1
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE TRANSITION PERIOD FROM ____ TO ____.
COMMISSION FILE NUMBER 0-16715
PHONETEL TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
OHIO 34-1462198
---- ----------
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OF 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
--------------
(ISSUER`S TELEPHONE NUMBER, INCLUDING AREA CODE)
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
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: AS OF AUGUST 12,
1999, 18,754,133 SHARES OF THE REGISTRANT'S COMMON STOCK, $.01 PAR VALUE, WERE
OUTSTANDING.
1
2
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
FORM 10-Q
SIX AND THREE MONTHS ENDED JUNE 30, 1999
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1998
and June 30, 1999................................................................3
Consolidated Statements of Operations for the Six and Three
Months Ended June 30, 1998 and 1999..............................................4
Statements of Changes in Mandatorily Redeemable Preferred
Stock for the Year Ended December 31, 1998 and
the Six Months Ended June 30, 1999...............................................5
Statements of Changes in Non-mandatorily Redeemable Preferred
Stock, Common Stock and Other Shareholders' Equity (Deficit)
for the Year Ended December 31, 1998 and
the Six Months Ended June 30, 1999...............................................6
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1998 and 1999..............................................7
Notes to Consolidated Financial Statements...........................................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................................16
Item 3. Quantitative and Qualitative Disclosures about
Market Risk......................................................................23
PART II. OTHER INFORMATION
Item 3. Defaults Upon Senior Securities.....................................................24
Item 6. Exhibits and Reports on Form 8-K....................................................24
Signatures.......................................................................................................25
2
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
- -------------------------------------------------------------------------------
(UNAUDITED)
DECEMBER 31 JUNE 30
1998 1999
--------- ---------
ASSETS
Current assets:
Cash $ 5,768 $ 5,259
Accounts receivable, net of allowance for doubtful
accounts of $935 and $997, respectively 14,021 11,972
Other current assets 1,389 2,046
--------- ---------
Total current assets 21,178 19,277
--------- ---------
Property and equipment, net 27,837 24,371
Intangible assets, net 101,073 94,038
Other assets 586 624
--------- ---------
$ 150,674 $ 138,310
========= =========
LIABILITIES AND EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt $ 165,239 $ 167,551
Accounts payable 11,254 10,151
Accrued expenses:
Location commissions 2,756 2,263
Personal property and sales tax 3,145 2,675
Interest 8,728 16,212
Salaries, wages and benefits 335 819
Other 1,703 1,747
--------- ---------
Total current liabilities 193,160 201,418
--------- ---------
Commitments and contingencies -- --
14% Cumulative Preferred Stock Mandatorily Redeemable
(redemption amount $10,189 due June 30, 2000) 9,112 9,901
Non-mandatorily Redeemable Preferred Stock,
Common Stock and Other Shareholders' Equity (Deficit) (51,598) (73,009)
--------- ---------
$ 150,674 $ 138,310
========= =========
The accompanying notes are an integral part of these financial statements
3
4
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30 JUNE 30
---------------------------- -----------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
REVENUES:
Coin calls $ 26,935 $ 20,863 $ 13,747 $ 10,452
Non-coin telecommunication services 22,477 18,832 11,572 9,470
Other 39 69 9 59
------------ ------------ ------------ ------------
49,451 39,764 25,328 19,981
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Line and transmission charges 14,632 10,891 7,716 4,763
Telecommunication and validation fees 5,856 4,653 3,142 2,305
Location commissions 6,559 6,402 3,409 3,316
Field operations 10,534 10,539 5,004 5,377
Selling, general and administrative 6,433 5,105 3,359 2,586
Depreciation and amortization 12,662 12,908 6,356 6,475
Other unusual charges and contractual settlements 994 73 851 27
------------ ------------ ------------ ------------
57,670 50,571 29,837 24,849
------------ ------------ ------------ ------------
Loss from operations (8,219) (10,807) (4,509) (4,868)
OTHER INCOME (EXPENSE):
Interest expense - related parties (1,036) -- (320) --
Interest expense - others (8,103) (9,925) (4,340) (5,111)
Interest income 74 68 37 33
Other 236 42 236 12
------------ ------------ ------------ ------------
(8,829) (9,815) (4,387) (5,066)
------------ ------------ ------------ ------------
NET LOSS ($ 17,048) ($ 20,622) ($ 8,896) ($ 9,934)
============ ============ ============ ============
Earnings per share calculation:
Net loss ($ 17,048) ($ 20,622) ($ 8,896) ($ 9,934)
Preferred dividend payable in kind (213) (8) (116) (4)
Accretion of 14% Preferred to its redemption value (456) (781) (225) (399)
------------ ------------ ------------ ------------
Net loss applicable to common shareholders ($ 17,717) ($ 21,411) ($ 9,237) ($ 10,337)
============ ============ ============ ============
Net loss per common share, basic and diluted ($ 1.07) ($ 1.14) ($ 0.56) ($ 0.55)
============ ============ ============ ============
Weighted average number of shares, basic and diluted 16,567,288 18,754,133 16,598,384 18,754,133
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
4
5
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
STATEMENTS OF CHANGES IN MANDATORILY REDEEMABLE PREFERRED STOCK
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
- -------------------------------------------------------------------------------
(UNAUDITED)
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1998 JUNE 30, 1999
------------------ ------------------
SHARES AMOUNT SHARES AMOUNT
------- ------- ------- -------
14 % CUMULATIVE REDEEMABLE
CONVERTIBLE PREFERRED STOCK
Balance at beginning of year 138,147 $ 7,716 158,527 $ 9,112
Dividends payable-in-kind 20,380 268 11,291 8
Accretion of carrying value to amount
payable at redemption on June 30, 2000 -- 1,128 -- 781
------- ------- ------- -------
Balance at end of year 158,527 $ 9,112 169,818 $ 9,901
======= ======= ======= =======
The accompanying notes are an integral part of these financial statements
5
6
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
STATEMENTS OF CHANGES IN NON-MANDATORILY REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
-------------------------------------------------------------------------------
(UNAUDITED)
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1998 JUNE 30, 1999
-------------------------- -------------------------
SHARES AMOUNT SHARES AMOUNT
----------- ---------- ------------ ---------
SERIES A SPECIAL CONVERTIBLE
PREFERRED STOCK
Balance at beginning of year - - - -
Exercise of warrants 100,875 $20 - -
Conversion to common stock (100,875) (20) - -
----------- ---------- ------------ ---------
Balance at end of period - - - -
=========== ---------- ============ ---------
COMMON STOCK
Balance at beginning of year 16,360,829 164 18,754,133 $188
Exercise of warrants and options 375,804 4 - -
Conversion of Series A Preferred 2,017,500 20 - -
----------- ---------- ------------ ---------
Balance at end of period 18,754,133 188 18,754,133 188
=========== ---------- ============ ---------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year 62,600 61,233
Exercise of warrants and options 25 -
Exercise of warrants - Series A Preferred (20) -
Put under warrants issued for Series A Preferred (1,452) -
Other issuances of stock 80 -
---------- ---------
Balance at end of period 61,233 61,233
---------- ---------
ACCUMULATED DEFICIT
Balance at beginning of year (66,806) (113,019)
Net loss for the period (44,817) (20,622)
14% Preferred dividends payable-in-kind
and accretion (1,396) (789)
---------- ---------
Balance at end of period (113,019) (134,430)
---------- ---------
TOTAL NON-MANDATORILY REDEEMABLE
PREFERRED STOCK, COMMON STOCK AND
OTHER SHAREHOLDERS' EQUITY (DEFICIT) ($51,598) ($73,009)
========== =========
The accompanying notes are an integral part of these financial statements.
6
7
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- -------------------------------------------------------------------------------
(UNAUDITED)
SIX MONTHS ENDED JUNE 30
---------------------------
1998 1999
-------- --------
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss ($17,048) ($20,622)
Adjustments to reconcile net loss to net cash flow
from operating activities:
Depreciation and amortization 12,662 12,908
Increase in allowance for doubtful accounts 476 398
Gain on disposal of assets (236) (42)
Changes in current assets (3,991) 994
Changes in current liabilities 496 5,947
-------- --------
(7,641) (417)
-------- --------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchases of property and equipment (1,887) (863)
Acquisitions (1,336) --
Deferred charges - commissions and signing bonuses (376) (298)
Proceeds from sale of assets 331 56
Change in other assets (210) (38)
-------- --------
(3,478) (1,143)
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from debt issuances 13,636 2,500
Principal payments on borrowings (503) (190)
Debt financing and restructuring costs (1,534) (1,259)
Proceeds from warrant and option exercises 29 --
-------- --------
11,628 1,051
-------- --------
Increase (decrease) in cash 509 (509)
Cash at beginning of period 6,519 5,768
-------- --------
Cash at end of period $ 7,028 $ 5,259
======== ========
The accompanying notes are an integral part of these financial statements.
7
8
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE SIX AND THREE MONTHS ENDED JUNE 30, 1999
(IN THOUSANDS OF DOLLARS EXCEPT FOR INSTALLED PUBLIC PAY TELEPHONE, SHARE AND
- -----------------------------------------------------------------------------
PER SHARE AMOUNTS)
- ------------------
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included and all intercompany balances and transactions have been
eliminated. Operating results for the six and three months ended June 30, 1999
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1999. The consolidated balance sheet information at December
31, 1998 was derived from the audited financial statements included in the
Company's Annual Report on Form 10-K. These interim financial statements should
be read in conjunction with that Form 10-K report.
Certain amounts relating to 1998 have been reclassified to conform to
the current quarter presentation. The reclassifications have had no impact on
total assets, shareholders' equity (deficit) or net loss as previously reported.
2. DEBT RESTRUCTURING AND CHAPTER 11 BANKRUPTCY FILING
In January 1999, the Company announced that it had reached an agreement
in principle with an Unofficial Committee of Noteholders (the "Unofficial
Committee") of its $125,000 aggregate principal amount 12% Senior Notes, due
2006 (the "Senior Notes") providing for the conversion of the Senior Notes into
95% of the reorganized Company's common stock (the "Restructuring"). The
Unofficial Committee is comprised of certain holders of the Senior Notes
representing approximately 59.3% in principal amount of the Senior Notes. The
Restructuring is being implemented by a proposed plan of reorganization (the
"Prepackaged Plan") and further provides that existing preferred and common
shareholders are to receive the remaining 5% of the reorganized Company's common
stock (as well as warrants to purchase approximately 11% of the reorganized
Company's common stock at an exercise price of $10.50 per share, assuming
10,000,000 common shares outstanding post-restructuring). These equity interests
would be subject to dilution by certain other equity issuances, including
issuances upon the exercise of certain warrants and awards to purchase up to an
aggregate of 5% of the common stock under a new management incentive plan
proposed as part of the Prepackaged Plan. The terms of the Prepackaged Plan are
summarized in a Disclosure Statement mailed on May 11, 1999 to holders of record
as of April 23, 1999 of the Senior Notes and the 14% Cumulative Redeemable
Convertible Preferred Stock (the "14% Preferred").
The Company solicited acceptances of the Prepackaged Plan from the
holders of the Senior Notes and 14% Preferred in anticipation of the
commencement of a case under chapter 11 of the Bankruptcy Code (the "Case").
Effective June 11, 1999, the Company obtained acceptances of the Prepackaged
Plan from holders of 99.9 percent of the Senior Notes and 100 percent of the 14%
Preferred shares voting in response to the solicitation. Such acceptances
substantially exceed the levels required to confirm the Prepackaged Plan.
On July 14, 1999, the Company commenced the Case in the U.S. Bankruptcy
Court in the Southern District of New York (the "Court") and is continuing in
the operation of its business as a debtor-in-possession. The Company also
obtained an order from the Court which allows the Company to pay prepetition and
postpetition claims of employees, trade and other creditors, other than the
Senior Note claims, in the ordinary course of business. The Court has scheduled
a confirmation hearing for September 2, 1999, at which time the Court will hear
objections, if any, to the Company's Prepackaged Plan. Upon confirmation, the
Company shall promptly implement the Restructuring described above.
8
9
The Company believes that it will be able to implement the
Restructuring, which would result in material increases in working capital and
stockholders' equity. In addition, cash flow required for debt service would be
reduced by $15,000 annually upon conversion of the Senior Notes to common stock.
Assuming implementation of the Restructuring, management believes, but cannot
assure, that cash flow from operations (including substantial collections of
accounts receivable from dial-around compensation) or from additional financing
will allow the Company to sustain its operations and meet its obligations
through the remainder of 1999. In the event that the Company and the holders of
the Senior Notes are unable to implement the Restructuring and the Company is
unable to obtain a revised working capital facility, the Company will be
required to evaluate other available options.
3. ACCOUNTS RECEIVABLE AND DIAL-AROUND COMPENSATION
A dial-around call occurs when a non-coin call is placed from the
Company's public pay telephone which utilizes any carrier other than the
presubscribed carrier (the Company's dedicated provider of long distance and
operator assisted calls). Dial-around calls include 1-800 subscriber calls, as
well as 1010xxx calls to access a long distance carrier or operator service
provider selected by the caller. The Company receives revenues from such
carriers and records those revenues based upon the per-phone or per-call rate
("dial around compensation") in effect under certain orders issued by the
Federal Communications Commission (the "FCC"). Retroactive changes in the
dial-around compensation rate resulting from said orders have been accounted for
as changes in accounting estimates and have been recorded as adjustments to
revenues at the beginning of the most recent period prior to the announcement of
such change. At December 31, 1998 and June 30, 1999, accounts receivable
included $13,905 and $10,949, respectively, arising from dial-around
compensation. Such receivables are typically received on a quarterly basis at
the beginning of the second quarter following the quarter in which such revenues
are recognized.
For the six months ended June 30, 1998 and 1999, revenues from non-coin
telecommunication services included $9,637 and $7,776, respectively, for
dial-around compensation. Revenues for the six months ended June 30, 1998 have
not been restated to reflect the retroactive reduction in dial-around
compensation recorded in the fourth quarter of 1998 as discussed below. If
revenues from dial-around compensation had been recorded at the revised rate in
the first six months of 1998 ($0.238 per call or $31.18 per month based on an
estimated 131 calls per month), revenues from dial-around compensation would
have been $8,078 for the six months ended June 30, 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, 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 ("Flex Ani")
and required the local exchange carriers ("LECs") to make such coding available
to the payphone providers as a transmit item included in the local access line
service.
9
10
In July 1997, the United States Court of Appeals for the District of
Columbia Circuit (the "Appeals 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 Appeals 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 Appeals 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.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC
98-48 1, which extended and waived certain requirements of certain LECs
regarding the provision of Flex Ani, which identify a call as originating from a
payphone. Without the transmission of Flex Ani, some of the interexchange
carriers have claimed they are unable to identify a call as a payphone call
eligible for dial-around compensation. With the stated purpose of assuring 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 Flex Ani
designation, but gave the IXCs a choice for computing the amount of compensation
for payphones on LEC lines not transmitting Flex Ani 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 Appeals Court again remanded the per-call
compensation rate to the FCC for further explanation without vacating the $0.284
per call rate mandated by the 1997 Payphone Order. The Appeals Court stated that
the FCC had failed to explain adequately its derivation of the $0.284 default
rate. The Appeals 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 comments
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 and 1998 Payphone
Orders to a cost-based method, citing technological impediments that it viewed
as inhibiting the marketplace and the unreliability of certain assumptions
underlying the market-based method as a basis for altering its analysis. In
setting the 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 amounts charged by LECs for providing
Flex Ani) will serve as the default per-call compensation rate for coinless
payphone calls from
10
11
March 1999 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.
The 1999 Payphone Order deferred a final ruling on the initial interim
period (November 7, 1996 to October 6, 1997) treatment of dial-around
compensation to a later, as yet unreleased order; however, it appears from the
1999 Payphone Order that the $0.238 per-call rate will be applied to the initial
interim period. Upon establishment of said rate, the FCC has further ruled that
a true-up will be made for all payments or credits, together with applicable
interest due and owing between the IXCs and the payphone service providers for
the payment period November 7, 1996 through the effective date of the $0.24
rate. In the fourth quarter of 1998, the Company recorded an adjustment to
reduce revenues previously recognized for the period from November 7, 1996 to
September 30, 1998 due to the further decrease in the dial-around compensation
rate from $0.284 to $0.238 per call. This adjustment of $6,075 included $1,559
recorded as revenue in the first six months of 1998 and $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. The Appeals Court
is expected to hear oral arguments on this matter in November 1999. 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 March 31, 1999 is $31.18 per pay telephone per
month based on $0.238 per call and 131 calls per pay telephone per month ($31.44
per month based on $0.24 per call after March 1999). 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 ($31.44 per month after March
1999).
4. LONG-TERM DEBT
Long-term debt consisted of the following:
December 31 June 30
1998 1999
------------ ------------
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. 40,014 42,500
Other notes payable 225 51
------------ ------------
$ 165,239 $ 167,551
============ ============
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 indenture to the Senior
Notes, as amended, contains 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 Senior Notes for 101% of their aggregate outstanding
principal value plus accrued and unpaid interest.
The Company has not paid the semiannual interest payments which were due
December 15, 1998 and June 15, 1999 on the 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 and June 30, 1999, the principal balance due has been
classified as a current liability in the accompanying consolidated balance
sheets. As discussed in Note 2, the Company has obtained the consent of the
requisite number of holders of the Senior Notes to convert the Senior Notes and
accrued interest to common stock and has
11
12
commenced a case under chapter 11 of the U.S. Bankruptcy Code. Conversion of the
Senior Notes to common stock is dependent upon the confirmation of the Company's
plan of reorganization by the Bankruptcy Court.
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 ("Revolving Credit
Commitment"). 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 Credit Agreement included covenants which, among other things,
required 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 limited 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 Revolving Credit 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 was 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. The Third
Amendment provided for a prepayment penalty and the modification of certain
financial covenants under the Credit Agreement. The Company incurred $1,174 in
fees and expenses in connection with the Third Amendment, of which $328 was
included in other unusual charges and contractual settlements in the Company's
consolidated statements of operations in the second quarter of 1998.
During the second quarter of 1998, the Company borrowed $10,547 under
the Revolving Credit Commitment for interest payments due under the 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 installed pay telephones acquired from TDS Telecommunications
Corporation on May 18, 1998.
At December 31, 1998, March 31, 1999 and June 30, 1999, the Company was
not in compliance with certain financial covenants and was in default under the
Credit Agreement. Accordingly, the Company has classified the amounts due under
the Credit Agreement as a current liability in the accompanying consolidated
balance sheets. In addition, beginning April 1, 1999, the Company was required
to pay the default rate of interest which is two percent per annum higher than
the otherwise applicable rate (11.75% at June 30, 1999).
In April 1999, the Company requested and received an additional advance
of $2,500 which increased the principal balance outstanding under its Revolving
Credit Commitment to $22,500. Proceeds of the advance were and are to be used
for the payment of professional fees and expenses, loan fees and certain
accounts payable. The Company also received a commitment from the Lenders to
provide $45,900 in debtor-in-possession financing
12
13
("D.I.P." financing) in anticipation of the Case described in Note 2. The
Company incurred $250 in fees relating to the additional advance and a $250 fee
for the debtor-in-possession financing commitment.
On July 21, 1999, the outstanding balance of the Credit Agreement was
paid from the proceeds of the Company's D.I.P. financing described below. The
Company incurred a loss from debt extinguishment of approximately $2,900,
including the write-off of deferred financing costs and an $800 prepayment
penalty, the payment of which penalty will be waived in the event the Company
obtains financing from its existing lender upon conclusion of the Case. The loss
will be reported as an extraordinary item in the third quarter of 1999.
DEBTOR-IN-POSSESSION LOAN AGREEMENT
On July 14, 1999, the Company entered into a debtor-in-possession loan
agreement ("D.I.P. Loan") with Foothill Capital Corporation. The D.I.P. Loan
provided a $45,900 revolving credit commitment, which was used to pay the
outstanding balance, including accrued interest, due under the Credit Agreement
on July 21, 1999. The Company also received an advance of $2,541 for working
capital purposes and has an additional $533 available for the payment of legal
and other costs associated with the Case.
Interest on the D.I.P. Loan is payable monthly in arrears at 3% above
the base rate (as defined in the D.I.P. Loan Agreement) through November 12,
1999 and 3.75% above the base rate thereafter. The loan is secured by
substantially all of the assets of the Company. The D.I.P. Loan Agreement
includes covenants which limits the incurrence of additional debt, capital
leases and liens and the disposal of assets. The D.I.P. Loan matures on the
earliest of the date on which the Company emerges from the Case, converts to a
case under chapter 7 of the Bankruptcy Code or November 15, 1999.
5. PREFERRED STOCK MANDATORILY REDEEMABLE
Mandatorily redeemable preferred stock consisted of the following:
December 31 June 30
1998 1999
---- ----
14% Cumulative Redeemable Convertible Preferred Stock;
$60 stated value - 200,000 shares authorized; 107,918 shares
issued and outstanding, cumulative dividends issuable of 50,609
shares at December 31, 1998 (valued at $1,118) and 61,900
shares at June 30, 1999 (valued at $1,126); mandatory
redemption amount of $10,189 due June 30, 2000 $ 9,112 $ 9,901
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. For the six months ended June 30, 1999, the carrying value
of the 14% Preferred was increased by $781 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.
13
14
6. 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 June 30
1998 1999
----------- ---------
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;
18,754,133 shares issued and outstanding at
December 31, 1998 and June 30, 1999) $ 188 $ 188
Additional paid-in capital 61,233 61,233
Accumulated deficit (113,019) (134,430)
-------- ----------
($51,598) ($73,009)
======== ==========
In January 1999, the Company granted options to purchase 35,000 shares
of common stock pursuant to an employment arrangement with a former officer at
an exercise price of $0.8125 per share. No compensation expense was recognized
as a result of this transaction.
In January 1998, warrants for 190,678 shares of common stock, including
warrants to purchase 179,996 shares of common stock with an exercise price of
$0.01 per share ("Nominal Value Warrants") were exercised by their holders. The
Company received proceeds of $27 as a result of the exercise of these warrants.
In April 1998, the Company granted warrants to purchase 100,000 shares of common
stock to its four non-employee Directors with an aggregate value of $80 and an
exercise price of $1.875 per share, as compensation for services during the
1997-98 service year. During the second quarter of 1998, Nominal Value Warrants
for 185,126 shares of common stock were exercised by their holders, including
Nominal Value Warrants for 89,998 shares of common stock held by a Director of
the Company. The Company received proceeds of $2 as a result of the exercise of
these Nominal Value Warrants.
7. TERMINATION OF MERGER WITH DAVEL COMMUNICATIONS GROUP, INC.
On June 11, 1998, the Company 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, the Company received a letter from Davel
purporting to terminate the Davel Merger Agreement. Thereafter, a complaint
against the Company was filed in the Court of Chancery of New Castle County,
Delaware by Davel, which was subsequently amended, alleging, among other things,
equitable fraud and breach of contract relating to the Davel Merger Agreement.
On October 27, 1998, the Company filed its answer to the amended complaint
denying the substantive allegations contained therein and filed a counterclaim
against Davel for breach of contract. At the same time, the Company 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. In December 1998, Peoples and Davel consummated the
transaction contemplated by the Peoples Merger Agreement.
The Company 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
14
15
amount. The Company 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 the
Company are without merit and is vigorously pursuing its claims against Davel
and Peoples.
8. 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.
9. 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 Senior
Notes. The following are the condensed consolidating financial statements of
PhoneTel and Cherokee as of June 30, 1999, and for the six months ended June 30,
1999.
Condensed Consolidating Financial Statements
Balance Sheet, at June 30, 1999
PhoneTel Cherokee(a) Eliminations Consolidated
-------- ----------- ------------ ------------
Current assets $ 14,381 $ 4,896 - $ 19,277
Property and equipment, net 20,998 3,373 - 24,371
Intangible assets, net 54,838 39,200 - 94,038
Other non-current assets 65,853 - ($65,229) 624
----------- ------------ ---------- --------------
Total $ 156,070 $ 47,469 ($65,229) $ 138,310
=========== ============ ========== ==============
Current liabilities $ 182,008 $ 19,410 - $ 201,418
Intercompany debt - 65,229 ($65,229) -
14% Preferred stock 9,901 - - 9,901
Other equity (deficit) (35,839) (37,170) - (73,009)
----------- ------------ ---------- --------------
Total $ 156,070 $ 47,469 ($65,229) $ 138,310
=========== ============ ========== ==============
Statement of Operations, for the six months ended June 30, 1999
Total revenues $ 28,853 $ 10,911 - $ 39,764
Operating expenses 37,629 12,942 - 50,571
----------- ------------ ---------- --------------
Loss from operations (8,776) (2,031) - (10,807)
Other income (expense), net (5,933) (3,882) - (9,815)
----------- ------------ ---------- --------------
Net loss ($14,709) ($5,913) - ($20,622)
=========== ============ ========== ==============
(a) The Cherokee separate financial statement data 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.
15
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (IN THOUSANDS OF DOLLARS EXCEPT FOR PUBLIC PAY
TELEPHONES, PER CALL, SHARE AND PER SHARE AMOUNTS)
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
Statements, other than historical facts, contained in this Form 10-Q
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.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
Revenues
- --------
Revenues decreased by $9,687 or 19.6%, from $49,451 for the first six
months of 1998 to $39,764 for the first six months of 1999. This decrease is
primarily due to a decline in call volume, offset in part by the increase in the
coin long distance call rates, the decrease in the average number of installed
pay telephones and the decrease in the dial-around compensation rate as
discussed below. The average number of installed pay telephones decreased from
43,320 for the six months ended June 30, 1998 to 41,676 for the six months ended
June 30, 1999, a decrease of 1,644 or 3.8%, principally due to the timing of
expiring location contracts and the competition for payphone locations in the
marketplace, and to a lesser degree, the removal of less performing pay
telephones.
Revenues from coin calls decreased by $6,072 or 22.5%, from $ 26,935
for the six months ended June 30, 1998 to $20,863 for the six months ended June
30, 1999. The decrease is due in part to the decrease in the number and duration
of coin long distance calls resulting from rate increases implemented at the end
of November 1998, including the elimination of the Company's program which
offered customers a four minute long distance call anywhere in the continental
United States for $1.00. Based on the results of that change, the Company has
reinstated its old rates, including the four minutes for a $1.00 program. 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 a competitive alternative to payphone usage. Coin revenue has also
declined due to the decrease in the average number of installed pay telephones
compared to the first six months of 1998.
Revenues from non-coin telecommunication services decreased by $3,645
or 16.2% from $22,477 for the six months ended June 30, 1998 to $18,832 for the
six months ended June 30, 1999. Of this decrease, long distance revenues from
operator service providers decreased by $1,784 principally due to continuing
aggressive dial-around
16
17
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 and the
decrease in the average number of installed pay telephones compared to 1998. In
addition, revenues from dial-around compensation decreased by $1,861, from
$9,637 in the first six months of 1998 to $7,776 in the first six months of
1999, due to regulatory changes which, among other things, retroactively reduced
the rate of compensation for dial-around calls from $0.284 to $0.238 per call.
Revenues for the six months ended June 30, 1998 have not been restated to
reflect the retroactive reduction in dial-around compensation recorded in the
fourth quarter of 1998 as discussed below. If revenues from dial-around
compensation had been recorded at the revised rate in the first six months of
1998 ($0.238 per call or $31.18 per month based on an estimated 131 calls per
month), revenues from dial-around compensation would have been $8,078
for the six months ended June 30, 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 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, 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 local exchange carriers 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 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 Appeals 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
to a separate affiliate.
In response to the remand by the Appeals 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.
17
18
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC
98-48 1, which extended and waived certain requirements of certain LECs
regarding the provision of Flex Ani, which identify a call as originating from a
payphone. Without the transmission of Flex Ani, some of the interexchange
carriers have claimed they are unable to identify a call as a payphone call
eligible for dial-around compensation. With the stated purpose of assuring 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 Flex Ani
designation, but gave the IXCs a choice for computing the amount of compensation
for payphones on LEC lines not transmitting Flex Ani 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 Appeals Court again remanded the per-call
compensation rate to the FCC for further explanation without vacating the $0.284
per call rate mandated by the 1997 Payphone Order. The Appeals Court stated that
the FCC had failed to explain adequately its derivation of the $0.284 default
rate. The Appeals 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 comments
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 and 1998 Payphone
Orders to a cost-based method, citing technological impediments that it viewed
as inhibiting the marketplace and the unreliability of certain assumptions
underlying the market-based method as a basis for altering its analysis. In
setting the 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 amounts charged by LECs for providing
Flex Ani) will serve as the default per-call compensation rate for coinless
payphone calls from March 1999 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.
The 1999 Payphone Order deferred a final ruling on the initial interim
period (November 7, 1996 to October 6, 1997) treatment of dial-around
compensation to a later, as yet unreleased order; however, it appears from the
1999 Payphone Order that the $0.238 per-call rate will be applied to the initial
interim period. Upon establishment of said rate, the FCC has further ruled that
a true-up will be made for all payments or credits, together with applicable
interest due and owing between the IXCs and the payphone service providers for
the payment period November 7, 1996 through the effective date of the $0.24
rate. In the fourth quarter of 1998, the Company recorded an adjustment to
reduce revenues previously recognized for the period from November 7, 1996 to
September 30, 1998 due to the further decrease in the dial-around compensation
rate from $0.284 to $0.238 per call. This adjustment of $6,075 included $1,559
recorded as revenue in the first six months of 1998 and $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. The Appeals Court
is expected to hear oral arguments on this matter in November 1999. 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 March 31, 1999 is $31.18 per pay telephone per
month based on $0.238 per call and 131 calls per pay telephone per month ($31.44
per month based
18
19
on $0.24 per call after March 1999). 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 ($31.44 per month after March 1999).
Operating Expenses.
- -------------------
Total operating expenses decreased $7,099, or 12.3%, from $57,670 for
the six months ended June 30, 1998 to $50,571 for the six months ended June 30,
1999. The decrease was due to a reduction in substantially all expense
categories other than depreciation and amortization, due in part to the decrease
in the average number of installed pay telephones and personnel in 1999 compared
to the first six months of 1998, and the reduction of expenses that vary with
payphone revenues and call volumes.
Line and transmission charges decreased $3,741, or 25.6%, from $14,632
for the six months ended June 30, 1998 to $10,891 for the six months ended June
30, 1999. Line and transmission charges represented 29.6% of total revenues for
the six months ended June 30, 1998 and 27.4% of total revenues for the six
months ended June 30, 1999, a decrease of 2.2%. The dollar decrease was due to
the decrease in the average number of installed pay telephones, the decrease in
local and long distance line charges that are based upon call volumes and
duration and lower line charges resulting from the use of competitive local
exchange carriers ("CLECs"). In 1999, the Company also recovered approximately
$400 of prior year line charges resulting from cost-based rate reductions
ordered by state regulators. The decrease as a percentage of revenues is
primarily due to the lower line charges from CLECs and prior year amounts
recovered as a result of cost-based rate cases.
Telecommunication and validation fees (consisting primarily of
processing costs relating to operator services) decreased $1,203, or 20.5%, from
$5,856 for the six months ended June 30, 1998 to $4,653 for the six months ended
June 30, 1999. As a percentage of total revenue, telecommunication and
validation fees decreased slightly from 11.8% of total revenues for the six
months ended June 30, 1998 to 11.7% for the six months ended June 30, 1999. The
dollar decrease was primarily the result of the decrease in operator service
revenues compared to the first six months of 1998.
Location commissions decreased $157, or 2.4%, from $6,559 for the six
months ended June 30, 1998 to $6,402 for the six months ended June 30, 1999.
Location commissions represented 13.3% of total revenues for the six months
ended June 30, 1998 and 16.1% of total revenues for the six months ended June
30, 1999, an increase of 2.8%. The dollar decrease is due to the reduction in
revenues in the first six months of 1999 compared to 1998 offset by increases in
commission rates necessary to meet competition for new location providers as
well as the renewal of location contracts with existing location providers. The
increase as a percentage of total revenues is principally due to the increase in
commission rates.
Field operations (consisting principally of field operations personnel
costs, rents and utilities of the local service facilities and repair and
maintenance of the installed public pay telephones), increased slightly from
$10,534 for the six months ended June 30, 1998 to $10,539 for the six months
ended June 30, 1999. Field operations represented 21.3% of total revenues for
the six months ended June 30, 1998 and 26.5% of total revenues for the six
months ended June 30, 1999, an increase of 5.2%. The slight dollar increase in
1999 was due in part to a moderate increase in personnel costs offset by lower
costs of repair parts and service facilities. The increase as a percentage of
total revenues was a result of the lower revenues during the first six months of
1999.
Selling, general and administrative ("SG&A") expenses decreased $1,328,
or 20.6%, from $6,433 for the six months ended June 30, 1998 to $5,105 for the
six months ended June 30, 1999. SG&A expenses represented 13.0% of total
revenues for the six months ended June 30, 1998 and 12.8% of total revenues for
the six months ended June 30, 1999, a decrease of 0.2%. The dollar and
percentage decreases were primarily due to the reduction in personnel and
related costs as well as other cost reduction efforts during the fourth quarter
of 1998.
Depreciation and amortization increased $246, or 1.9%, from $12,662 for
the six months ended June 30, 1998 to $12,908 for the six months ended June 30,
1999. Depreciation and amortization represented 25.6% of total revenues for the
six months ended June 30, 1998 and 32.5% of total revenues for the six months
ended June 30,
19
20
1999, an increase of 6.9%. The dollar and percentage increases were primarily
due to the increase in depreciation resulting from additions to the Company's
public pay telephone base and the reduction in total revenues.
Other unusual charges and contractual settlements were $994 in the six
months ended June 30, 1998 and consisted primarily of legal and professional
fees relating to non-recurring litigation and contractual matters and certain
fees relating to amendments to the Company's Credit Agreement. Other unusual
charges and contractual settlements were $73 in the six months ended June 30,
1999.
Other Income (Expense)
- ----------------------
Other income (expense) is comprised principally of interest expense
incurred on debt and interest and other income. Total interest expense increased
$786, or 8.6%, from $9,139 for the six months ended June 30, 1998 to $9,925 for
the six months ended June 30, 1999. Interest expense represented 18.5% of total
revenues for the six months ended June 30, 1998 and 25.0% of total revenues for
the six months ended June 30, 1999, an increase of 6.5%. The dollar and
percentage increases were a result of the additional borrowings under the
Company's Credit Agreement during 1998 and 1999, primarily for working capital
purposes and additions to the Company's pay telephone base, and due to the
payment of interest at the default rate under the Company's Credit Agreement.
The percentage increase was also due to the decrease in total revenues. Other
income decreased $194 primarily due to the sale of the Company's Jacksonville,
Texas land and building during the second quarter of 1998.
EBITDA
- ------
EBITDA (income before interest income, interest expense, taxes,
depreciation and amortization, and other unusual charges and contractual
settlements) decreased $3,263, or 60.0%, from $5,437 for the six months ended
June 30, 1998 to $2,174 for the six months ended June 30, 1999. EBITDA
represented 11.0% of total revenues for the six months ended June 30, 1998 and
5.5% of total revenues for the six months ended June 30, 1999, a decrease of
5.5%. The dollar and percentage decreases are primarily due to the decreases in
coin and non-coin telecommunication revenues (including dial-around
compensation) offset in part by decreases in operating expenses. As previously
discussed, results for the first six months of 1998 have not been restated to
reflect the retroactive reduction in dial-around compensation recorded in the
fourth quarter of 1998. If revenues from dial-around compensation had been
recorded at the revised rate in the first six months of 1998, EBITDA would have
been $3,878 for the six months ended June 30, 1998.
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 determined 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. 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
- ------------------------------------
The Company has a working capital deficiency, excluding long-term debt
classified as current liabilities, of $14,640 at June 30, 1999 compared to
$6,976 at December 31, 1998, an increase of $7,664, resulting from an increase
in accrued interest payable and a decrease in accounts receivable. Net cash used
in operating activities during the six months ended June 30, 1998 and 1999 were
$7,641 and $417, respectively. Net cash used in operating activities resulted
mainly from the increase in the net loss for the six months ended June 30, 1999,
offset by non-cash charges for depreciation and amortization and the increase in
current liabilities resulting from the default in payment of accrued interest
relating to the Company's Senior Notes.
20
21
Cash Flows from Investing Activities
- ------------------------------------
Cash used in investing activities during the six months ended June 30,
1998 and 1999 were $3,478 and $1,143, respectively. In the first six months of
1998 and 1999, cash used in investing activities consisted mainly of purchases
of telephones and other property and equipment, including the cost incurred in
1998 for the equipment and upgrades relating to installed pay telephones
acquired from TDS Telecommunication Corporation on May 18, 1998.
Cash Flows from Financing Activities
- ------------------------------------
Cash flows provided by financing activities during the six months ended
June 30, 1998 and 1999 were $11,628 and $1,051, respectively, which in 1998
consisted primarily of borrowings under the Company's Credit Agreement for
capital expenditure and working capital purposes offset by principal payments on
borrowings and debt financing costs. Cash flows used in financing activities
during the six months ended June 30, 1999 consisted primarily of additional
borrowings under the Company's Credit Agreement offset by debt financing costs
and expenditures for professional fees for the proposed restructuring of the
Company's Senior Notes.
Debt Restructuring and Chapter 11 Bankruptcy Filing
- ---------------------------------------------------
In January 1999, the Company announced that it had reached an agreement
in principle with an Unofficial Committee of Noteholders of the Senior Notes
providing for the conversion of the Senior Notes into 95% of the reorganized
Company's common stock. The Unofficial Committee is
comprised of certain holders of the Senior Notes representing approximately
59.3% in principal amount of the Senior Notes. The Restructuring is being
implemented by a proposed plan of reorganization and further provides that
existing preferred and common shareholders are to receive the remaining 5% of
the reorganized Company's common stock (as well as warrants to purchase
approximately 11% of the reorganized Company's common stock at an exercise price
of $10.50 per share, assuming 10,000,000 common shares outstanding
post-restructuring). These equity interests would be subject to dilution by
certain other equity issuances, including issuances upon the exercise of certain
warrants and awards to purchase up to an aggregate of 5% of the common stock
under a new management incentive plan proposed as part of the Prepackaged Plan.
The terms of the Prepackaged Plan are summarized in a Disclosure Statement
mailed on May 11, 1999 to holders of record as of April 23, 1999 of the Senior
Notes and the 14% Preferred.
The Company solicited acceptances of the Prepackaged Plan from the
holders of the Senior Notes and 14% Preferred in anticipation of the
commencement of a case under chapter 11 of the Bankruptcy Code. Effective June
11, 1999, the Company obtained acceptances of the Prepackaged Plan from holders
of 99.9 percent of the Senior Notes and 100 percent of the 14% Preferred shares
voting in response to the solicitation. Such acceptances substantially exceed
the levels required to confirm the Prepackaged Plan.
On July 14, 1999, the Company commenced the Case in the U.S. Bankruptcy
Court in the Southern District of New York and is continuing in the operation of
its business as a debtor-in-possession. The Company also obtained an order from
the Court which allows the Company to pay prepetition and postpetition claims of
employees, trade and other creditors, other than the Senior Note claims, in the
ordinary course of business. The Court has scheduled a confirmation hearing for
September 2, 1999, at which time the Court will hear objections, if any, to the
Company's Prepackaged Plan. Upon confirmation, the Company shall promptly
implement the Restructuring described above.
Credit Facility
- ---------------
At December 31, 1998, March 31, 1999 and June 30, 1999, the Company was
not in compliance with certain financial covenants and was in default under the
Credit Agreement. Accordingly, the Company has classified the amounts due under
the Credit Agreement as a current liability in the accompanying consolidated
21
22
balance sheets. In addition, beginning April 1, 1999, the Company was required
to pay the default rate of interest which is two percent per annum higher than
the otherwise applicable rate (11.75% at June 30, 1999).
In April 1999, the Company requested and received an additional advance
of $2,500 which increased the principal balance outstanding under its Credit
Agreement to $42,500. Proceeds of the advance were and are to be used for the
payment of professional fees and expenses, loan fees and certain accounts
payable. The Company also received a commitment from the Lenders to provide
$45,900 in D.I.P. financing in anticipation of the Case described above. The
Company incurred $250 in fees relating to the additional advance and a $250 fee
for the debtor-in-possession financing commitment.
On July 21, 1999, the outstanding balance of the Credit Agreement was
paid from the proceeds of the Company's D.I.P. financing described below. The
Company incurred a loss from debt extinguishment of approximately $2,900,
including the write-off of deferred financing costs and an $800 prepayment
penalty, the payment of which penalty will be waived in the event the Company
obtains financing from its existing lender upon conclusion of the Case. The loss
will be reported as an extraordinary item in the third quarter of 1999.
Debtor-in-Possession Loan Agreement
- -----------------------------------
On July 14, 1999, the Company entered into a D.I.P. Loan Agreement with
Foothill Capital Corporation. The D.I.P. Loan provided a $45,900 revolving
credit commitment, which was used to pay the outstanding balance, including
accrued interest, due under the Credit Agreement on July 21, 1999. The Company
also received an advance of $2,541 for working capital purposes and has an
additional $533 available for the payment of legal and other costs associated
with the Case.
Interest on the D.I.P. Loan is payable monthly in arrears at 3% above
the base rate (as defined in the D.I.P. Loan Agreement) through November 12,
1999 and 3.75% above the base rate thereafter. The loan is secured by
substantially all of the assets of the Company. The D.I.P. Loan Agreement
includes covenants which limits the incurrence of additional debt, capital
leases and liens and the disposal of assets. The D.I.P. Loan matures on the
earliest of the date on which the Company emerges from its Case, converts to a
case under chapter 7 of the Bankruptcy Code or November 15, 1999.
Financial Condition
- -------------------
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 can
obtain additional financing to meet its debt service and other cash
requirements.
The Company believes that it will be able to implement the
Restructuring described above and convert its Senior Notes and its 14% Preferred
to common stock. The Company also believes it will be able to obtain adequate
financing to replace its D.I.P. Loan when the Company emerges from bankruptcy.
Implementing the Restructuring would result in material increases in working
capital and stockholders' equity and reduce cash flow required for debt service
by $15,000 annually. Assuming implementation of the Restructuring, management
believes, but cannot assure that cash flow from operations (including
substantial collections of accounts receivable from dial-around compensation) or
from additional financing will allow the Company to sustain its operations and
meet its obligations through the remainder of 1999. In the event that the
Company and is unable to implement the Restructuring and the Company is unable
to obtain a revised working capital facility, the Company will be required to
evaluate other available options.
22
23
CAPITAL EXPENDITURES
For the six months ended June 30, 1999, the Company had capital
expenditures of $863, which were financed by cash flows from operating
activities and proceeds from the Company's Credit Agreement. Capital
expenditures are principally for replacement and expansion of the Company's
installed public pay telephone base and include purchases of telephones, related
equipment, operating equipment and computer hardware.
SEASONALITY
The seasonality of the Company's historical operating results has been
affected by shifts in the geographic concentrations of its public pay telephones
resulting from acquisitions and other changes to the Company's customer mix.
Historically, first quarter revenues and related expenses have been lower than
other quarters due to weather conditions that affect pay telephone usage.
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 hardware or software that is used to process date-sensitive
data may recognize a date using "00" as the year 1900 rather than 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.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(IN THOUSANDS OF DOLLARS)
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 the
Senior Notes and its $45,900 borrowings under the Company's D.I.P. Loan.
As discussed in Note 2 to the Company's consolidated financial
statements, the Company has obtained the consent of its Noteholders to convert
the Senior Notes to common stock as part of its proposed plan of
23
24
reorganization. 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 changes in interest rates, if any.
The Company's earnings and cash flows are subject to market risk
resulting from changes in the interest rates with respect to its borrowings
under the Company's $45,900 D.I.P. Loan. 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.
PART II. OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(IN THOUSANDS OF DOLLARS)
(a) The Company has not paid the semiannual interest payments in the amount
of $7,500 each which were due December 15, 1998 and June 15, 1999 on
the Company's 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 and June 30, 1999, the principal balance due has been
classified as a current liability in the accompanying consolidated
balance sheets. As discussed in Note 2, the Company has obtained the
consent of the Noteholders to convert the Senior Notes and accrued
interest to common stock and has commenced a case under Chapter 11 of
the US Bankruptcy Code. Conversion of the Senior Notes to common stock
is dependent upon the confirmation of the Company's plan of
reorganization by the Bankruptcy Court.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(27) Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a report on Form 8-K dated April 6, 1999, reporting
under Item 5, other events, the appointment of John D. Chichester as
President and Chief Executive Officer.
24
25
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PHONETEL TECHNOLOGIES, INC.
August 16, 1999 By: /s/ Peter G. Graf
----------------------
Peter G. Graf
Chairman of the Board
August 16, 1999 By: /s/ Richard P. Kebert
-------------------------
Richard P. Kebert
Chief Financial Officer and
Treasurer
(Principal Financial Officer and
Accounting Officer)
25