exercisable into common stock during 1996, 1997
and 1998 was as follows:
Number Weighted Average
of Shares Exercise Price
--------- ----------------
BALANCE, DECEMBER 31, 1995 580,351 $ 6.40
Granted:
Nominal Value Warrants 2,018,942 0.01
Pursuant to anti-dilution provisions 322,958 2.37
To vendors 400,000 6.00
---------
Total Granted 2,741,900 1.16
Exercised (1,035,137) 0.01
Canceled (175,000) 6.00
---------
BALANCE, DECEMBER 31, 1996 2,112,114 2.40
Granted pursuant to
anti-dilution provisions 16,798 2.33
Exercised (309,754) .01
Canceled (189,991) 7.71
---------
BALANCE, DECEMBER 31, 1997 1,629,167 2.22
Granted to Directors 100,000 1.88
Exercised (375,804) .08
Canceled (118,006) 5.45
---------
BALANCE, DECEMBER 31, 1998 1,235,357 2.54
=========
All warrants outstanding at each period end are exercisable.
F-25
66
On March 15, 1996, Nominal Value Warrants to purchase 2,018,942 shares
of Common Stock were issued in conjunction with the IPP and Paramount
acquisitions, redemption of the 10%, 8% and 7% Preferred, and conversion of
certain related party debt of the Company to the 14% Preferred. The Nominal
Value Warrants expire on March 13, 2001. The estimated the fair market value of
the Nominal Value Warrants was $4,975, using the Black-Scholes valuation method,
of which $3,886 (the amount attributable to the Nominal Value Warrants provided
to related parties in connection with the redemption of the 10%, 8% and 7%
Preferred shares and conversion of certain debt) was included in other unusual
charges and contractual settlements in the Company's consolidated statements of
operations.
In April 1998, the Company granted warrants to purchase 100,000 shares
of Common Stock at an exercise price of $1.875 per share to its non-employee
Directors as compensation for services during the 1997-98 service year. The fees
for such services, valued at $80 using the Black-Scholes valuation method, were
included in selling, general and administrative expenses.
On March 15, 1996, the Company issued warrants to purchase 204,824
shares of Series A Preferred (the "Series A Warrants") to two former lenders at
an exercise price of $0.20 per share. Each share of Series A Preferred is
convertible into 20 shares of Common Stock.
On February 7, 1997, one of the Company's former lenders exercised
warrants for 12,500 shares of Series A Preferred (with net proceeds to the
Company of $3) which were immediately converted into 250,000 shares of common
stock. On October 13, 1998, the Company received notice from this former lender
which purported to exercise its put right as defined in the agreement for the
Series A Warrants (the "Warrant Agreement"), with respect to 89,912 Series A
Warrants and 124,300 Common Shares. The Warrant Agreement specifies that the
Company is to redeem Series A Warrants that are convertible into shares of
Common Stock (or shares of Common Stock obtained from such conversion) at a
value determined by a formula, subject to certain limitations, set forth
therein. In 1998, the Company recorded an accrued liability and a charge to
additional paid-in capital of $1,452 relating to this put. The Company is not
permitted to make payment pursuant to this purported exercise of a put right
under the indenture for the Company 12% Senior Notes. To make such a payment
would constitute a breach of the indenture. The Company intends to engage in
further negotiations with said former lender regarding such notice.
On November 13, 1998, the other former lender exercised Series A Warrants
immediately converted their Series A Convertible Preferred Stock to Common
Stock. This exercise resulted in the issuance of 2,017,500 shares of Common
Stock, net of Common Stock not issued in lieu of cash payment.
At December 31, 1997 and 1998, there were 192,324 and 89,912 warrants
which were exercisable into Series A Preferred. The warrants expire on April 1,
2006.
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 "Plan"). The
Plan provides for the issuance of incentive and non-qualified stock options to
purchase up to 2,000,000 shares of Common Stock 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 on the dates of grant to
substantially all officers and employees. The options granted provide for
graduated vesting, one-third each year on the anniversary of the date of grant,
and have a term of eight years.
Other options to purchase Common Stock are granted by the Company at
the discretion of the Board of Directors to employees, officers, directors and
others, and generally are exercisable immediately upon issuance, have terms of
three to five years and are issued with exercise prices at or slightly below
quoted market value of the Company's Common Stock on the date of grant. At
December 31, 1997 and 1998, 726,813 and 1,165,243 options, respectively, were
exercisable.
F-26
67
Stock option activity during 1996, 1997 and 1998 was as follows:
Number Weighted Average
of Shares Exercise Price
--------- ----------------
BALANCE, DECEMBER 31, 1995 471,764 $ 6.56
Granted:
Contractual settlement with former executive 5,000 6.00
Pursuant to anti-dilution provisions 556,898 2.11
---------
Total Granted 561,898 2.14
Exercised -- --
Canceled (12,332) 6.00
---------
BALANCE, DECEMBER 31, 1996 1,021,330 2.98
Granted:
1997 Stock Incentive Plan 1,592,400 3.12
Pursuant to anti-dilution provisions 37,743 2.19
---------
Total options granted 1,630,143 3.10
Exercised (100,000) 1.02
Canceled (467,660) 3.61
---------
BALANCE, DECEMBER 31, 1997 2,083,813 2.99
Granted to former executive 105,000 0.81
Canceled (272,078) 3.02
---------
BALANCE, DECEMBER 31, 1998 1,916,735
=========
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 using the intrensic 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 6.20% for
1996, 6.35% for 1997, and 5.95% for 1998; expected life equal to the period of
time remaining in which the options or warrants can be exercised; and expected
volatility of 99% in 1996, 81% in 1997 and 85% in 1998. There were no
compensation costs charged to operations in 1996, 1997 and 1998 for stock
options issued to employees. Had compensation cost been determined on the basis
of fair value pursuant to SFAS No. 123, net loss and the loss per share would
have increased as follows:
1996 1997 1998
---- ---- ----
Net loss:
As reported ($26,649) ($23,254) ($44,817)
Pro forma (29,930) (24,668) ( 46,418)
Loss per share (basic and diluted):
As reported (5.29) (1.51) (2.73)
Pro forma (5.45) (1.60) (2.83)
Weighted average fair value of options and warrants granted during:
1996 $ 1.76
1997 2.42
1998 0.42
F-27
68
The following is a summary of the status of options and warrants
outstanding at December 31, 1998:
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 - $0.01 308,929 2.2 years $ 0.01 308,929 $ 0.01
0.81 - 2.69 2,074,928 4.9 years 2.26 1,623,436 2.17
4.00 - 6.00 747,235 4.3 years 4.75 447,235 5.25
19.50 21,000 0.1 years 19.50 21,000 19.50
13. COMMITMENTS AND CONTINGENCIES
SEVERANCE AGREEMENTS
During 1996, the Company settled the amounts owed under Separation
Agreements with three of its former officers. Under the terms of the Separation
Agreements, the Company was obligated to pay the former officers the remainder
of their employment agreements and the Company agreed to accelerate the vesting
of options for 285,636 shares of the Company's Common Stock at $2.38 to $2.75
per share.
CONTINGENCIES
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.
14. OTHER REVENUES AND OTHER UNUSUAL CHARGES AND CONTRACTUAL SETTLEMENTS
Other revenues include $900 in 1996 and $300 in 1997 of income relating
to amortization of deferred revenue received as a result of a signing bonus
received in connection with a services agreement with an operator service
provider.
Other unusual charges and contractual settlements is comprised of:
December 31
-------------------------------
1996 1997 1998
---- ---- ----
Settlement of employee contractual obligations $ 342 $ 147 $ 92
Termination of CCI acquisition -- 7,771 --
Termination of Davel Merger -- -- 1,426
Settlement - operator service agreement -- -- 545
Other contractual settlements 211 210 190
Ordinary loss on early repayment of debt 631 -- --
Nominal Value Warrants 3,886 -- --
Amendment to Credit Agreement -- -- 328
Amendment to Indenture-12% Senior Notes -- 761 --
Write-off receivables and deposits 436 -- --
Relocation and employment related costs 429 -- --
Other 137 206 181
------ ------ ------
$6,072 $9,095 $2,762
====== ====== ======
F-28
69
15. CONDENSED CONSOLIDATING FINANCIAL STATEMENT DATA
The Company's wholly-owned subsidiary, Cherokee Communications, Inc.
("Cherokee") which was acquired January 1, 1997, is a guarantor of the $125,000
12% Senior Notes, due 2006. The indentures to the 12% Senior Notes provide for
joint and several, unconditional guarantees by all of the Company's
subsidiaries. The following are the condensed consolidating financial statements
of PhoneTel and Cherokee, the Company's only active subsidiary, as of December
31, 1998 and for the year ended December 31, 1998.
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
Balance Sheet, at December 31, 1998
PhoneTel Cherokee(a) Eliminations Consolidated
--------- ---------- ------------ ------------
Current assets $ 15,672 $ 5,506 -- $ 21,178
Property and equipment, net 23,715 4,122 -- 27,837
Intangible assets, net 59,009 42,064 -- 101,073
Other non-current assets 65,815 -- ($ 65,229) 586
--------- --------- --------- ---------
Total $ 164,211 $ 51,692 ($ 65,229) $ 150,674
========= ========= ========= =========
Current liabilities $ 175,434 $ 17,720 $ 193,154
Inter-company debt -- 65,229 ($ 65,229) --
Long-term debt and capital leases 6 -- -- 6
14% Preferred stock 9,112 -- -- 9,112
Other equity (deficit) (20,341) (31,257) -- (51,598)
--------- --------- --------- ---------
Total $ 164,211 $ 51,692 ($ 65,229) $ 150,674
========= ========= ========= =========
Income Statement, for the year
ended December 31, 1998
Total revenues $ 59,452 $ 31,934 -- $ 91,386
Operating expenses 76,425 41,413 -- 117,838
--------- --------- --------- ---------
Income (loss) from operations (16,973) (9,479) -- (26,452)
Other income (expense), net (7,482) (10,883) -- (18,365)
--------- --------- --------- ---------
Net income (loss) $ (24,455) $ (20,362) -- $ (44,817)
========= ========= ========= =========
(a) The Cherokee separate financial statement data is based upon allocations
of the consolidated amounts and reflects the push down of the Company's
debt, related interest expense and allocable debt issue costs associated
with the Company's acquisition of Cherokee.
F-29
70
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
---------------- --------------------------------- ---------------- ----------------
Balance Additions
---------------------------------
at Charged to From Deductions Balance
beginning costs, expenses acquired relating to at end
of year or tax benefit company write-offs of year
---------------- --------------- ---------------- ---------------- ----------------
YEAR ENDED DECEMBER 31, 1996
Allowances deducted from related
balance sheet accounts:
Accounts Receivable $40 $92 ($40) $92
Deferred Tax Assets 6,248 3,455 9,703
Intangible Assets 3,792 7,768 (1,368) 10,192
YEAR ENDED DECEMBER 31, 1997
Allowances deducted from related
balance sheet accounts:
Accounts Receivable 92 267 $148 507
Deferred Tax Assets 9,703 3,054 12,757
Intangible Assets 10,192 15,528 25,720
YEAR ENDED DECEMBER 31, 1998
Allowances deducted from related
balance sheet accounts:
Accounts Receivable 507 428 935
Deferred Tax Assets 12,757 9,872 22,629
Intangible Assets 25,720 17,132 42,852
F-30
71
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PHONETEL TECHNOLOGIES, INC.
March 31, 1999 By:/s/ Peter G. Graf
----------------------------------------
Peter G. Graf
Chairman of the Board 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/ Peter G. Graf Chairman of the Board, March 31, 1999
- ------------------------- Chief Executive Officer,
Peter G. Graf and Director
/s/ Richard P. Kebert Chief Financial Officer and March 31, 1999
- ------------------------- Treasurer
Richard P. Kebert
/s/ Joseph Abrams Director March 31, 1999
- -------------------------
Joseph Abrams
/s/ George H. Henry Director March 31, 1999
- -------------------------
George H. Henry
/s/ Aron Katzman Director March 31, 1999
- -------------------------
Aron Katzman
/s/ Steven Richman Director March 31, 1999
- -------------------------
Steven Richman
72
EXHIBIT INDEX
10.96 Pay Phone Communications Services Agreement dated as of November 16,
1998 by and between Qwest Communications Corporation and USLD
Communications, Inc. and PhoneTel Technologies, Inc.
21.1 Subsidiaries of PhoneTel Technologies, Inc.
27 Financial Data Schedule for the Year Ended December 31, 1998
- ----------------