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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1998
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission file number 0-22610
DAVEL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 59-3538257
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10120 Windhorst Road
Tampa, Florida 33619
(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (813) 628-8000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $0.01 par value per share
(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
--- ---
As of March 31, 1999, the aggregate market value of the voting stock held
by non-affiliates of the registrant was $48,760,586. As of March 31, 1999,
there were 10,536,155 shares of the registrant's Common Stock outstanding.
Documents incorporated by reference:
Information contained in the registrant's 1998 definitive proxy material to
be filed with the Securities and Exchange Commission has been incorporated by
reference in Part III of this Annual Report on Form 10-K.
1
PART I
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934:
Certain of the statements contained in the body of this Report are forward-
looking statements (rather than historical facts) that are subject to risks and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements. In the preparation of this Report,
where such forward-looking statements appear, The Company has sought to
accompany such statements with meaningful cautionary statements identifying
important factors that could cause actual results to differ materially from
those described in the forward-looking statements. An additional statement
summarizing the principal risks and uncertainties inherent in the Company's
business is included herein under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Regulatory Impact on
Revenue." Readers of this Report are encouraged to read these cautionary
statements carefully.
ITEM 1. BUSINESS
General Overview
Davel Communications, Inc. (the "Company" or "Davel") was incorporated on
June 9, 1998 under the laws of the State of Delaware to effect the merger (the
"Peoples Merger"), on December 23, 1998, of Davel Communications Group, Inc.
("Old Davel"), with Peoples Telephone Company, Inc. ("Peoples Telephone"). The
merger was accounted for as a pooling-of-interests and accordingly the results
of both companies have been restated as if they had been combined for all
periods presented.
As a result of the Peoples Merger and the acquisition of Communications
Central, Inc. (the "CCI Acquisition"), the Company is the largest domestic
independent payphone service provider in the United States, with approximately
twice the number of payphones as the second largest domestic independent
payphone service provider. The Company's principal executive offices are located
at 10120 Windhorst Road, Tampa, Florida 33619, and its telephone number is (813)
628-8000.
The Company owns and operates a network of nearly 85,000 payphones in 42
states and the District of Columbia, providing it with one of the broadest
geographic coverages of any payphone service provider in the country. The
Company's installed payphone base generates revenue through both coin calls
(local and long-distance) and non-coin calls (calling card, credit card, prepaid
calling card, collect, toll-free and third-party billed calls). The Company
also provides operator assisted services to its payphones through contractual
relationships with various interexchange carriers ("IXCs"), including Sprint and
AT&T, and through its own long-distance switching equipment. A significant
portion of the Company's payphones are located in high-traffic areas such as
shopping centers, convenience stores, truck stops, service stations, grocery
stores, restaurants and airports.
As part of the Telecommunications Act of 1996, Congress directed the
Federal Communications Commission ("FCC") to ensure widespread access to
payphones for the general
2
public. Industry reports estimate that there are approximately 2.1 million
payphones currently operating in the United States, of which approximately 1.8
million are operated by the five regional Bell operating companies ("RBOCs"),
AT&T and GTE. The remaining approximately 350,000 payphones are owned by more
than 1,000 independent payphone providers ("IPPs") and more than 1000 smaller
local exchange carriers ("LECs"). The Company believes that its scale,
geographic reach and proven integration expertise position it to play a leading
role in the consolidation of the fragmented payphone industry. The Company's
strategy is to increase its nationwide presence through internal growth
primarily focusing on regional and national accounts and through targeted
strategic acquisitions, generally in existing markets or contiguous markets.
Industry Overview
Today's telecommunications marketplace was principally shaped by the 1984
court-approved divestiture by AT&T of its local telephone operations (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 payphones
to the public switched network. The "public switched network" is the traditional
domestic landline public telecommunications network used to carry, switch and
connect telephone calls. The connection of independently owned payphones to the
public switched network has resulted in the creation of additional business
segments in the telecommunications industry. Prior to these developments, only
the consolidated Bell system or independent LECs were permitted to own and
operate payphones. Following the AT&T Divestiture, the independent payphone
sector developed as a competitive alternative to the consolidated Bell system
and other LECs by providing more responsive customer service, lower cost of
operations and higher commissions to the owners or operators of the premises at
which a payphone is located ("Location Owners").
Prior to the AT&T Divestiture, the LECs could refuse to provide payphone
service to a business operator or, if service was installed, would typically pay
no or relatively small commissions for the right to place a payphone on the
business premises. Following the AT&T Divestiture and the FCC's authorization of
payphone competition, IPPs began to offer Location Owners higher commissions on
coin calls made from the payphones in order to obtain the contractual right to
install the equipment on the Location Owners' premises. Initially, coin revenue
was the only source of revenue for the payphone operators because they were
unable to participate in revenues from non-coin calls. However, the operator
service provider ("OSP") industry emerged and enabled the competitive payphone
operators to compete more effectively with the regulated telephone companies by
paying commissions to payphone owners for non-coin calls. For the first time,
IPPs were able to receive non-coin call revenue from their payphones. With this
incremental source of revenue from non-coin calls, IPPs were able to compete
more vigorously on a financial basis with RBOCs and other LECs for site location
agreements, as a complement to the improved customer service and more efficient
operations provided by the IPPs.
3
As part of the AT&T Divestiture, the United States was divided into Local
Access Transport Areas ("LATAs"). RBOCs were authorized to provide telephone
service that both originates and terminates within the same LATA ("intraLATA")
pursuant to tariffs filed with and approved by state regulatory authorities.
They also provide payphone service primarily in their own respective
territories, and are now authorized to share revenues from telecommunications
services between LATAs ("interLATA"). Long-distance companies, such as Sprint,
AT&T and MCI Worldcom, provide interLATA services, and in some circumstances,
may also provide local or long-distance service within LATAs. An interLATA long-
distance telephone call generally begins with an originating LEC transmitting
the call from the originating payphone 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.
Business Strategy
The Company's objective is to increase revenues and earnings through
acquisitions, internal sales growth and continued reductions in its overall cost
structure. The Company has implemented the following strategy to meet its
objective.
Utilize Advanced Payphone Technology. The Company's payphones utilize
"smart" technology which provides voice synthesized calling instructions,
detects and counts coins deposited during each call, informs the caller at
certain intervals of the time remaining on each call, identifies the need for
and the amount of an additional deposit in order to continue the call, and other
functions associated with the completion of calls. Through the use of a non-
volatile, electronically erasable, programmable read-only memory chip, the
payphones can also be programmed and reprogrammed from the Company's central
computer facilities to update rate information or to direct different kinds of
calls to particular carriers. The Company's payphones can also distinguish
coins by size and weight, report to a remote location the total amount of coins
in the coin box, perform self-diagnosis and automatically report problems to a
pre-programmed service number. Virtually all of the Company's payphones operate
on power available from the payphone lines, thereby avoiding the need for and
reliance upon an additional power source at the installation location.
Apply Sophisticated Monitoring and Management Information Systems. The
Company utilizes proprietary and non-proprietary software that continuously
tracks coin and non-coin revenues from each payphone as well as expenses
relating to that payphone, including commissions payable to the Location Owners.
The software allows the Company to generate detailed financial information by
customer, by location and by payphone, which allows it to monitor the
profitability and operating condition of each location and payphone.
Provide Outstanding Customer Service. The technology used by the Company
enables it to (i) respond quickly to equipment malfunctions and (ii) maintain
accurate records of payphone activity which can be verified by customers. The
Company strives to minimize "downtime" on its payphones by identifying service
problems immediately. The Company's standard of performance is to repair
malfunctions within 24 hours of their occurrence, thereby minimizing downtime
and lost revenues. The Company's ability to service payphones promptly allows it
to retain existing customers and attract new ones. The Company employs both
advanced telecommunications technology and trained field technicians as part of
its
4
commitment to provide superior customer service. The records generated through
the Company's technology allow for the more timely and accurate payment of
commissions to Location Owners.
Develop Strong Relationships with Service Providers and Suppliers. As part
of its strategy to continue to reduce operating costs, the Company has formed
strategic alliances with a number of service and equipment providers. The
Company has formed alliances with a number of LECs and competitive local
exchange carriers to purchase local line access services, and has agreements
with a number of IXCs to provide operator services to its payphones for call
traffic not carried by its switch. In addition, the Company's consistent volume
of new payphone installations has allowed it to negotiate favorable purchasing
arrangements with a number of payphone equipment providers.
Facilitate Growth Through Internal Sales and Marketing. The Company
actively seeks to install new payphones through its sales and marketing efforts
to obtain additional contracts with new and existing accounts. The Company
conducts site surveys to examine various factors, including population density,
traffic patterns and historical usage information. The Company intends to
install approximately 8,000 payphones in 1999, compared with 6,884 payphones
installed in 1996, 6,311 payphones installed in 1997 and 7,233 payphones
installed in 1998, exclusive of acquisitions.
Pursue Strategic Acquisitions. The Company intends to use its experience in
identifying, negotiating and integrating strategic acquisitions in its continued
consolidation of the fragmented payphone industry. Strategic acquisitions have
enabled the Company to expand its market presence and further its strategy of
concentrating its payphones more rapidly than with internal sales growth alone.
Concentrating its payphones in close proximity allows the Company to plot more
efficient collection routes. The Company believes that route density contributes
to cost savings. Because smaller companies typically are not able to achieve
the economies of scale that may be realized by the Company, the integration of
acquired payphones into the Company's network of payphones often results in
lower operating costs than the seller of such payphones had been able to
realize. By clustering its payphones around its regional offices, the Company
is able to leverage its existing infrastructure through more efficient service
and collection routes which leads to a lower overall cost structure. For
example, since integrating the CCI Acquisition (as defined below), Davel has
been able to increase the number of payphones per technician to an average of
186 from 167 as a result of greater payphone density, workforce rationalizations
and computerized route design. The Company believes it will be able to increase
this number from 186 to approximately 210 upon the complete integration of the
operations of Peoples Telephone.
Acquisitions
The Company generates growth by pursuing the acquisition of payphone
companies or assets within its existing market areas and in areas in which the
Company desires to establish a new market presence. In the merger with Peoples
Telephone in December 1998, the Company added approximately 43,000 payphones to
its network. In the CCI Acquisition on February 3, 1998, the Company added
19,543 payphones to its network. In addition, during 1998, the Company added an
additional 4,019 payphones to its network through other acquisitions. The
Company believes that it is well positioned to capitalize on the fragmented
nature of the independent payphone industry by maintaining an active acquisition
program. The Company seeks to acquire payphone companies or assets that can
provide cost savings and economies of
5
scale through integration into the Company's service and maintenance, long-
distance and management information networks and believes that further
acquisitions present a significant growth opportunity for the Company.
Listed below is a summary of acquisitions completed by Old Davel and Peoples
Telephone during 1998 and 1997.
Number of Purchase Price
Company Date Payphones (In thousands)
- -------------------------------------- -------------- ----------- --------------
Eat N' Park Restaurants December 1998 136 $ 286
Call Communications, Inc. August 1998 1,251 2,948
Communications Central Inc. February 1998 19,543 109,117
Indiana Telecom January 1998 2,632 11,317
Tele/Data Pay Telephone August 1997 183 511
Blair Telephone June 1997 1,255 3,868
Quarter Call June 1997 954 2,160
Mid-Eastern April 1997 117 233
All others (less than 70 phones
each) 481 362
-------------------------------
Totals 26,552 $130,802
Integration Plan
The Company believes that it can achieve cost savings through the
combination of the payphone routes, management information systems and
administrative functions of Old Davel, Peoples Telephone and CCI. The Company
has formed a transition team (the "Transition Team") consisting of senior
members of management to oversee integration of the companies. Each senior
executive on the Transition Team is managing the transition process in one of
the following major functional areas of the Company's operations: field
operations, network operations, equipment repair and supply, human resources,
finance and accounting, legal and regulatory, sales and marketing, and customer
service. The Transition Team has begun the process of identifying and developing
potential areas of cost savings and revenue enhancement. Members of the
Transition Team have recommended strategies for achieving their objectives in
the most cost-effective manner, including specific recommendations for
eliminating redundant functions, employees and facilities. The integration of
CCI's operations into those of Old Davel has been virtually completed, and the
Transition Team expects the integration process with Peoples Telephone to be
substantially complete by the end of the 1999.
Operations
As of December 31, 1998 and December 31, 1997, the Company owned and
operated 84,384 and (treating the Peoples Telephone payphones as pooled together
with the Old Davel payphones) 59,009 payphones, respectively, an increase of
25,375 installed payphones. The CCI Acquisition in February 1998, increased the
number of installed payphones by 19,543 units.
6
Coin Calls
The Company's payphones generate coin revenues primarily from local calls.
Historically, the maximum rate that LECs and independent payphone companies
could charge for local calls was generally set by state regulatory authorities
and in most cases was $0.25 or $0.35 through October 6, 1997. In ensuring "fair
compensation" for all calls, the FCC previously determined that local coin rates
from payphones should be generally deregulated by October 7, 1997, but provided
for possible modifications or exemptions from deregulation upon a detailed
showing by an individual state that there are market failures within the state
that would not allow market-based rates to develop. On July 1, 1997, a federal
court issued an order which upheld the FCC's authority to deregulate local coin
call rates. In accordance with the FCC's ruling and the court order, certain
LECs and IPPs, including the Company, began to increase rates for local coin
calls from $.25 to $.35 commencing October 7, 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Regulatory Impact on Revenue -- Local Coin Rates."
InterLATA long distance coin calls are carried by the Company's long
distance switching equipment and long distance carriers that have agreed to
provide service to the Company's payphones. The Company pays a charge to a long
distance carrier each time that carrier transports a long distance call for
which the Company receives coin revenue. The Company's payphones also generate
coin revenue from intraLATA long distance calls.
Non-Coin Calls
The Company also receives revenues from non-coin calls made from its
payphones. Non-coin calls include credit card, calling card, prepaid calling
card, collect and third-party billed calls. Certain non-coin calls from the
Company's payphones are handled by the Company's subsidiary, DavelTel, Inc.
("DavelTel"). DavelTel's switching equipment is located in Tampa, Florida. See
"Technology." DavelTel performs certain of the operator services necessary to
complete non-coin calls.
The services needed to complete a non-coin call include providing an
automated or live operator to answer the call, verifying billing information,
validating calling cards and credit cards, routing and transmitting the call to
its destination, monitoring the call's duration and determining the charge for
the call, and billing and collecting the applicable charge. The Company has
contracted with an operator service provider to provide live operators to
handle calls that require operator services. Billing information is verified and
collect calls and credit cards are validated by the Company's switch through one
of several companies that provide on-line access to validation databases. The
Company contracts for transport of its calls over networks operated by long
distance carriers. The Company's switch is programmed to select the most cost-
effective carrier and transmission circuit then available to the Company to
complete the call as dialed. Billing and collection of call charges is performed
for the Company by one of several service bureaus specializing in that activity.
The Company realizes additional revenues from certain long distance
companies pursuant to FCC regulation as compensation for "dial-around" non-coin
calls made from its
7
payphones. A dial-around call is made by dialing an access code for the purpose
of reaching a long distance company other than the one designated by the
payphone operator by making a "toll free" call, generally by dialing a 1-
800/888/877 number, a 950-number or a seven-digit "1010XXX" code before dialing
"0" for operator service. See "Business--Regulation."
Payphone Base
In addition to payphones acquired by the Company (see "Acquisitions"), the
Company's payphone base includes payphones installed by the Company. The
following table sets forth, for the last three fiscal years, the number of
Company payphones acquired, installed and removed during the year as well as the
net increase in Company payphones in operation.
1998 1997 1996
--------- --------- --------
Acquired 23,691 2,861 2,767
Installed 7,233 6,311 6,884
Removed (5,549) (3,953) (5,239)
Net Increase 25,375 5,219 4,412
Most of the Company's payphones are located in proximity to one of the
Company's divisional offices, from which Company employees operate and service
payphones and conduct sales and marketing efforts. The following table sets
forth the number of payphones operated by Old Davel and Peoples Telephone in
each state and the District of Columbia as of December 31, 1998, 1997 and 1996:
December 31
------------------------------------------------------------------
State 1998 1997 1996
- -------------------------- ----------------- ---------------- -----------------
Alabama 2,357 692 614
Arkansas 528 45 27
Arizona 779 745 706
California 3,760 3,830 3,737
Colorado 447 33 55
District of Columbia 511 460 447
Delaware 119 97 73
Florida 15,708 12,851 12,612
Georgia 5,357 2,838 2,020
Iowa 747 784 959
Illinois 2,626 1,713 1,683
Indiana 2,947 895 856
Louisiana 2,580 1,676 1,502
Kansas 13 9 9
Kentucky 1,436 913 794
Massachusetts 534 410 344
Maine 52 39 39
Maryland 3,464 3,258 2,495
Michigan 504 406 398
Minnesota 471 - 33
Missouri 366 170 143
Mississippi 2,201 1,205 1,055
North Carolina 4,586 3,578 3,299
8
North Dakota 10 - -
Nebraska 32 36 66
New Hampshire 80 57 47
Nevada 388 404 427
New York 6,022 6,022 5,930
New Jersey 611 588 562
Ohio 2,719 1,583 1,286
Oklahoma 102 10 -
Oregon 11 12 12
Pennsylvania 3,472 2,691 1,456
Rhode Island 76 42 58
South Carolina 2,892 2,219 2,051
South Dakota 1 3 4
Tennessee 4,763 2,632 2,488
Texas 4,237 2,015 2,095
Vermont 18 17 18
Virginia 5,917 3,372 2,917
Utah 272 248 187
Washington - 1 1
Wisconsin 266 149 144
West Virginia 402 261 138
Wyoming - - 3
----------------- ---------------- -----------------
Totals 84,384 59,009 53,790
================= ================ =================
The Company selects locations for its payphones where there is typically
high demand for payphone service, such as convenience stores, truck stops,
service stations, grocery stores, shopping centers, restaurants, hotels and
airports. For many locations, historical information regarding an installed
payphone is available because payphone operators are often obligated pursuant to
agreements to provide this information to Location Owners for their payphones.
In locations where historical revenue information is not available, the Company
relies on its site survey to examine geographic factors, population density,
traffic patterns and other factors in determining whether to install a payphone.
The Company's marketing staff attempts to obtain agreements to install the
Company's payphones ("Location Agreements") at locations with favorable
historical data regarding payphone revenues.
Location Agreements generally provide for revenue sharing with the
applicable Location Owners. The Company's Location Agreements generally provide
commissions based on fixed percentages of revenues and are generally of three to
five-year terms. The Company can generally terminate a Location Agreement on 30
days' notice to the Location Owner if the payphone does not generate sufficient
revenue.
The Company routinely monitors its payphone base and removes
underperforming payphones, which it often relocates to locations with more
potential for profitability. In particular, the Company often removes and
relocates a number of payphones following acquisitions because its performance
criteria are generally more stringent than the criteria of the payphone
operators from which it acquires payphones.
9
Service and Maintenance
The Company employs field service technicians, each of whom collects coin
boxes from, and cleans and maintains an average of approximately 200 payphones.
The technicians also respond to trouble calls made by a Location Owner, by a
user of a payphone or by the telephone itself as part of its internal diagnostic
procedures. Some technicians are also responsible for the installation of new
payphones. Due to the proximity of most of the Company's payphones to one of
the Company's divisional offices and the ability of the field service
technicians to perform on-site service and maintenance functions, the Company is
able to limit the frequency of trips to the payphone as well as the number of
employees needed to service the payphones.
Customers, Sales and Marketing
The Company employs marketing personnel for its payphone operations in each
of its regions of operation. Regional marketing personnel are responsible for
finding desirable locations for payphones and obtaining Location Agreements with
Location Owners within their geographic areas. The Company believes that using
regional marketing personnel provides better market penetration because of their
familiarity with and proximity to their regions. To date, IPPs have had a
competitive advantage over LECs due to their ability to offer commissions to
Location Owners for both local and long-distance calls. Historically, LECs
generally were unable to derive revenues from interstate calls and non-coin,
interLATA calls, and consequently, were unable to offer commissions on such
calls. Recently enacted rules adopted pursuant to the Telecommunications Act
grant LECs the ability to select the long-distance carrier for interLATA long-
distance calls in conjunction with the Location Owner. This will enable LECs to
derive revenues from and pay commissions on these calls in the future. See "
Business--Regulation."
The Company's customers are a diverse group of small-, medium-sized and
large businesses which are frequented by individuals often needing payphone
access. The majority of the Company's customers are convenience stores, truck
stops, service stations, grocery stores, shopping centers, hotels and airports.
As of December 31, 1998, corporate payphone accounts of 50 or more payphones
represented approximately 36% of the Company's installed payphones.
Service and Equipment Suppliers
The Company's primary suppliers provide payphone components, local line
access, billing and collection services and long distance services. In order to
promote acceptance by end users accustomed to using LEC-owned payphone
equipment, the Company utilizes payphones designed to be similar in appearance
and operation to payphones owned by LECs.
The Company's primary supplier of circuit boards for new payphone
installations is Protel, Inc. of Lakeland, Florida, a leading supplier of
payphone equipment. The Company also purchases circuit boards manufactured by
other suppliers for repair of installed payphones utilizing circuit boards
provided by other manufacturers. The Company primarily utilizes the billing and
collection services of ILD Teleservices, Inc. and obtains local line access from
various LECs, including BellSouth, GTE, Ameritech, SBC Communications, US West
and various other suppliers of local line access. New sources of local line
access are expected to emerge as competition is authorized in local service
markets. Long-distance services are
10
provided to the Company through the use of its own long-distance switching
equipment and by various long-distance and operator service providers, including
Sprint, AT&T, MCI Worldcom, WilTel, LCI and others.
The Company expects the availability of such products and services to
continue in the future, however, the continuing availability of alternative
sources cannot be assured. Transition from the Company's existing suppliers, if
necessary, could have a disruptive influence on the Company's operations and
could give rise to unforeseen delays and/or expenses. The Company is not aware
of any current circumstances that would require the Company to seek alternative
suppliers for any of the products or services used in the operation of its
business.
Assembly and Repair of Payphones
The Company assembles and repairs payphone equipment for its own use. The
assembly of payphone equipment provides the Company with technical expertise
used in the operation, service, maintenance and repair of its payphones. The
Company assembles payphones from standard payphone components purchased from
component manufacturers. These components include a metal case, an integrated
circuit board incorporating a microprocessor, a handset and cord, and a coin box
and lock. All of the components purchased by the Company are available from
several suppliers, and Davel does not believe that the loss of any supplier
would have a material adverse effect on its assembly operations.
The Company's payphones comply with all FCC requirements regarding the
performance and quality of payphone equipment and have all of the operating
characteristics required by the regulatory authorities of most states,
including: free access to local emergency ("911") telephone numbers and, where
not available, to local directory assistance; dial-around access to all locally
available long-distance companies; the capability of receiving incoming calls at
no charge; and automatic coin return capability for incomplete calls.
Technology
The payphone equipment installed by the Company makes use of
microprocessors to provide voice synthesized calling instructions, detect and
count coins deposited during each call, inform the caller at certain intervals
of the time remaining on each call, identify the need for and the amount of an
additional deposit and other functions associated with completion of calls.
Through the use of non-volatile, electronically erasable, programmable read-only
memory chips, the payphones can also be programmed and reprogrammed from the
Company's central computer facilities to update rate information or to direct
different kinds of calls to particular carriers.
The Company's payphones can distinguish coins by size and weight, report to
a remote location the total coinage in the coin box, perform self-diagnosis and
automatically report problems to a pre-programmed service number, and
immediately report attempts at vandalism or theft. Virtually all of the
payphones operate on power available from the telephone lines, thereby avoiding
the need for and reliance upon an additional power source at the installation
location.
The Company utilizes proprietary and non-proprietary software that tracks
the coin and non-coin revenues from each payphone as well as expenses relating
to that payphone, including
11
commissions payable to the Location Owners. The software allows the Company to
generate detailed financial information by Location Owner, location and
payphone, which allows the Company to monitor the profitability and operating
condition of each location and payphone.
The Company provides all technical support required to operate the
payphones, such as computers and software and hardware specialists, at its
headquarters in Tampa, Florida. The Company's manufacturing support operations
provide materials, equipment, spare parts and accessories. Each of the Company's
divisional offices maintains inventories for immediate access by field service
technicians.
The Company maintains switching equipment in Tampa, Florida which receives
calls, routes calls through transmission lines to their destination and records
information about the source, destination and duration of the call. Long-
distance calls from the Company's payphones that are not handled by its switch
or an unbundled services arrangement are serviced by long-distance companies
that pay commissions to the Company for those calls. The Company expects in the
future to make increasing use of the long distance services of Sprint as a
result of a Telecommunications Services Term Agreement signed in January 1999.
Regulation
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 initial rules and policies to implement
Section 276 of the Telecommunications Act of 1996 (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 payphone regulations to the
extent that any state requirements are inconsistent with the FCC's
implementation of Section 276.
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 service providers ("PSPs"), who
send calls to those OSPs. The requirements of TOCSIA as implemented by the FCC
included call branding, information posting, rate quotations, the filing of
informational tariffs and the right of payphone users to access 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 upon providing this "open
access" to carriers.
TOCSIA further directed the FCC to consider the need to provide
compensation for IPPs for dial-around 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 for 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 per month and a rate of
$0.40 per call. The
12
failure by the FCC to provide compensation for 800 "toll free" dial-around calls
was challenged by the IPPs, and a federal court subsequently ruled that the FCC
should have provided compensation for these toll free calls.
In 1996, recognizing that independent payphone providers had been at a
severe competitive disadvantage under the existing system of regulation and had
experienced substantial increases in dial-around calls without a corresponding
adjustment in compensation, Congress enacted Section 276 to promote both
competition among payphone service providers and the widespread deployment of
payphones throughout the nation. Section 276 directed the FCC to implement rules
by November 1996 which would:
. create a standard regulatory scheme for all public payphone service
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 LEC and independent payphone service providers and
remove the LEC payphones from the LEC's regulated asset base;
. provide for the RBOCs to have the same rights that independent payphone
service providers 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 the 1996 Payphone Order. In
the 1996 Payphone Order, the FCC determined that the best way to ensure fair
compensation to independent and LEC PSPs 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.
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.
13
In the first phase, November 1996 to October 1997, the FCC prescribed flat-rate
compensation payable to the PSPs 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 was 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 PSP as well as 800 "toll free" 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 the PSPs 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 PSP
and the IXC. To facilitate per-call compensation, the FCC required the PSPs to
transmit payphone-specific coding digits which would identify each call as
originating from a payphone and required the LECs to make such coding available
to the PSPs as a tariffed item included in the local access line service.
In July 1997, 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 Court's remand, the FCC issued the 1997 Payphone Order
in October of 1997. The FCC determined that distinct and severable costs of
$0.066 were attributable to coin calls that did not apply to the costs incurred
by the PSPs in providing access for dial-around calls. 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 PSPs were entitled to compensation for each
and every call during the first phase, it deferred for later the decision on the
precise method of allocating the initial interim period (November 1996 through
October 1997) 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 98-481, 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
14
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 from the effective date of the Court's decision.
In response to the Court's second remand, the FCC conducted further
proceedings and sought additional comment from interested parties to address the
relevant issues posed by the Court. On February 4, 1999, the FCC released the
Third Report and Order on Reconsideration of the Second Report and Order (the
"1999 Payphone Order"), in which the FCC abandoned its efforts to derive a
"market-based" default dial-around compensation rate and instead adopted a
"cost-based" rate of $0.24 per dial-around call. This new rate will become
effective on April 21, 1999, and will serve as the default rate through January
31, 2002. The new rate will also be applied retroactively to the period
beginning on October 7, 1997, less a $0.002 amount to account for FLEX ANI
payphone tracking costs, for a net compensation rate of $0.238 applicable during
this retroactive period. It also appears from the 1999 Payphone Order that this
new rate will be applied to the initial "interim" period, running from November
8, 1996 through October 7, 1997; however, the 1999 Payphone Order deferred a
final ruling on the interim period treatment to a later, as yet unreleased,
order. The FCC has further ruled that an adjustment will be made for all
payments or credits (with applicable interest at 11.25%) due and owing between
the IXCs and the PSPs, including Davel. It is possible that the final
implementation of the 1999 Payphone Order, including resolution of this
retroactive adjustment and the outcome of any related administrative or judicial
appeals, could have a material adverse effect on the Company. See "Effect of
Federal Regulation of Local Coin and Dial-Around Calls" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Regulatory Impact on Revenue--Dial-Around Compensation."
Effect of Federal Regulation of Local Coin and Dial-Around Calls
Dial-Around Calls. Based on the FCC's tentative conclusion in the 1997
Payphone Order, the Company adjusted the amounts of dial-around compensation
previously recorded for the period November 7, 1996 to June 30, 1997 from the
initial $45.85 per-phone, per-month rate to $37.20 ($0.284 per call multiplied
by 131 calls). Based on this adjustment, the Company recorded a provision in the
three-month period ended September 30, 1997 to reflect reduced dial-around
compensation. In addition, beginning with the third quarter of 1997, the Company
recorded dial-around compensation at the same rate of $37.20 per payphone per
month. Based on the reduction in the per-call compensation rate in the 1999
Payphone Order, the Company further reduced, through an adjustment to non-coin
revenues totaling $9.0 million, the amounts of dial-around compensation
previously recorded for the period from November 7, 1996 to
15
December 31, 1998. The adjustment included approximately $6.0 million to adjust
revenue recorded during the period November 7, 1996 to October 6, 1997 from
$37.20 per-phone per-month to $31.18 per phone per month ($0.238 per call
multiplied by 131 calls). The remaining $3.0 million of the adjustment was to
adjust revenues recorded during the period October 7, 1997 through December 31,
1998 to actual dial-around call volumes for the period multiplied by $0.238 per
call. The Company believes that it is legally entitled to fair compensation
under the Telecommunications Act for dial-around calls which were delivered to
any carrier during the period from November 7, 1996 to December 31, 1998.
While the amount of $0.24 per call constitutes the Company's assessment of
the minimum level of fair compensation, certain IXCs have asserted in the past,
are asserting and are expected to assert in the future, that the appropriate
level of fair compensation should be lower than $0.24 per call or should be
determined by requiring the user to deposit coinage at the time of making a
dial-around call.
The payments for dial-around calls prescribed in the 1997 Payphone Order
significantly increased dial-around compensation revenues to the Company over
the levels received prior to implementation of the Telecommunications Act
(although the 1999 Payphone Order has now moderated those increases). However,
market forces and factors outside the Company's control could significantly
affect the resulting revenue impact. These factors include the following: (1)
the final resolution of the $0.24 rate recently ordered by the FCC and the
possibility of subsequent appeals to the courts, (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) the IXCs' reaction to
the FCC's recognition that existing regulations do not prohibit an IXC from
blocking 800 subscriber numbers from payphones in order to avoid paying per-call
compensation on such calls and (5) ongoing technical or other difficulties in
the responsible carriers' ability and willingness to properly track or pay for
dial-around calls actually delivered to them.
Local Coin Call Rates. As a result of the Telecommunications Act and in
accordance with the FCC's initial rulings implementing Section 276 of the Act
(which were upheld on appeal by the U.S. Supreme Court), rates for local coin
calls placed from payphones have been effectively deregulated. The Company and
other PSPs have utilized this new deregulatory environment as an opportunity to
adjust prices in an effort to maximize revenues from this call category. In
deciding to deregulate local coin rates for payphones the FCC did, however,
provide for possible modifications or exemptions from deregulation, either upon
its own motion in response to consumer complaints or where an individual state
regulatory body makes a detailed showing that there are market failures within
the state that would not allow market-based rates to develop. While no such
action has been taken to date by the FCC or state regulators, no assurances can
be given as to the future regulatory treatment of local coin call rates,
including the potential re-regulation of those rates or other modifications.
Moreover, the Company cannot predict with any certainty the ultimate impact of
local coin rate deregulation upon its operations.
16
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 a potentially material reduction in the number of coin calls made. The
Company is unable to predict the ultimate impact on its operations of local coin
call rate deregulation.
Other Provisions of the Telecommunications Act and FCC Rules
As a whole, the Telecommunications Act and FCC Rules significantly alters
the competitive framework of the payphone industry. The Company believes that
implementation of the Telecommunications Act has addressed certain historical
inequities in the payphone marketplace and has, in part, led to a more equitable
competitive environment for all payphone providers. However, there are numerous
uncertainties in the implementation and interpretation of the Telecommunications
Act which make it impossible for the Company to provide assurance that the
Telecommunications Act will result in a long-term positive impact. The Company
has identified the following such uncertainties:
. Various matters pending in several federal courts and raised before the
Congress which, while not directly challenging Section 276, relate to the
validity and constitutionality of the Telecommunications Act, as well as
other uncertainties related to the impact, timing and implementation of the
Telecommunications Act.
. The 1996 Payphone Order 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. Proceedings are now pending
in various stages and formats, before numerous state regulatory bodies
across the nation to resolve these issues.
. 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.
. The 1996 Payphone Order preempts 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.
Outstanding questions exist with respect to 0+ local and 0- call routing
whose classification will await the outcome of various state regulatory
proceedings or initiatives.
. The 1996 Payphone Order determined that the administration of programs for
maintaining public interest payphones should be left to the states within
certain guidelines. Various state proceedings are underway in reviewing
this issue.
17
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 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.
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 the Companies to comply with
applicable rules, regulations and reporting requirements. The states that
currently permit independent payphone providers 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.
The Company 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,
the Company 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 access alternate carriers. The Company 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 the Company believes that selected states'
continuing review of local line access charges, coupled with competition for
local line access service resulting from implementation of the
Telecommunications Act, could lead to more options available to the Company for
local line access at competitive rates. The Company cannot provide assurance,
however, that such options or local line access rates will become available. The
Telecommunications Act also contains other provisions which 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.
18
The Company 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. The Company believes that
some of these fees and restrictions may be in violation of 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. However, in at least one instance, involving a
challenge to a payphone ordinance adopted by the Village of Huntington Park,
California, 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 the Company and
other PSPs unless the industry is successful in resisting or moderating this
trend.
Competition
The Company competes for payphone locations directly with LECs and IPPs.
The Company also competes, indirectly, with long-distance companies, which can
offer Location Owners commissions on long-distance calls made from LEC-owned
payphones. Most LECs and long-distance companies against which the Company
competes and some IPPs may have substantially greater financial, marketing and
other resources than the Company. In addition, many LECs, faced with competition
from the Company and other IPPs, have increased their compensation arrangements
with Location Owners to offer more favorable commission schedules.
The Company believes the principal competitive factors in the payphone
business are (1) the commission payments to a Location Owner and the opportunity
for a Location Owner to obtain commissions on both local and long-distance calls
from the same provider, (2) the ability to serve accounts with locations in
several LATAs or states, (3) the quality of service and the availability of
specialized services provided to a Location Owner and payphone users, and (4)
responsiveness to customer service needs. The Company believes it is currently
competitive in each of these areas.
The Company competes with long-distance carriers that provide dial-around
services which can be accessed through the Company's payphones. Certain national
long-distance operator service providers and prepaid calling card providers have
implemented extensive advertising promotions and distribution schemes which have
increased dial-around activity on payphones owned by LECs and IPPs, including
the Company, thereby detracting from the Company's primary OSPs. However, the
Company receives compensation for dial-around calls placed from its payphones.
See "Regulation."
The Company also competes with providers of wireless communications
services for both local and long distance traffic. Certain providers of wireless
communication services have recently introduced rate plans that are
competitively priced with certain of the products offered by the Company.
Employees
As of December 31, 1998, the Company had 958 full-time employees, none of
whom is the subject of a collective bargaining agreement. The Company believes
that its relationship with its employees is good.
19
ITEM 2. PROPERTIES
The Company leases approximately 48,500 square feet in Tampa, Florida that
includes two locations for executive office space, a divisional office for
payphone operations and facilities for the assembly of payphones. The Company
also leases approximately 40 divisional offices for payphone operations in
various geographical locations. In addition, the Company operates a regional
distribution and assembly center in approximately 10,000 square feet in
Jacksonville, Illinois, which the Company leases from its Chairman. The Company
also leases 18,000 square feet of warehouse space in Jacksonville, Illinois from
its Chairman. The Company believes that these facilities are adequate to meet
the Company's needs in the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
On September 29, 1998, the Company announced that it was exercising its
contractual rights to terminate a merger agreement (the "Davel/PhoneTel Merger
Agreement") with PhoneTel Technologies, Inc. ("PhoneTel"), based on breaches of
representations, warranties and covenants by PhoneTel. On October 1, 1998, the
Company filed a lawsuit in Delaware Chancery Court seeking damages, rescission
of the Davel/PhoneTel Merger Agreement and a declaratory judgment that such
breaches occurred. On October 27, 1998, PhoneTel answered the complaint and
filed a counterclaim against the Company alleging that the Davel/PhoneTel Merger
Agreement had been wrongfully terminated. At the same time, PhoneTel also filed
a third party claim against Peoples Telephone (acquired by Davel in the Peoples
Merger) alleging that Peoples Telephone wrongfully caused the termination of the
Davel/PhoneTel Merger Agreement. The counterclaim and third party claim seek
specific performance by Davel of the transactions contemplated by the
Davel/PhoneTel Merger Agreement and damages and other equitable relief from
Davel and Peoples Telephone. The Company believes that it has meritorious claims
against PhoneTel and intends to defend vigorously against the counterclaim
against Davel and the third party claim against Peoples Telephone initiated by
PhoneTel. The Company at this time cannot predict the outcome of this
litigation.
In December 1995, Cellular World, Inc. filed a complaint in Dade County
Circuit Court against Peoples and its subsidiary, PTC Cellular, Inc., alleging
wrongful interference with Cellular World's business relationship with Alamo
Rent-A-Car, and alleged misappropriation of Cellular World's trade secrets
concerning Cellular World's proprietary cellular car phone rental system
equipment. Cellular World is seeking damages alleged to exceed $10 million.
Formal discovery is nearly completed. Pending completion of discovery, the
Company expects the trial to be scheduled for May or June 1999. Based on the
proceedings conducted to date, the Company believes that it has several
meritorious legal and factual defenses. The Company at this time cannot predict
the outcome of this litigation.
The Company is involved in other litigation arising in the normal course of
its business which it believes will not materially affect its financial position
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 22, 1998, the Company held its 1998 Annual Meeting of
Stockholders in Chicago, Illinois. Two proposals were brought before the
stockholders for a vote. The first
20
was a proposal to approve and adopt the merger agreement between Davel and
Peoples Telephone. Of the 5,777,998 shares of Davel Common Stock outstanding on
the record date of November 11, 1998, 5,458,242 shares, or 94.47%, voted in
person or by proxy. On the Peoples Telephone Merger proposal, 4,941,676 votes,
or 85.5%, were cast in favor of the proposal, 10,572 votes, or 0.18%, were cast
against the proposal or withheld, and there were 7,900 abstentions, representing
0.14%, and 498,094 broker non-votes, or 8.62% of the shares represented by
proxy.
The second stockholder proposal was to elect seven members of the Company's
Board of Directors. The Company's directors hold one-year terms and are subject
to annual re-election by the stockholders. Each nominee who was proposed for
election was elected by the stockholders. The following tabulation displays the
names of each nominee elected, the number of votes cast for each nominee, and
the number of votes withheld for each nominee.
Name of Nominee Number of Votes For Number of Votes Withheld
- ------------------ ------------------- ------------------------
F. Philip Handy 5,451,710 6,532
Michael E. Hayes 5,451,710 6,532
David R. Hill 5,451,710 6,532
Robert D. Hill 5,451,710 6,532
Thomas M. Vitale 5,451,710 6,532
A. Jones Yorke 5,451,710 6,532
Samuel Zell 5,451,710 6,532
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
Market Information. The Company's Common Stock trades on the NASDAQ
------------------
National Market System. The following table sets forth, for the periods
indicated, the high and low closing prices on the NASDAQ National Market System
from January 1, 1996 through December 31, 1998.
High Low
---- ---
1996
----
First Quarter 13.75 12.50
Second Quarter 20.00 12.75
Third Quarter 20.75 15.00
Fourth Quarter 19.00 15.25
1997
----
First Quarter 18.25 14.75
Second Quarter 18.00 12.00
Third Quarter 23.25 15.25
Fourth Quarter 29.00 21.25
21
1998
----
First Quarter 28.50 24.38
Second Quarter 29.25 21.25
Third Quarter 25.25 10.88
Fourth Quarter 19.75 9.00
As of March 31, 1999, there were approximately 427 holders of record of the
Common Stock, not including stockholders whose shares were held in "nominee" or
"street" name. The last sale price of the Company's Common Stock on March 31,
1999 was $7.00 per share.
Dividends. The Company did not pay any dividends on its Common Stock
---------
during 1998 and does not intend to pay any Common Stock dividends in the
foreseeable future. It is the current policy of the Company's Board of
Directors to retain earnings to finance the growth and development of the
Company's business. The payment of dividends is effectively prohibited by the
Company's Senior Credit Facility. Payment of cash dividends, if made in the
future, will be determined by the Company's Board of Directors based on the
conditions then existing, including the Company's financial condition, capital
requirements, cash flow, profitability, business outlook and other factors.
22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data presented below under the captions "Operating
Data" and "Balance Sheet Data" are derived from the audited consolidated
financial statements of the Company. The selected financial data should be read
in conjunction with the financial statements and notes thereto included
elsewhere in this Annual Report and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Year ended December 31 (1)
-------------------------------------------------------------------
(In thousands, except per share data)
1998 (2) 1997 1996 1995 1994
------------ ------------ ------------ ------------ -----------
Revenue $195,594 $159,243 $143,979 $144,192 $139,171
Expenses 221,376 153,200 140,665 146,516 135,024
------------ ------------ ------------ ------------ -----------
Operating Income (loss) (25,782) 6,043 3,314 (2,324) 4,147
Other expense (23,881) (13,084) (12,519) (10,844) (12,947)
Income taxes - 2,459 1,868 2,186 (3,439)
------------ ------------ ------------ ------------ -----------
Loss from continuing operations before
Extraordinary item (49,663) (9,500) (11,073) (15,354) (5,361)
Gain (loss) from discontinued operations 607 2,092 (1,114) (17,867) (9,279)
Extraordinary loss from extinguishment of debt (17,856) - - (3,327) -
------------ ------------ ------------ ------------ -----------
Net loss $(66,912) $ (7,408) $(12,187) $(36,548) $(14,640)
======== ======== ======== ======== ========
Basic and diluted loss per share:
Continuing operations before extraordinary item $ (5.68) $ (1.27) $ (1.47) $ (1.92) $ (0.66)
Gain (loss) from discontinued operations 0.07 0.25 (0.13) (2.18) (1.14)
Extraordinary loss from extinguishment of debt (1.98) - - (0.40) -
Net loss $ (7.59) $ (1.02) $ (1.60) $ (4.50) $ (1.80)
Weighted average common shares outstanding 9,029 8,407 8,317 8,236 8,148
Balance Sheet Data:
Total assets $273,018 $180,786 $184,732 $193,399 $223,626
Long-term debt and obligations under capital leases,
Less current maturities 225,451 107,076 106,956 102,782 98,386
Mandatorily redeemable preferred stock - 16,284 15,079 13,886 -
Shareholders' equity 1,649 20,290 28,641 42,278 75,393
(1) On December 23, 1998, the Company consummated its merger with Peoples
Telephone which was accounted for as a pooling-of-interests. Accordingly,
all financial data has been restated to reflect the combined operations of
Old Davel and Peoples Telephone for all periods presented.
(2) The year ended December 31, 1998, includes the results of CCI from the date
of the CCI Acquisition, February 3, 1998.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
Certain of the statements contained below are forward-looking statements
(rather than historical facts) that are subject to risks and uncertainties that
could cause actual results to differ materially from those described in the
forward-looking statements.
General
On December 23, 1998, the Company and Peoples Telephone merged together in
a transaction accounted for as a pooling-of-interests. As such, the results of
both companies have been restated as if they had been combined for all periods
presented.
During 1998, the Company derived its revenues from two principal sources:
coin calls and non-coin calls. Coin calls represent calls paid for by callers
with coins deposited in the payphone. Coin call revenues are recorded in the
amount of coins collected from the payphones.
Non-coin calls made from the Company's payphones generate revenues in an
amount that depends upon whether the Company or a long distance company handles
the call. If the non-coin call is handled by the Company through its switch or
an "unbundled" services arrangement, the Company recognizes non-coin revenues
equal to the total amount charged for the call. If the non-coin call is handled
by a long distance company, the Company generally recognizes revenues in an
amount equal to the commission on that call paid to the Company by the long
distance company. Under an unbundled services arrangement, the Company
performs certain functions necessary to service non-coin calls, uses the long
distance company's switching equipment and its other services on an as-needed
basis, and pays the long distance company on an unbundled basis for the operator
services actually used to complete these calls.
The Company also recognizes non-coin revenues from calls that are dialed
from its payphones to gain access to a long distance company other than the one
pre-programmed into the telephone; this is commonly referred to as "dial-around"
access. See "Business--Regulation." The Company also derives revenue from
certain LECs for intraLATA non-coin calls. See "Business-Operations."
The principal costs related to the ongoing operation of the Company's
payphones include telephone charges, commissions, and service, maintenance and
network costs. Telephone charges consist of payments made by the Company to
LECs and long distance carriers for access charges and use of their networks.
Commission expense represents payments to Location Owners. Service, maintenance
and network costs represent the cost of servicing and maintaining the payphones
on an ongoing basis, costs related to the operation of the Company's switch and,
in connection with unbundled services arrangements, the fees paid for those
services.
24
Regulatory Impact on Revenue
Local Coin Rates
In ensuring "fair compensation" for all calls, the FCC previously
determined that local coin rates from payphones should be generally deregulated
by October 7, 1997, but provided for possible modifications or exemptions from
deregulation upon a detailed showing by an individual state that there are
market failures within the state that would not allow market-based rates to
develop. On July 1, 1997, a federal court issued an order which upheld the
FCC's authority to deregulate local coin call rates. In accordance with the
FCC's ruling and the court order, certain LECs and independent payphone service
providers, including the Company, increased rates for local coin calls from $.25
to $.35. Given the lack of direction on the part of the FCC on specific
requirements for obtaining a state exemption, the Company's inability to predict
the responses of individual states or the market, and the Company's inability to
provide assurance that deregulation, if and where implemented, will lead to
higher local coin call rates, the Company is unable to predict the ultimate
impact on its operations of local coin rate deregulation. In 1998, the Company
experienced lower coin call volumes on its payphones resulting from the
increased rates, growth in wireless communication services and changes in call
traffic and the geographic mix of the Company's payphones.
Dial-Around Compensation
On September 20, 1996, the Federal Communications Commission ("FCC")
adopted rules which became effective November 7, 1996 (the "1996 Payphone
Order"), initially mandating dial-around compensation for both access code calls
and 800 subscriber calls at a flat rate of $45.85 per payphone per month (131
calls multiplied by $0.35 per call). Commencing October 7, 1997 and ending
October 6, 1999 the $45.85 per payphone per month rate was to transition to a
per-call system at the rate of $0.35 per call. Several parties challenged
certain of the FCC regulations including the dial-around compensation rate. On
July 1, 1997, a federal court vacated certain portions of the FCC's 1996
Payphone Order, including the dial-around compensation rate.
In accordance with the court's mandate, on October 9, 1997, the FCC adopted
a second order (the "1997 Payphone Order"), establishing a rate of $0.284 per
call for the first two years of per-call compensation (October 7, 1997 through
October 6, 1999). The IXCs were required to pay this per-call amount to
payphone service providers, including the Company, beginning October 7, 1997.
On May 15, 1998, the court again remanded the per-call compensation rate to the
FCC for further explanation without vacating the $.284 default rate.
In accordance with the court's second mandate, on February 4, 1999, the FCC
released a third order (the "1999 Payphone Order"), in which the FCC abandoned
its efforts to derive a "market based" default dial-around compensation rate and
instead adopted a "cost based" rate of $.24 per dial-around call. This rate
will become effective on April 21, 1999, and will serve as a default rate
through January 31, 2002. The new rate will also be applied retroactively to
the period beginning on October 7, 1997, less a $.002 amount to account for FLEX
ANI payphone tracking costs, for a net compensation rate of $.238 applicable
during this retroactive period. It also appears from the 1999 Payphone Order
that this new rate will be applied to the initial "interim" period, running from
November 7, 1996 through October 7, 1997; however, the 1999 Payphone Order
deferred a final ruling on the interim period treatment to a later, as yet
25
unreleased, order. Upon establishment of the interim period, the FCC has
further ruled that a true-up will be made for all payments or credits (with
applicable interest at 11.25%) due and owing between the IXCs and the PSPs,
including the Company, for the payment period commencing on November 7, 1996
through the effective date of the new $.24 per call rate.
Based on the FCC's conclusion in the 1997 Payphone Order, the Company
adjusted the amounts of dial-around compensation previously recorded for the
period November 7, 1996 to June 30, 1997 from the initial $45.85 rate to $37.20
($0.284 per call multiplied by 131 calls). As a result of this adjustment, the
provision recorded in the year ended December 31, 1997 for reduced dial-around
compensation is approximately $3.3 million. For periods beginning November 7,
1996, prior to the release of the 1999 Payphone Order, the Company has recorded
dial-around compensation at the rate of $37.20 per payphone per month.
The Company believes that it is legally entitled to fair compensation under
the Telecommunications Act for dial-around calls which the Company delivered to
any carrier during the period from November 7, 1996 to October 6, 1997. 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 to October 6, 1997 is $31.18 per payphone per month (131
calls multiplied by $0.238 per call) and the Company, based on the information
available to it, does not believe that it is reasonably possible that the amount
will be materially less than $31.18 per payphone per month.
While the amount of $0.24 per call constitutes the Company's assessment of
the minimum level of fair compensation following the April 21, 1999 effective
date, certain IXCs have asserted in the past, are asserting and are expected to
assert in the future that the appropriate level of fair compensation should be
lower than $0.24 per call.
The payment levels for dial-around calls prescribed in the 1996 and 1997
Payphone Orders significantly increase dial-around compensation revenues to the
Company over the levels received prior to implementation of the
Telecommunications Act (although the 1999 Payphone Order has now moderated those
increases). However, market forces and factors outside the Company's control
could significantly affect these revenue increases. These factors include the
following: (i) the final resolution of the $.24 rate recently ordered by the FCC
and the possibility of subsequent appeals to the courts, (ii) the 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, (iii) the possibility of other litigation seeking to
modify or overturn the 1999 Payphone Order or portions thereof, (iv) 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 (v) 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.
26
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.
Year ended December 31,
------------------------------------
1998 1997 1996
--------- ---------- ---------
REVENUES:
Coin calls 67.7% 63.8% 66.7%
Non-coin calls, net of dial-around compensation adjustments 32.3 36.2 33.3
----- ----- -----
Total revenues 100.0 100.0 100.0
----- ----- -----
COSTS AND EXPENSES:
Telephone charges 23.3 24.4 26.1
Commissions 24.0 22.5 24.0
Service, maintenance and network costs 22.2 19.0 19.2
Depreciation and amortization 19.7 16.1 16.3
Selling, general and administrative 16.3 14.2 13.1
Non-recurring items 5.5 - (1.0)
Restructuring charge 2.2 - -
----- ----- -----
Total operating costs and expenses 113.2 96.2 97.7
----- ----- -----
Operating income (loss) (13.2) 3.8 2.3
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
For the year ended December 31, 1998, total revenues from continuing
operations increased approximately $36.4 million or 22.8%, compared to the year
ended December 31, 1997, increasing from $159.2 million in the year ended
December 31, 1997, to $195.6 million in the year ended December 31, 1998. This
growth was primarily attributable to an increase from 59,009 (treating the
Peoples Telephone payphones as pooled together with the Old Davel payphones)
payphones on December 31, 1997 to 84,384 payphones on December 31, 1998. The
growth in the number of payphones was primarily due to the CCI Acquisition,
consisting of 19,543 installed payphones, and the acquisition of Indiana Telcom
by Peoples Telephone in January 1998, consisting of 2,632 installed payphones.
Coin call revenues increased approximately $30.8 million, or 30.3%, rising from
$101.7 million in 1997 to $132.5 million in 1998, driven primarily by the
increase in the number of installed payphones. While coin call revenues
increased during the period on an aggregate basis, coin call revenues on a per-
phone, per-month basis decreased due to lower coin call volumes resulting from
the growth in wireless communication services and changes in call traffic and
the geographic mix of the Company's payphones.
Non-coin call revenues increased approximately $5.5 million, or 9.6%,
increasing from $57.6 million in the year ended December 31, 1997 to $63.1
million in the year ended December 31, 1998. The increase in non-coin call
revenues was primarily attributable to the growth in the number of installed
payphones. While non-coin call revenues increased during the period on an
aggregate basis, non-coin call revenues on a per-phone, per-month basis
decreased due to lower
27
call volumes resulting primarily from the growth in wireless communication
services. Non-coin call revenues were further reduced, through an adjustment
totaling $9.0 million resulting from the adjustment to the dial-around
compensation rate prescribed in the 1999 Payphone Order. The adjustment included
approximately $6.0 million to adjust revenue recorded during the period November
7, 1996 to October 6, 1997 from $37.20 per-phone per-month to $31.18 per phone
per month ($0.238 per call multiplied by 131 calls). The remaining $3.0 million
of the adjustment was to adjust revenues recorded during the period October 7,
1997 through December 31, 1998 to actual dial-around call volumes for the period
multiplied by $0.238 per call.
Telephone charges increased $6.7 million, or 17.2%, increasing from $38.9
million in the year ended December 31, 1997 to $45.6 million in the year ended
December 31, 1998. The increase in telephone charges was primarily attributable
to the growth in the number of installed payphones. Telephone charges for the
year 1998 decreased to 23.3% of total revenues compared to 24.4% in the prior
year. The decrease in telephone charges as a percentage of revenues was due to
reductions in line access charges on a per-phone per-month basis as a result of
rate reductions received from certain LECs with which the Company has negotiated
agreements for the provision of local access services, based on increased call
volumes as a result of the CCI Acquisition.
Commissions increased $11.1 million, or 31.0%, rising from $35.9 million in
the year ended December 31, 1997, to $47.0 million in the year ended December
31, 1998. The increase in commissions was primarily attributable to the growth
in the number of installed payphones. Commissions increased to 24.0% of total
revenues compared to 22.5% in the prior year. The increase in commissions as a
percentage of total revenues was primarily attributable to the CCI Acquisition
which included a higher proportion of national accounts than those previously
serviced by the Company. National accounts typically receive higher commission
rates than local and regional accounts due primarily to their higher revenues.
Service, maintenance and network costs rose $13.0 million, increasing from
$30.3 million in the year ended December 31, 1997 to $43.3 million in the year
ended December 31, 1998. The increase was primarily attributable to the growth
in the number of installed payphones. Service, maintenance and network costs
increased to 22.2% of total revenues compared to 19.0% in the prior year. The
increase in service, maintenance and network costs as a percentage of total
revenues was primarily attributable to the CCI Acquisition. Service, maintenance
and network costs in 1998 include the network costs related to the CCI payphones
which primarily direct long distance call traffic to an unbundled services
agreement. In 1997, the Company had a higher mix of long distance call traffic
directed to commission plans which do not include a cost component in service,
maintenance and network costs.
Depreciation and amortization expense increased approximately $13.0
million, or 50.7%, from the prior year, rising from $25.6 million in 1997 to
$38.6 million in 1998, driven by the increase in the number of installed
payphones. Approximately $10.0 million of the increase in depreciation and
amortization expense was related to the CCI Acquisition.
Selling, general and administrative expenses increased approximately $9.2
million, or 40.8%, from the prior year, increasing from $22.6 million in the
year ended December 31, 1997 to $31.8 million in the year ended December 31,
1998. The increase was primarily attributable to selling, general and
administrative expenses related to the CCI Acquisition. The Company
28
continued to operate the former corporate office of CCI through August 1998,
when CCI's administrative functions were combined into the Company's facilities
in other locations. In addition, the Company eliminated nine duplicative field
offices during the year in the integration of CCI's operations with Old Davel's
operations.
The Company recognized a non-recurring charge of approximately $10.8
million in 1998 for costs associated with the Peoples Merger, consisting
primarily of legal, accounting and investment banking fees, change of control
payments to former executives of Peoples Telephone, printing costs and other
expenses related to the transaction. In addition, the Company recognized
restructuring charges during the year ended December 31, 1998 of approximately
$4.3 million related to the integration and restructuring of Old Davel. The
restructuring charges were primarily related to severance pay for terminated
employees, lease termination costs and costs related to the closing of redundant
facilities.
Other income and expense decreased approximately $3.4 million, from income
of $0.5 million in the year ended December 31, 1997 to expense of $2.9 million
in the year ended December 31, 1998. This decrease resulted primarily from the
recognition of a $2.8 million impairment loss on an investment held by Peoples
Telephone prior to the merger with Old Davel. The remaining decrease was
primarily due to a reduction in interest income as a result of lower cash
balances available for investment.
Interest expense in 1998 increased approximately $7.4 million, or 54.3%,
rising from $13.6 million in 1997 to $21.0 million in 1998. This increase
resulted primarily from the incurrence of $120.0 million in indebtedness in
connection with the CCI Acquisition and refinancing of Old Davel's credit
facility.
Loss from continuing operations before extraordinary item increased
approximately $40.2 million from the prior year. Loss before extraordinary item
increased approximately $41.6 million from approximately $7.4 million in 1997 to
approximately $49.0 million in 1998.
The Company's gain on discontinued operations included $0.6 million of a
gain realized on the sale of the Peoples Telephone investment in Shared
Technologies Cellular, Inc. (STC) Common Stock which was received in 1995 as
proceeds from the sale of Peoples Telephone cellular telephone operations which
were treated as discontinued operations in 1995. The Company's loss from
discontinued operations in 1997 represents a $2.4 million loss on the sale of
the inmate phone division and received $0.3 million related to its previously
discontinued cellular telephone operations.
In the year ended December 31, 1998, the Company recorded an extraordinary
loss of $17.9 million, consisting of approximately $12.9 million in premiums and
fees related to the repurchase of $100.0 million principal amount of Peoples
Telephone's outstanding 12 1/4% Senior Notes due 2002 in connection with the
refinancing of the combined companies' credit facilities as part of the Peoples
Merger. The Company also recorded approximately $5.0 million in extraordinary
losses related to the write-off of unamortized debt issuance costs related to
the refinancing of the existing credit facilities of Old Davel and Peoples
Telephone.
Net loss increased approximately $59.5 million from approximately $7.4
million in 1997 to approximately $66.9 million in 1998.
29
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
For the year ended December 31, 1997, total revenues from continuing
operations increased approximately $15.3 million or 10.6%, increasing from
$144.0 million in the year ended December 31, 1996 to $159.2 million in the year
ended December 31, 1997. This growth was primarily attributable to an increase
from 53,790 (treating the Peoples Telephone payphones as pooled together with
the Old Davel payphones) payphones on December 31, 1996 to 59,009 payphones on
December 31, 1997. Coin call revenues increased approximately $5.7 million, or
6.0%, rising from $95.9 million in the year ended December 31, 1996 to $101.7
million in the year ended December 31, 1997, driven primarily by the increase in
the number of installed payphones.
Non-coin call revenues increased approximately $9.6 million, or 19.9%,
increasing from $48.0 million in the year ended December 31, 1996 to $57.6
million in the year ended December 31, 1997. The increase in non-coin call
revenues was primarily attributable to approximately $6.1 million in additional
revenues resulting from an increase in the rate of dial-around call compensation
associated with the implementation of the Telecommunications Act, which became
effective in November 1996, and approximately $3.5 million in additional non-
coin call revenues resulting from the growth in the number of installed
payphones.
Telephone charges increased approximately $1.3 million, or 3.4%, increasing
from $37.6 million in the year ended December 31, 1996 to $38.9 million in the
year ended December 31, 1997. The increase in telephone charges was primarily
attributable to the growth in the number of installed payphones. Telephone
charges for the year 1997 decreased to 24.4% of total revenues compared to 26.1%
in the prior year. The decrease in telephone charges as a percentage of
revenues was due to reductions in line access charges on a per-phone per-month
basis as a result of rate reductions received from certain LECs with which the
Company has agreements for the provision of local access services.
Commissions increased approximately $1.3 million, or 3.8%, rising from
$34.5 million in the year ended December 31, 1996 to $35.8 million in the year
ended December 31, 1997. The increase in commissions was primarily attributable
to the growth in the number of installed payphones. Commissions for 1997
decreased to 22.5% of total revenues compared to 24.0% in the prior year. The
decrease in commissions as a percentage of total revenues was primarily
attributable to higher payphone revenues. A portion of the Company's Location
Agreements exclude certain types of call traffic from commission calculations,
and some others are based on flat monthly rates set by the agreements, resulting
in a disproportionate increase in payphone revenues over commissions.
Service, maintenance and network costs increased $2.6 million, or 9.4%,
increasing from $27.7 million in the year ended December 31, 1996 to $30.3
million in the year ended December 31, 1997. The increase was primarily
attributable to the growth in the number of installed payphones. Service,
maintenance and network costs in 1998 decreased to 19.0% of total revenues
compared to 19.2% in the prior year. The decrease in service, maintenance and
network costs as a percentage of total revenues was primarily attributable to
higher payphone revenues during the year and increasing operating efficiencies
achieved through increasing density in the Company's payphone routes resulting
from expansion of its installed base of payphones.
30
Depreciation and amortization expense increased approximately $2.2 million,
or 9.2%, from the prior year, rising from $23.5 million in 1996 to $25.6 million
in 1997, driven by the increase in the number of installed payphones.
Selling, general and administrative expenses increased approximately $3.7
million, or 19.2%, from the prior year, increasing from $18.9 million in the
year ended December 31, 1996 to $22.6 million in the year ended December 31,
1997. The increase was primarily attributable to additional costs associated
with the opening and operation of three new divisional sales and service offices
and the hiring of support personnel needed to service the Company's expanding
base of installed payphones.
Other income and income expense decreased approximately $0.1 million or
22.9% in 1997 over 1996, decreasing to $0.5 million in 1997 from $0.6 million in
1996. The decrease was primarily due to a reduction in interest income as a
result of lower cash balances available for investment.
Interest expense increased approximately $0.4 million, or 3.2%, rising from
$13.2 million in the year ended December 31, 1996 to approximately $13.6 million
in the year ended December 31, 1997. This increase resulted primarily from an
increase in long-term debt in the last two quarters of 1996 and during 1997 for
the acquisition of payphone companies and payphone assets.
In the year ended December 31, 1996, the Company recognized income of
approximately $1.5 million in connection with settlements of loans and
employment contracts with former officers of Peoples Telephone, Peoples
Telephone's former equity interest in the operating results of an unconsolidated
affiliate and amounts related to the resolution of outstanding litigation
involving Peoples Telephone.
Losses from continuing operations improved approximately $1.6 million, or
14.2%, from the prior year period, decreasing from a loss of $11.1 million in
the year ended December 31, 1996 to a loss of $9.5 million in the year ended
December 31, 1997.
The Company's loss from discontinued operations in 1996 represents a $1.8
million loss on the operations of the Company's inmate phone division. The
Company also recorded a gain of $0.7 million, net of income taxes of $0.4
million from the sale of its hospitality division, and a loss of $0.1 million,
net of income taxes of $0.1 million, from the sale of its remanufacturing
division.
The Company's earnings on discontinued operations in 1997 included income
of approximately $0.3 million related to a payment on a promissory note that had
been fully reserved resulting from the sale of Peoples Telephone's cellular
telephone operations in 1995. On December 19, 1997, the Company sold the
remaining operating assets of its inmate phone division to Talton Holdings, Inc.
for approximately $10.6 million in cash, plus additional contingent
consideration based on a formula which shares incremental profits from certain
existing contracts and from Talton's closing on certain pending bids. This
transaction resulted in a gain on sale of approximately $4.2 million. The gain,
combined with an operating loss of approximately $2.4 million, resulted in
earnings of approximately $1.8 million from the discontinued inmate division in
1997.
31
Net loss decreased approximately $4.8 million from a loss of approximately
$12.2 million in 1996 to a loss of approximately $7.4 million in 1997.
Liquidity and Capital Resources
Cash Flows
As of December 31, 1998, the Company had a current ratio of 1.12 to 1,
decreasing from 1.58 to 1 at December 31, 1997. From 1997 to 1998, working
capital decreased from approximately $21.3 million as of December 31, 1997 to
approximately $5.8 million as of December 31, 1998. The change in the Company's
working capital is primarily a result of the application of approximately $11.3
million of cash in January 1998 by Peoples Telephone to acquire the assets of
Indiana Telcom.
The Company's capital expenditures, exclusive of acquisitions, for the
years ended December 31, 1998 and 1997 were $11.9 million and $7.0 million,
respectively. The Company's capital expenditures primarily consisted of costs
associated with the installation of new payphones. The Company made acquisitions
of payphones totaling approximately $118.5 million and $7.1 million during the
years 1998 and 1997, respectively. In 1998, the Company financed its capital
expenditures and acquisitions primarily with an increase in long-term debt of
approximately $127.2 million. Net cash used in operating activities in the year
ended December 31, 1998 totaled approximately $6.3 million and consisted
primarily of the funding of operating losses and the increase in accounts
receivable from dial-around compensation. In 1997, the Company financed its
capital expenditures and acquisitions primarily with approximately $13.7 million
in cash provided by continuing operations and an increase of $2.1 million in
long-term debt.
Credit Agreement
In connection with the merger with Peoples Telephone on December 23, 1998,
the Company entered into a senior credit facility ("Senior Credit Facility")
with NationsBank, N.A. (the "Administrative Agent") and the other lenders named
therein. The Senior Credit Facility provides for borrowings by Davel from time
to time of up to $280.0 million for working capital and other corporate
purposes.
Indebtedness of the Company under the Senior Credit Facility is secured by
substantially all of its and its subsidiaries' assets, including but not limited
to their equipment, inventory, receivables and related contracts, investment
property, computer hardware and software, bank accounts and all other goods and
rights of every kind and description and is guaranteed by Davel and all its
subsidiaries.
The Company's borrowings under the Senior Credit Facility bear interest at
a floating rate and may be maintained as Base Rate Loans (as defined in the
Senior Credit Facility) or, at the Company's option, as Eurodollar Loans (as
defined in the Senior Credit Facility). Base Rate Loans shall bear interest at
the Base Rate (defined as the higher of (i) the applicable prime lending rate of
NationsBank, N.A. or (ii) the Federal Reserve reported certificate of deposit
rate plus 1%). Eurodollar Loans shall bear interest at the Eurodollar Rate (as
defined in the Senior Credit Facility), plus a margin based on leverage.
32
The Company is required to pay the lenders under the Senior Credit Facility
a commitment fee, payable in arrears on a quarterly basis, on the average unused
portion of the Senior Credit Facility during the term of the facility. The
Company is also required to pay an annual agency fee to the Agent. In addition,
the Company was also required to pay an arrangement fee for the account of each
bank in accordance with the banks' respective pro rata share of the Senior
Credit Facility. The Agent and the lenders will receive such other fees as have
been separately agreed upon with the Agent.
The Senior Credit Facility requires the Company to meet certain financial
tests, including, without limitation, maximum levels of Senior Secured Debt as a
ratio of EBITDA (as defined in the Senior Credit Facility), minimum interest and
fixed charge ratios and maximum amount of capital expenditures. The Senior
Credit Facility also contains certain covenants which, among other things, will
limit the incurrence of additional indebtedness, prepayments of other
indebtedness (including the Notes), liens and encumbrances and other matters
customarily restricted in such agreements.
In the first quarter of 1999, the Company gave notice to the Administrative
Agent that lower than expected performance in the first quarter of 1999 would
result in the Company's inability to meet certain financial covenants contained
in the Senior Credit Facility. On April 8, 1999, the Company and the Lenders
agreed to the First Amendment to Credit Agreement and Consent and Waiver (the
"First Amendment") which waived compliance, for the fiscal quarter ending March
31, 1999, with the financial covenants set forth in the Senior Credit Facility.
In addition, the First Amendment waived any event of default related to two
acquisitions made by the Company in the first quarter of 1999, and waived the
requirement that the Company deliver annual financial statements to the Lenders
within 90 days of December 31, 1998, provided that such financial statements
shall be delivered no later than April 15, 1999. The First Amendment contained
amendments that provided for the following:
. amendment of the applicable percentages for Eurodollar Loans for the period
between April 1, 1999 and June 30, 2000 at each pricing level to 0.25%
higher than those in the previous pricing grid
. prepayment of debt from receipt of dial-around compensation accounts
receivable related to the period November 1996 through October 1997
. further limitations on permitted acquisitions as defined in the Credit
Agreement through June 30, 2000
. during the period April 1, 1999 to June 30, 2000, required lenders' consent
for the making of loans or the issuance of letters of credit if the sum of
revolving loans outstanding plus letter of credit obligations outstanding
exceeds $50.0 million
. the introduction of a new covenant to provide certain operating data to the
Lenders on a monthly basis
. increases in the maximum allowable ratio of funded debt to EBITDA through
the quarter ended June 30, 2000
. decreases in the minimum allowable interest coverage ratio through the
quarter ended June 30, 2000
. decreases in the minimum allowable fixed charge coverage ratio through the
quarter ended June 30, 2000
33
The Company believes that it is probable that it will comply with the loan
covenants for the next twelve months and, as such, has not classified the
obligations under the Senior Credit Facility as current liabilities.
The First Amendment also places limits on capital expenditures and required
the payment of an amendment fee equal to the product of each Lender's commitment
multiplied by 0.35%.
The Senior Credit Facility contains customary events of default, including
without limitation, payment defaults, breaches of representations and
warranties, covenant defaults, cross-defaults to certain other indebtedness,
certain events of bankruptcy and insolvency, judgment defaults, failure of any
guaranty or security document supporting the Senior Credit Facility to be in
full force and effect, and a change of control of the Company.
The Company believes that cash generated from operations and available
borrowings under the Senior Credit Facility will be sufficient to fund the
Company's forseeable cash requirements, including capital expenditures through
December 23, 2003. The Company also believes that it will be able to fund any
future acquisitions through a combination of cash generated from operations,
additional borrowing and the issuance of shares of the Company's Common Stock.
There can be no assurance, however, that the Company will continue to expand at
its current rate or that additional financing will be available when needed or,
if available, will be available on terms acceptable to the Company.
Impact of Inflation
Inflation is not a material factor affecting the Company's business.
General operating expenses such as salaries, employee benefits and occupancy
costs are, however, subject to normal inflationary pressures.
Seasonality
The Company's revenues from its payphone operating regions are affected by
seasonal variations, geographic distribution of payphones and type of location.
Because many of the Company's payphones are located outdoors, weather patterns
have differing effects on the Company's results depending on the region of the
country where the payphones are located. Most of the Company's payphones in
Florida produce substantially higher call volume in the first and second
quarters than at other times during the year, while the Company's payphones
throughout the midwestern and eastern United States produce their highest call
volumes during the second and third quarters. While the aggregate effect of the
variations in different geographical regions tend to counteract the effect of
one another, the Company has historically experienced higher revenue and income
in the second and third quarters than in the first and fourth quarters. Changes
in the geographical distribution of its payphones may in the future result in
different seasonal variations in the Company's results.
Year 2000 Issue
The Company is working to resolve the potential impact of the year 2000 on
the ability of the Company's computerized information systems to accurately
process information that may be date-sensitive. Any of the Company's programs
that recognize a date using "00" as the year 1900 rather than the year 2000
could result in errors or system failures. The
34
Company utilizes a number of computer programs across its entire operation. The
Company has assessed the impact of the year 2000 on both its computer programs
and its computer systems. As the Company acquires other payphone assets, it will
continue to assess the impact of the year 2000 on such acquired assets. To date,
the Company has spent approximately $0.2 million in assessing and addressing
year 2000 issues and estimates that its total costs will not exceed $0.5
million, which is approximately 25% of the Company's budgeted expenditures for
information technology. The Company does not believe that these costs will have
a material effect on its financial position. The Company is also in the process
of addressing the potential impact of the year 2000 on its suppliers and other
parties on whom it relies in providing payphone and operator services. The
Company intends to complete this assessment by June 30, 1999. The failure of
third parties on which the Company relies to address their year 2000 issues in a
timely manner could result in a material financial risk to the Company. Through
its assessment of the impact of year 2000 on both its computer programs and
systems, the Company believes that it has sufficient resources available to
implement new and modified computer systems to address the impact of the year
2000, and accordingly, has not to date identified any need for other contingency
planning. However, the Company's continuing assessment of its assets and of
third parties external to the Company may reveal the need for contingency
planning in the future. The Company plans to devote all resources required to
resolve any significant year 2000 issues in a timely manner.
New Accounting Pronouncements
The Financial Accounting Standards Board recently issued SFAS No. 133
Accounting for Derivative Instruments and Hedging Activities, which requires
that all derivatives be recognized as either assets or liabilities in the
statement of financial position at fair value unless specific hedge criteria are
met. The Company is required to adopt the provisions of SFAS No. 133 in 2000.
Adoption of this statement is not expected to significantly impact the Company's
consolidated financial position, results of operations or cash flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks related to changes in interest
rates. The Company's objective is to minimize the volatility in earnings and
cash flow from these risks. In connection with the provisions of its long-term
debt agreement and the Company's overall interest rate objectives, the Company
utilizes derivative financial instruments to reduce its interest rate exposure
to market risks from significant increases in interest rates. The Company's
strategy is to purchase interest rate swaps, collars and caps from large
financial institutions that in the aggregate maintain notional amounts exceeding
40% of the Company's outstanding long-term debt balance to limit the impact of
increases in interest rates on the Company's variable rate long-term debt.
Based on the Company's overall interest rate exposure at December 31, 1998, a
ten percent increase in interest rates would not have a material impact on the
financial position, results of operations or cash flows of the Company. These
effects of hypothetical changes in interest rates, however, ignore other effects
the same movement may have arising from other variables, and actual results
could differ from the sensitivity calculations of the Company. The Company
regularly assesses these variables, establishes policies and business practices
to protect against
35
the adverse effects of interest rate fluctuations and does not anticipate any
material losses generated by these risks.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Supplementary Data
PAGE NUMBERS
------------
Independent Public Accountants Report of Arthur Andersen LLP
for the years ended December 31, 1998, 1997 and 1996 38
Consolidated Balance Sheets for December 31, 1998 and 1997 39
Consolidated Statements of Operations for the years
ended December 31, 1998, 1997 and 1996 40
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1998, 1997 and 1996 41
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 42
Notes to Consolidated Financial Statements 43
37
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Davel Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Davel
Communications, Inc. (a Delaware corporation) and Subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits 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 are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Davel
Communications, Inc. and Subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
St. Louis, Missouri,
March 15, 1999, except for Note 20,
as to which the date is April 8, 1999
38
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
-------------------------------------------
CONSOLIDATED BALANCE SHEETS - DECEMBER 31, 1998 AND 1997
--------------------------------------------------------
(In thousands, except per share and share data)
ASSETS
------
1998 1997
--------- ---------
CURRENT ASSETS:
Cash and cash equivalents $ 17,162 $ 25,401
Restricted cash 790 920
Trade accounts receivable, net of allowance for doubtful accounts of $5,383 and $5,121, respectively 30,838 26,166
Other current assets 3,694 5,869
--------- ---------
Total current assets 52,484 58,356
PROPERTY AND EQUIPMENT 130,099 84,890
LOCATION CONTRACTS 34,252 26,146
GOODWILL 47,458 4,368
OTHER ASSETS 8,725 7,026
--------- ---------
Total assets $ 273,018 $ 180,786
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt and obligations under capital leases $ 11,525 $ 2,671
Accounts payable and accrued expenses 34,393 34,357
--------- ---------
Total current liabilities 45,918 37,028
--------- ---------
LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES 225,451 107,076
--------- ---------
DEFERRED INCOME TAXES -- 108
--------- ---------
REDEEMABLE PREFERRED STOCK:
Preferred stock - Series C, $.01 par value, 160,000 shares authorized in 1997,
150,000 shares issued and outstanding, $100 per share liquidation value -- 13,711
Preferred stock dividends payable -- 2,573
--------- ---------
Total preferred stock -- 16,284
--------- ---------
SHAREHOLDERS' EQUITY:
Preferred stock - $.01 par value, 1,000,000 shares authorized, none issued and outstanding -- --
Preferred stock - $.01 par value, 4,240,000 shares authorized in 1997, none issued and outstanding -- --
Convertible preferred stock - Series B, $.01 par value, 600,000 shares
authorized in 1997, none issued and outstanding -- --
Common stock - $.01 par value, 50,000,000 shares authorized in 1998 and 10,000,000
shares authorized in 1997, 10,536,155 and 8,438,532 shares issued and outstanding, respectively 105 84
Additional paid-in capital 126,325 80,100
Accumulated deficit (124,781) (57,869)
Accumulated unrealized loss on investment -- (2,025)
--------- ---------
Total shareholders' equity 1,649 20,290
--------- ---------
Total liabilities and shareholders' equity $ 273,018 $ 180,786
--------- ---------
The accompanying notes are an integral part of these balance sheets.
39
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
-------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
(In thousands, except per share and share data)
1998 1997 1996
----------- ----------- -----------
REVENUES:
Coin calls $ 132,483 $ 101,660 $ 95,949
Non-coin calls, net of dial-around compensation adjustments--Note 18 63,111 57,583 48,030
----------- ----------- -----------
Total revenues 195,594 159,243 143,979
----------- ----------- -----------
COSTS AND EXPENSES:
Telephone charges 45,582 38,886 37,608
Commissions 46,986 35,858 34,536
Service, maintenance and network costs 43,290 30,283 27,676
Depreciation and amortization 38,617 25,620 23,452
Selling, general and administrative 31,762 22,553 18,893
Non-recurring items 10,814 -- (1,500)
Restructuring charge 4,325 -- --
----------- ----------- -----------
Total operating costs and expenses 221,376 153,200 140,665
----------- ----------- -----------
Operating income (loss) (25,782) 6,043 3,314
OTHER INCOME (EXPENSE):
Interest expense (20,955) (13,581) (13,164)
Loss on investment (2,772) -- --
Other (154) 497 645
----------- ----------- -----------
Total other expense (23,881) (13,084) (12,519)
----------- ----------- -----------
Loss from continuing operations before income taxes (49,663) (7,041) (9,205)
PROVISION FOR INCOME TAXES -- 2,459 1,868
----------- ----------- -----------
Loss from continuing operations before extraordinary item (49,663) (9,500) (11,073)
DISCONTINUED OPERATIONS:
Loss from operations -- (2,418) (1,758)
Gain on sale of discontinued operations 607 4,510 644
----------- ----------- -----------
Gain (loss) on discontinued operations 607 2,092 (1,114)
----------- ----------- -----------
Loss before extraordinary item (49,056) (7,408) (12,187)
EXTRAORDINARY LOSS FROM EARLY EXTINGUISHMENT OF DEBT (17,856) -- --
----------- ----------- -----------
Net loss $ (66,912) $ (7,408) $ (12,187)
=========== =========== ===========
BASIC AND DILUTED EARNINGS PER SHARE: - Note 14
Loss from continuing operations before extraordinary item $ (5.68) $ (1.27) $ (1.47)
----------- ----------- -----------
Gain (loss) from discontinued operations .07 .25 (.13)
----------- ----------- -----------
Extraordinary loss (1.98) -- --
----------- ----------- -----------
Net loss per share $ (7.59) $ (1.02) $ (1.60)
=========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 9,029,285 8,407,255 8,317,215
=========== =========== ===========
The accompanying notes are an integral part of these statements.
40
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
-------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
-----------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
(In thousands, except share data)
Common Stock Additional
--------------------------- Paid-In Accumulated
Shares Amount Capital Deficit
------------ ------------ ------------ ------------
BALANCE, December 31, 1995 8,240,380 $ 83 $ 80,469 $ (38,274)
Stock options and warrants exercised 126,269 1 1,139 --
Stock issued for prior acquisition 20,445 -- 75 --
Series C preferred stock dividends accrued -- -- (1,050) --
Preferred stock issuance cost accretion -- -- (144) --
Unrealized loss on investment -- -- -- --
Net loss for the year ended December 31, 1996 -- -- -- (12,187)
------------ ------------ ------------ ------------
BALANCE, December 31, 1996 8,387,094 84 80,489 (50,461)
Stock options exercised and grants of common stock 51,438 -- 817 --
Series C preferred stock dividends accrued -- -- (1,050) --
Preferred stock issuance cost accretion -- -- (156) --
Unrealized loss on investment -- -- -- --
Net loss for the year ended December 31, 1997 -- -- -- (7,408)
------------ ------------ ------------ ------------
BALANCE, December 31, 1997 8,438,532 84 80,100 (57,869)
Stock options exercised and grants of common stock 160,146 2 2,225 --
Series C preferred stock dividends accrued -- -- (1,464) --
Preferred stock issuance cost accretion -- -- (158) --
Sale of stock 1,000,000 10 26,529 --
Stock issued as payment for services provided 44,659 -- 751 --
Stock issued for retirement of preferred stock 892,977 9 17,897 --
Option repricing -- -- 445 --
Unrealized loss on investment -- -- --
Reclassification of investment to a trading security -- -- -- --
Fractional shares retired upon completion of merger (159) -- -- --
Net loss for the year ended December 31, 1998 -- -- -- (66,912)
------------- ------------ ------------ ------------
BALANCE, December 31, 1998 10,536,155 $ 105 $ 126,325 $ (124,781)
============= ============ ============ ============
Unrealized Total
Loss on Shareholders' Comprehensive
Investment Equity Loss
------------ ---------- ------------
BALANCE, December 31, 1995 $ -- $ 42,278 $ --
Stock options and warrants exercised -- 1,140 --
Stock issued for prior acquisition -- 75 --
Series C preferred stock dividends accrued -- (1,050) --
Preferred stock issuance cost accretion -- (144) --
Unrealized loss on investment (1,471) (1,471) (1,471)
Net loss for the year ended December 31, 1996 -- (12,187) (12,187)
------------ ---------- ------------
BALANCE, December 31, 1996 (1,471) 28,641 $ (13,658)
============
Stock options exercised and grants of common stock -- 817 --
Series C preferred stock dividends accrued -- (1,050) --
Preferred stock issuance cost accretion -- (156) --
Unrealized loss on investment (554) (554) (554)
Net loss for the year ended December 31, 1997 -- (7,408) (7,408)
------------ ---------- ------------
BALANCE, December 31, 1997 (2,025) 20,290 $ (7,962)
============
Stock options exercised and grants of common stock -- 2,227 --
Series C preferred stock dividends accrued -- (1,464) --
Preferred stock issuance cost accretion -- (158) --
Sale of stock -- 26,539 --
Stock issued as payment for services provided -- 751 --
Stock issued for retirement of preferred stock -- 17,906 --
Option repricing -- 445 --
Unrealized loss on investment (747) (747) (747)
Reclassification of investment to a trading security 2,772 2,772 2,772
Fractional shares retired upon completion of merger -- -- --
Net loss for the year ended December 31, 1998 -- (66,912) $ (66,912)
------------ ---------- ------------
BALANCE, December 31, 1998 $ -- $ 1,649 $ (64,887)
============ ========== ============
The accompanying notes are an integral part of these statements.
41
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
-------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
(In thousands)
1998 1997 1996
---------- --------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (66,912) $ (7,408) ($ 12,187)
Adjustments to reconcile net loss to cash flows from operating activities-
Gain on sale of discontinued operations (607) (4,510) (644)
Losses from discontinued operations - 2,418 1,758
Depreciation and amortization 38,617 25,620 23,452
Gain on sale of property and equipment (36) (156) (546)
Deferred income taxes - 1,021 833
Nonrecurring items 3,769 - -
Restructuring charge 2,969 - -
Option repricing 445 - -
Recognition of unrealized loss on investment 2,772 - -
Stock issued as payment for services provided 751 - -
Extraordinary loss from the early extinguishment of debt 17,856 - -
Changes in assets and liabilities, net of effects from acquisition-
Accounts receivable 3,636 (9,932) (3,934)
Other assets 4,114 750 608
Accounts payable and accrued expenses (15,246) 5,946 (1,051)
-------- ------- ---------
Net cash (used in) provided by operating activities (7,872) 13,749 8,289
Net cash (used in) provided by discontinued operations - (337) 4,252
-------- ------- ---------
Net cash flows (used in) provided by operating activities (7,872) 13,412 12,541
-------- ------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (11,920) (7,024) (8,024)
Proceeds from sale of discontinued operations - 10,625 3,502
Payment for certain contracts (6,248) (3,163) (3,347)
Purchase of payphone assets, net of cash acquired (3,216) (7,131) (8,570)
Purchase of Communications Central, Inc., net of cash acquired (101,644) - -
Purchase of Indiana Telecom, net of cash acquired (11,317) - -
Other 181 407 1,374
-------- ------- ---------
Net cash flows used in investing activities (134,164) (6,286) (15,065)
-------- ------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 366,500 13,660 7,411
Payments on long-term debt (240,436) (11,576) (2,466)
Bond tender premium paid on early extinguishment of debt (12,929) - -
Principal payments under capital lease agreements (769) (1,594) (1,174)
Debt issuance costs (7,335) (218) -
Sale of common stock 26,539 - -
Issuance of common stock through stock options and warrants 2,227 817 1,140
-------- ------- ---------
Net cash flows provided by financing activities 133,797 1,089 4,911
-------- ------- ---------
Net (decrease) increase in cash and cash equivalents (8,239) 8,215 2,387
CASH AND CASH EQUIVALENTS, beginning of period 25,401 17,186 14,799
-------- ------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 17,162 $ 25,401 $ 17,186
======== ======= =========
The accompanying notes are an integral part of these statements.
42
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
-------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(Dollars in thousands, except per share and share data)
1. DESCRIPTION OF BUSINESS AND THE PEOPLES MERGER:
-----------------------------------------------
Davel Communications, Inc. (the "Company" or "Davel") was incorporated on June
9, 1998 under the laws of the State of Delaware to effect the merger, on
December 23, 1998 (the "Peoples Merger"), of Davel Communications Group, Inc.
("Old Davel"), with Peoples Telephone Company, Inc. ("Peoples Telephone"). As a
result of the Peoples Merger, the Company is the largest domestic independent
payphone service provider in the United States, with approximately twice the
number of payphones as the second largest domestic independent payphone service
provider. The Company operates in a single business segment within the
telecommunications industry, operating, servicing and maintaining a system of
approximately 85,000 payphones in 42 states and the District of Columbia and
provides operator services to these payphones. The Company's headquarters is
located in Tampa, Florida, with divisional and administrative facilities in 35
dispersed geographic locations.
Pursuant to an Agreement and Plan of Merger dated July 5, 1998 as amended and
restated on October 22, 1998, a merger was consummated between the Company and
Peoples (the Peoples Merger) on December 23, 1998. The stock-for-stock
transaction was approved by the shareholders of the two companies, with the
Company continuing as the surviving corporation in the merger. Under the merger
agreement, each outstanding share of Peoples common stock was converted into the
right to receive 0.235 common shares of the Company and resulted in the issuance
of approximately 3,812,810 shares of common stock to the common shareholders of
Peoples. In addition, the outstanding shares of People's Series C Preferred
Stock and accrued Preferred Stock dividends were converted into approximately
892,977 shares of common stock. This transaction has been accounted for as a
pooling of interests, and accordingly, the financial statements of the Company
have been restated to reflect the combined financial position and operating
results as if the companies had operated as one entity since inception. For
periods preceding the merger, there were no intercompany transactions which
required elimination from the combined consolidated results of operations.
Selected financial information for the combining entities included in the
consolidated statements of operations for the three years ended December 31,
1998, 1997 and 1996 are as follows:
Year ended December 31
-----------------------------------
1998 1997 1996
Total revenues
Davel $ 84,663 $ 47,008 $ 36,973
Peoples 110,931 112,235 107,006
-------- -------- --------
Combined $195,594 $159,243 $143,979
======== ======== ========
Net income (loss)
Davel $(13,952) $ 4,262 $ 3,805
Peoples (19,965) (11,670) (15,992)
Non-recurring items (10,814) - -
Restructuring charges (4,325) - -
Extraordinary item (17,856) - -
-------- -------- --------
Combined $(66,912) $ (7,408) $(12,187)
======== ======== ========
43
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
Principles of Consolidation
- ---------------------------
The accompanying financial statements include the accounts of the Company and
its wholly owned subsidiaries. Financial data for all periods presented reflect
the retroactive effect of the merger, accounted for as a pooling of interest,
with Peoples Telephone, Inc. (Peoples) consummated in December 1998. All
significant intercompany accounts and transactions are eliminated in
consolidation.
The divestitures of the Company's hospitality, remanufacturing, cellular and
inmate telephone operations have been classified as discontinued operations.
Accordingly, operating results and cash flows for these businesses have been
segregated and reported as discontinued operations in the accompanying
consolidated financial statements.
Restricted Cash
- ---------------
Approximately $790 and $920 of cash on the accompanying consolidated balance
sheets at December 31, 1998 and 1997, respectively, is restricted and serves as
collateral for the Company's performance under a letter of credit.
Cash and Cash Equivalents
- -------------------------
The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
Concentrations of Credit Risk
- -----------------------------
Receivables have a significant concentration of credit risk in the
telecommunications industry. In addition, a significant amount of receivables
are generated by approximately 19% of the Company's payphones located in the
state of Florida.
Fair Value of Financial Instruments
- -----------------------------------
The fair value of the Company's financial instruments approximate their carrying
amounts. Fair value for all financial instruments other than long-term debt,
for which no quoted market prices exist, were based on appropriate estimates.
The value of the Company's long-term debt is estimated based on market prices
for similar issues or on the current rates offered to the Company for debt of
the same remaining maturities.
Property and Equipment
- ----------------------
Property and equipment is stated at cost and depreciation is provided over the
estimated useful lives using the straight-line method. Installed payphones and
related equipment includes installation costs which are capitalized and
amortized over the estimated useful lives of the equipment. The costs
associated with maintenance, repair and refurbishment of telephone equipment are
charged to expense as incurred.
The capitalized cost of equipment and vehicles under capital leases is amortized
over the lesser of the lease term or the asset's estimated useful life, and is
included in depreciation and amortization expense in the consolidated statements
of operations.
Location Contracts
- ------------------
Location contracts include acquisition costs allocated to location owner
contracts and other costs associated with obtaining written and signed location
contracts. These assets are amortized on a straight-line basis over their
estimated useful lives based on contract terms (3 to 5 years). Accumulated
amortization as of December 31, 1998 and 1997 was approximately $30,665 and
$23,109, respectively.
44
Goodwill
- --------
Goodwill is amortized on a straight-line basis over periods estimated to be
benefited, generally 15 years. Accumulated amortization as of December 31, 1998
and 1997 was approximately $7,911 and $3,072 respectively.
Long-Lived Assets
- -----------------
The Company accounts for long-lived assets pursuant to SFAS No. 121 Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of, which requires impairment losses to be recorded on long-lived assets used in
operations when events or changes in circumstances indicate that the carrying
amount on an asset may not be recoverable. Management reviews long-lived assets
and the related intangible assets for impairment whenever events or changes in
circumstances indicate the asset may be impaired. The Company does not believe
that any long-lived assets are impaired at December 31, 1998 based on the
estimated future cash flows of the Company.
Recognition of Revenue
- ----------------------
Revenues from coin calls and non-coin calls are recognized based on estimates of
calls made. When revenue on a telephone call is recorded, an expense is also
recorded for fees associated with the call.
Income Taxes
- ------------
The Company has accounted for income taxes under SFAS No. 109, an asset and
liability approach to accounting and reporting for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Although these estimates are based on management's knowledge of current events
and actions it may undertake in the future, they may ultimately differ from
actual results.
Reclassification
- ----------------
Certain reclassifications have been made to prior year balances to conform to
the 1998 presentation.
3. DISCONTINUED OPERATIONS:
------------------------
Hospitality Division
- --------------------
On December 31, 1996, the Company sold its Hospitality Division, ComTel Computer
Corp. (ComTel), in a stock sale agreement for approximately $5,000 (cash
proceeds of $2,700 and a note receivable of $2,300). The sale resulted in a gain
of $746, after tax expense of $439. The Company recorded a gain from operations
of $334, net of income taxes of $116 in 1996.
Remanufacturing Division
- ------------------------
During the fourth quarter of 1996, the Company committed to discontinue its
remanufacturing operations. The sale resulted in a loss of $102, after a tax
benefit of $63 and the Company recorded a loss from operations of $368 net of an
income tax benefit of $192 in 1996.
Inmate Telephone Operations
- ---------------------------
On December 19, 1997, the Company sold the remaining assets of the Company's
inmate phone division to Talton Holdings, Inc. (Talton) for $10,625 in cash plus
additional contingent consideration. This transaction resulted in a gain of
approximately $4,242. The contingent consideration is payable within 18 months
after
45
the closing based upon a formula which generally provides for the sharing
of (a) incremental profits from revenue increases on certain contracts sold to
Talton and (b) profits resulting from Talton closing on pending bids initiated
by the Company which result in new contracts. For financial accounting
purposes, the contingent consideration will be recognized as received. The
Company recorded a loss in discontinued operations of $2,418 and $1,724 for the
years ended December 31, 1997 and 1996, respectively. The inmate phone division
had revenues of $11,931 and $17,952 in 1997 and 1996, respectively.
Cellular Operations
- -------------------
During the year ended December 31, 1998, the Company sold its investment in
Shared Technologies Cellular, Inc. (STC) Common Stock resulting in a gain of
$607. The STC Common Stock was received in 1995 as part of the proceeds from
the sale of the Company's cellular telephone operations to STC which was treated
as discontinued operations. Accordingly, the gain from the sale of the
investment is recorded in discontinued operations in the 1998 statement of
operations.
4. ACQUISITIONS
------------
On February 3, 1998, the Company completed its acquisition of Communications
Central Inc. (the CCI Acquisition) at a price of $10.50 per share in cash, or
approximately $70.2 million in the aggregate, assumed CCI's outstanding debt of
$36.7 million and incurred $2.2 million in transaction costs. The CCI
Acquisition has been accounted for by the purchase method, and accordingly the
results of operations are included in the Company's consolidated statement of
operations from the date of acquisition. Goodwill associated with the
acquisition will be amortized over fifteen years using straight-line
amortization. The following summarizes unaudited pro forma consolidated results
of operations for the year ended December 31, 1997 assuming the CCI Acquisition
occurred at the beginning of 1997. These pro forma results are provided for
comparative purposes only and do not purport to be indicative of the results
which would have been obtained if this acquisition had been effected on the
dates indicated or which may be obtained in the future.
Year Ended December 31, 1997:
Total revenues $214,395
========
Loss from continuing operations $(14,031)
========
Basic and diluted loss from continuing
operations per share $ (1.81)
========
The allocation of the purchase price of the
CCI Acquisition is summarized as follows:
Working Capital $ 8,892
Property and equipment 46,119
Goodwill 42,541
Identifiable intangible assets 11,565
--------
$109,117
========
In January 1998, the Company acquired the operating assets of Indiana Telcom
Corporation including 2,632 payphones for $11,317 in a cash transaction
accounted for as a purchase. Accordingly, $5.4 million of the purchase price
was allocated to installed payphones and related equipment and $0.3 million was
allocated to location contracts. The excess of the purchase price over the fair
value of the assets acquired of $5.6 million was recorded as goodwill and is
being amortized over five years. Pro forma results of operations have not been
presented because the effect of this acquisition was not significant.
During the years ended December 31, 1998 and 1997, the Company made additional
acquisitions, which have been accounted for as purchases. The consolidated
financial statements include the operating results of each business from the
date of acquisition. Pro forma results of operations have not been presented
because the effects of each of these acquisitions were not significant. For all
transactions, the purchase price was allocated to payphones and associated
assets and, in some instances, noncompete agreements and goodwill. These
acquisitions included a total of 1,516 and 2,861 payphones in 1998 and 1997,
respectively, for purchase prices totaling $3,216 and $7,131, respectively.
46
5. NON-RECURRING ITEMS AND RESTRUCTURING CHARGE
--------------------------------------------
In connection with the Peoples merger, the Company recognized non-recurring
costs of $10,814 in 1998. These costs include legal fees, investment banking
fees, accounting fees and change of control payments. In addition, the Company
recognized restructuring costs of $4,325 related to the Peoples Merger and other
restructurings. These costs were composed of payments incurred in connection
with early lease terminations, facility closing costs, a writedown of the value
of the former Peoples headquarters and employee termination benefits for 143
excess field operations and administrative personnel. The following table
summarizes the restructuring charge and the amounts incurred during the year
ended December 31, 1998.
Facility Employee Merger
Closing Termination Writedown of Closing
Costs Costs Assets Other Costs Total
--------- ----------- ---------- ------ -------- -------
Non-recurring and
restructuring charge $1,140 $1,424 $ 790 $ 971 $10,814 $15,139
Utilized during 1998 (251) (131) (790) (184) (7,045) (8,401)
--------- ----------- ---------- ------ -------- -------
Remaining reserve at December 31, 1998 $ 889 $1,293 $ - $ 787 $ 3,769 $ 6,738
========= =========== ========== ====== ======== =======
In 1996, the Company recognized income of approximately $1,500 in connection
with settlements of loans and employment contracts with former officers, the
Company's former equity interest in the operating results of an unconsolidated
affiliate and amounts related to the resolution of outstanding litigation.
6. INVESTMENTS AND OTHER COMPREHENSIVE LOSS
----------------------------------------
Investments in debt and equity securities are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
The Company's investment in Global Telecommunications Solutions, Inc. (GTS) is
classified, as of December 31, 1998, as a trading security due to the Company's
plan to dispose of these securities in the near-term. Accordingly, the Company
recognized the unrealized loss on the investment of $2,772 in the accompanying
statement of operations. The Company's investment in GTS common stock at
December 31, 1998 and 1997, respectively, was approximately $363 and $1,110 and
is included in other assets in the accompanying consolidated balance sheets.
As of January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of SFAS No. 130
had no impact on the Company's net loss or shareholders' equity. SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities, which, prior to adoption, were reported separately in shareholders'
equity, to be included in other comprehensive loss. Prior year financial
statements have been reclassified to conform to the requirements of SFAS No.
130.
47
7. PROPERTY AND EQUIPMENT:
-----------------------
Property and equipment is summarized as follows at December 31:
Estimated
Useful Life
1998 1997 in Years
---------- ---------- -----------
Installed payphones and related equipment $ 209,177 $148,464 10
Furniture, fixtures and office equipment 8,638 5,833 5-7
Vehicles, equipment under capital leases and other equipment 6,432 6,632 4-10
Building and improvements 4,027 4,596 25
Land 950 950
-------- --------
229,224 166,475
Less- Accumulated depreciation (110,871) (90,065)
-------- --------
118,353 76,410
Uninstalled payphone equipment 11,746 8,480
-------- --------
$ 130,099 $ 84,890
======== ========
8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
-------------------------------------
Accounts payable and accrued expenses consist of the following at December 31:
1998 1997
------- -------
Accounts Payable $ 5,498 $ 4,294
Taxes Payable 5,472 3,843
Accrued Commissions 7,551 10,625
Accrued Merger and Restructuring Costs 6,738 323
Accrued Telephone Bills 3,259 700
Deferred Revenue 1,725 3,258
Interest Payable 491 5,981
Accrued Compensation 1,210 2,121
Other 2,449 3,212
------ ------
$34,393 $34,357
====== ======
9. ALLOWANCE FOR DOUBTFUL ACCOUNTS:
--------------------------------
Activity in the allowance for doubtful accounts is summarized as follows for the
years ended December 31:
1998 1997 1996
-------- -------- --------
Balance, at beginning of period $ 5,121 $ 4,515 $ 5,478
Charged to expense 1,299 4,590 4,374
Uncollected balances written off,
net of recoveries (1,037) (3,984) (5,338)
------ ------ ------
Balance, at end of period $ 5,383 $ 5,121 $ 4,514
====== ====== ======
48
10. RELATED-PARTY NOTES AND TRANSACTIONS:
-------------------------------------
Transactions With Chairman of the Board
- ---------------------------------------
The Company engaged in the following transactions with the Chairman of the Board
during the years ended December 31:
1998 1997 1996
----- ----- -----
Payments made for rent of commercial real
estate and lease of long distance
switching equipment $ 258 $ 196 $ 239
==== ==== ====
Payments received for providing administrative
services $ 85 $ 107 $ 122
==== ==== ====
During 1997, the Company sold a life insurance policy, a house and an airplane
to Mr. David Hill (the Chairman of the Board) who owns approximately 18% of the
Company's outstanding common stock as of December 31, 1998. The sale price was
at the estimated fair value of the assets as determined based upon independent
appraisals and the sale resulted in a gain of $273. The house and the airplane
were subsequently leased back to the Company and the gain was deferred and is
being recognized ratably over the term of the lease. During 1998 and 1997, the
Company recognized $72 and $128, respectively, of the deferred gain.
In September 1997, the Company purchased the long distance switching equipment
that had previously been leased from Mr. Hill. The price of $378 was the
estimated fair market value of the equipment based upon independent appraisals.
During the year ended December 31, 1998, the Company received management
advisory services from Equity Group Corporate Investments, Inc. (EGCI), an
affiliate of the Company. In exchange for these services, the Company issued to
affiliates of EGCI 44,659 shares of common stock with a fair value of $751 at
the date of grant.
11. LONG-TERM DEBT:
---------------
Following is a summary of long-term debt as of December 31:
Senior Credit Facility 1998 1997
- ---------------------- --------- --------
Term note payable to banks at an adjusted
LIBOR rate (9.50% at December 31, 1998),
interest payments due quarterly beginning
March 31, 1999 and principal payments due
quarterly beginning June 30, 1999,
collateralized by the Company's assets $125,000 $ -
Term note payable to the banks at an adjusted
LIBOR rate (10.25% at December 31,
1998), interest payments due quarterly
beginning March 31, 1999 and principal
payments due quarterly beginning June 30,
1999, collateralized by the Company's assets 95,000 -
Revolving Advance on bank's line of credit at
the bank's adjusted LIBOR rate (9.50%
at December 31, 1998), interest due quarterly
with the principal due December 23, 2003,
collateralized by the Company's assets 15,000 -
$100 million Senior Notes due 2002 with
stated interest rate of 12.25% - 100,000
Term note payable to the bank at the bank's
adjusted LIBOR rate (7.66% at December 31,
1997), principal payments of $375 plus
interest due quarterly beginning October 1,
1997, collateralized by the Company's Assets - 7,125
49
Revolving Advance on bank's line of credit
at the bank's corporate base rate (8.50%
at December 1997), interest due monthly
with the principal due September 30, 2001,
collateralized by the Company's assets - 1,176
Capital lease obligations and other notes
with various interest rates and various
maturity dates through 2002 1,976 1,446
-------- -------
236,976 109,747
Less- Current maturities 11,525 2,671
-------- --------
$225,451 $107,076
======== ========
In connection with the Peoples Merger on December 23, 1998, the Company entered
into a senior credit facility ("Senior Credit Facility") with NationsBank, N.A.
(the "Administrative Agent") and the other lenders named therein. The Senior
Credit Facility provides for borrowings by the Company from time to time of up
to $280 million for working capital and other corporate purposes.
Indebtedness of the Company under the Senior Credit Facility is secured by
substantially all of its and its subsidiaries' assets, including but not limited
to their equipment, inventory, receivables and related contracts, investment
property, computer hardware and software, bank accounts and all other goods and
rights of every kind and description and is guaranteed by the Company.
The Company's borrowings under the Senior Credit Facility bear interest at a
floating rate and may be maintained as Base Rate Loans (as defined in the Senior
Credit Facility) or, at the Company's option, as Eurodollar Loans (as defined in
the Senior Credit Facility). Base Rate Loans shall bear interest at the Base
Rate (defined as the higher of (i) the applicable prime lending rate of
NationsBank, N.A. or (ii) the Federal Reserve reported certificate of deposit
rate plus 1%). Eurodollar Loans shall bear interest at the Eurodollar Rate (as
defined in the Senior Credit Facility), plus a margin based on leverage.
The Company is required to pay the lenders under the Senior Credit Facility a
commitment fee of 0.5%, payable in arrears on a quarterly basis, on the average
unused portion of the Senior Credit Facility during the term of the facility.
The Company is also required to pay an annual agency fee to the Agent. In
addition, the Company was also required to pay an arrangement fee for the
account of each bank in accordance with the banks' respective pro rata share of
the Senior Credit Facility. The Agent and the lenders will receive such other
fees as have been separately agreed upon with the Agent.
The Senior Credit Facility requires the Company to meet certain financial tests,
including, without limitation, maximum levels of Senior Secured Debt as a ratio
of EBITDA (as defined in the Senior Credit Facility), minimum interest coverage,
minimum fixed charge coverage and maximum amount of capital expenditures. The
Senior Credit Facility also contains certain covenants which, among other
things, will limit the incurrence of additional indebtedness, prepayments of
other indebtedness (including the Notes), liens and encumbrances and other
matters customarily restricted in such agreements.
The Senior Credit Facility contains customary events of default, including
without limitation, payment defaults, breaches of representations and
warranties, covenant defaults, cross-defaults to certain other indebtedness,
certain events of bankruptcy and insolvency, judgement defaults, failure of any
guaranty or security document supporting the Senior Credit Facility to be in
full force and effect, and a change of control of the Company.
Upon consummation of the Peoples Merger, the Company redeemed $100,000 in Senior
Notes that were scheduled to mature in 2002. In addition, the Company also
retired approximately $96,660 in notes payable prior to maturity. In connection
with this early extinguishment of debt, the Company recognized an extraordinary
loss of $17,856.
50
Annual maturities of long-term debt are as follows:
Year ended December 31:
1999 $ 11,525
2000 21,552
2001 31,473
2002 31,226
2003 50,950
Thereafter 90,250
-------
$236,976
=======
In connection with the provisions of its Senior Credit Facility and the
Company's overall interest rate management objectives, the Company utilizes
derivative financial instruments to reduce its exposure to market risks from
significant increases in interest rates. The Company's strategy is to purchase
interest rate swaps, collars and caps from large financial institutions that in
the aggregate maintain notional amounts exceeding 40% of the Company's
outstanding long-term debt balance to limit the impact of increases in interest
rates on the Company's variable rate long-term debt. As of December 31, 1998,
the Company has two interest rate swap agreements with an aggregate notional
amount of $23 million with a termination date of March 2001. The interest rate
swaps require the Company to pay fixed rates of 5.9% in exchange for variable
rate payments based on the U.S. three month LIBOR (5.1% as of December 31,
1998). Interest rate differentials are paid or received every three months and
are recognized as adjustments to interest expense.
Subsequent to year-end, the Company purchased two interest rate cap agreements
with an aggregate notional amount of $40 million that terminate in March 2000.
The interest rate cap agreements require premium payments to the counterparty
based on the notional amount of the contract that are capitalized and amortized
to interest expense over the life of the contract. These agreements entitle the
Company to receive quarterly payments from the counterparties for amounts, if
any, by which the U.S. three month LIBOR rate exceeds 7%. In addition, the
Company entered into an interest rate collar agreement with a large financial
institution that terminates in February 2002. The notional amount of the
interest rate collar is $25 million and the agreement has a cap rate of 7% and a
floor rate of 4.8% based on the U.S. one month LIBOR rate.
The Company does not hold or issue derivative financial instruments for trading
purposes. The Company is exposed to credit risk in the event of nonperformance
by the counterparties; however, the Company does not anticipate nonperformance
by any of its counterparties. The carrying amount and fair value of these
contracts are not significant.
12. LEASE COMMITMENTS:
------------------
The Company conducts a portion of its operations in leased facilities under
noncancellable operating leases expiring at various dates through 2004. Some of
the operating leases provide the Company pay taxes, maintenance, insurance and
other occupancy expenses applicable to leased premises. The Company also
maintains certain equipment under noncancellable capital leases expiring at
various dates through 2002.
The annual minimum rental commitments under operating and capital leases are as
follows:
Year ended December 31: Operating Capital Total
--------- -------- --------
1999 $2,155 $ 787 $2,942
2000 1,697 702 2,399
2001 1,149 607 1,756
2002 706 318 1,024
2003 579 - 579
Thereafter 888 - 888
------ ------ ------
Total minimum payments required 7,174 2,414 9,588
Less amount representing interest - (438) (438)
------ ------ ------
$7,174 $1,976 $9,150
====== ====== ======
51
Rent expense for operating leases from continuing operations for the year ended
December 31, 1998, 1997 and 1996 was $1,060, $864 and $713, respectively.
13. CAPITAL STOCK TRANSACTIONS:
---------------------------
Preferred Stock
- ---------------
The Company's articles of incorporation authorize 1,000,000 shares of preferred
stock, par value $.01 per share. The Company does not have any immediate plans
to issue any shares of preferred stock.
Peoples' articles of incorporation authorized 5,000,000 shares of preferred
stock, of which 600,000 shares were designated as Series B Preferred Stock and
160,000 shares were designated as Series C Preferred Stock. During 1995,
Peoples issued 150,000 shares of Series C Cumulative Convertible Preferred Stock
to UBS Capital II LLC, a wholly owned subsidiary of Union Bank of Switzerland,
for proceeds of $15.0 million. The Preferred Stock accumulated dividends at an
annual rate of 7%. The dividends were payable in cash or may accumulate. In
connection with the Peoples Merger, the Company issued 892,977 shares of common
stock for the outstanding Series C Preferred Stock and cumulative dividends and
cancelled the 5,000,000 authorized shares of Peoples Preferred Stock.
Common Stock
- ------------
On June 30, 1998, the Company announced the closing of an investment by an
affiliate of EGCI, a privately-held investment company controlled by Sam Zell.
In the transaction, the EGCI affiliate invested $28 million in the Company as
payment for 1,000,000 shares of newly issued common stock and warrants to
purchase an additional 215,531 shares, which are exercisable at a price of
$32.00 per share. Proceeds of the sale were used to reduce amounts outstanding
under the Company's term loan facility.
In December 1998, the shareholders of the Company approved an increase in the
number of shares of authorized common stock from 10,000,000 to 50,000,000 in
order to accommodate issuance of stock in connection with the Peoples Merger.
Stock Options and Warrants
- --------------------------
The Company has several stock option plans under which options to acquire up to
2,234,525 shares may be granted to directors, officers and certain employees of
the Company including the stock option plans acquired in the Peoples merger.
Vesting periods for options issued under these plans range from immediate
vesting up to 10 years and generally expire after 5 to 10 years. The plans also
provide for the outright grant of common stock. For the years ended December
31, 1998 and 1997, respectively, 7,286 and 25,004 outright stock grants were
issued. During 1998, 45,000 warrants with an exercise price of $15.60 issued in
connection with the Company's initial public offering in 1993 expired. The
exercise price of each option generally equals the market price of the Company's
stock on the date of grant. Accordingly, no compensation cost has been
recognized for options granted under the plans. Had compensation cost for the
plans been determined based on the fair value of the options at the grant dates
consistent with the method of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net earnings and earnings per share would have been
reduced to the pro forma amounts indicated below:
1998 1997 1996
--------- --------- ---------
Net loss As reported $(66,912) $(7,408) $(12,187)
Pro forma $(71,766) $(8,921) $(13,105)
Basic and diluted loss per common share As reported $ (7.59) $ (1.02) $ (1.60)
Pro forma $ (8.13) $ (1.20) $ (1.72)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes options-pricing method with the following weighted-average
assumptions used for grants in 1998, 1997 and 1996: dividend yield of 0% for
all years; expected volatility of 48.8%, 54.0% and 32.9%, respectively, risk-
free interest rates of 5.4%, 5.7% and 6.2%, respectively, and expected life of
approximately five years.
52
A summary of the status of the Company's stock option plans as of December 31
and changes during the years ending on those dates is presented below:
1998 1997 1996
---------------- --------------------- ----------------
(shares in thousands)
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ ------
Outstanding at beginning of year 1,136 $20.34 903 $19.26 955 $20.85
Granted 407 23.98 317 23.04 321 14.20
Exercised (153) 13.35 (27) 13.35 (174) 12.36
Expired (99) 15.60 (23) 23.95 (7) 14.68
Cancelled - - (34) 22.85 (192) 24.89
------ ------ ------
Outstanding at end of year 1,291 $20.88 1,136 $20.34 903 $19.26
====== ====== ====== ====== ====== ======
Options exercisable at end of
year 1,065 $20.03 1,946 $21.29 663 $20.71
Weighted-average fair value of
options granted during the year $11.92 $ 6.04 $ 3.98
The following information applies to options outstanding at December 31, 1998:
Options Outstanding Options Exercisable
- ---------------------------------------------------------------------------- ------------------------------------------
Number Weighted Average Weighted Number
Range of Exercise Outstanding at Remaining Average Exercisable at Weighted Average
Price December 31, 1998 Contractual Life Exercise Price December 31, 1998 Exercise Price
----- ----------------- ---------------- -------------- ----------------- --------------
$ 9.25 to $19.38 600 3.12 years $14.48 600 $14.48
$21.53 to $26.60 538 4.47 years $24.56 312 $24.33
$30.85 to $36.17 153 4.49 years $33.16 153 $33.16
----- -----
1,291 3.85 years $20.88 1,065 $20.03
===== =====
As a result of a change of control provision included in Peoples' option
agreement with Mr. Jeffery Hanft (former Peoples Chairman and Chief Executive
Officer), the exercise price on 250,000 options was modified from $8.50 per
share to $2.80 per share which represents Peoples average closing stock price
for the 30 days prior to the announcement of the merger. A charge of $445 is
included in non-recurring items in the accompanying 1998 statement of operations
related to the option repricing. Upon completion of the Peoples Merger the
options were converted to options for Davel Common Stock.
At December 31, 1998, approximately 943,525 shares of Common Stock were reserved
pursuant to stock option plans.
53
14. EARNINGS PER SHARE:
-------------------
For the years ended December 31, 1998, 1997 and 1996, the treasury stock method
was used to determine the dilutive effect of the options and warrants on
earnings per share data. The following table summarizes the restated net loss
from continuing operations per share and the weighted average number of shares
outstanding used in the computations in accordance with SFAS No. 128. In
accordance with SFAS No. 128, the following table reconciles net income and
weighted average shares outstanding to the amounts used to calculate the basic
and diluted earnings per share for each of the years ended December 31, 1998,
1997 and 1996 (in thousands, except per share and share data):
1998 1997 1996
----------- ----------- -----------
Loss from continuing operations $ (49,663) $ (9,500) $ (11,073)
Deduct:
Cumulative preferred stock dividend requirement 1,464 1,050 1,050
Preferred stock issuance cost accretion 158 156 144
---------- ---------- ----------
Loss applicable to common shareholders $ (51,285) $ (10,706) $ (12,267)
========== ========== ==========
Weighted average common shares outstanding 9,029,285 8,407,255 8,317,215
========== ========== ==========
Basic and diluted loss per share $ (5.68) $ (1.27) $ (1.47)
========== ========== ==========
Diluted earnings per share is equal to basic earnings per share since the
exercise of outstanding options and warrants would be anti-dilutive for all
periods presented.
15. INCOME TAXES:
-------------
Deferred income taxes arise from temporary differences between the tax bases of
assets and liabilities and their reported amounts in the financial statements.
Deferred tax assets or liabilities at the end of each period are determined
using the tax rate expected to be in effect when taxes are actually paid or
recovered. Income tax provisions will increase or decrease in the same period
in which a change in tax rates is enacted.
The components of the provision for income taxes are as follows:
1998 1997 1996
---- ---- ----
Current provision:
Federal $ - $1,323 $ 828
State 108 115 207
Deferred provision (108) 1,021 833
----- ------ ------
Income tax expense from continuing $ - $2,459 $1,868
operations
Income tax expense from discontinued
operations - - 300
----- ------ ------
Total income tax expense $ - $2,459 $2,168
===== ====== ======
54
A reconciliation of federal statutory income taxes to the Company's effective
tax provision is as follows:
1998 1997 1996
--------- -------- --------
Provision for federal income tax at the
statutory rate (34%) $(16,885) $(2,394) $(3,130)
State income taxes net of federal benefit (1,902) (270) (353)
Change in valuation allowance 17,808 5,167 5,372
Goodwill amortization 927 - -
Other, net 52 (44) (21)
-------- ------- -------
Income taxes from continuing operations $ - $ 2,459 $ 1,868
Expected income tax expense (benefit) from
discontinued and extraordinary items (6,525) 792 (308)
Change in valuation allowance 6,525 (792) 608
-------- ------- -------
Total income tax expense $ - $ 2,459 $ 2,168
======== ======= =======
The tax effects of significant temporary differences representing deferred tax
assets and liabilities are as follows:
1998 1997
---------- ----------
Deferred Tax Assets:
Net operating loss carryforward $ 62,772 $ 30,119
Capital loss carryforward 574 798
Amortization 12,989 7,368
Alternative minimum tax credit carryforward 1,200 83
Other 10,259 4,492
-------- --------
Total deferred tax assets $ 87,794 $ 42,860
Valuation allowance (54,797) (26,556)
-------- --------
Net deferred tax assets $ 32,997 $ 16,304
-------- --------
Deferred Tax Liabilities:
Depreciation $(32,061) $(16,387)
Other (936) (25)
-------- --------
Total deferred tax liabilities $(32,997) $(16,412)
-------- --------
Net Deferred Tax Liability $ - (108)
======== ========
At December 31, 1998, the Company had tax net operating loss carryforwards of
approximately $167 million and capital losses of $1.5 million, which expire in
various amounts in the years 2001 to 2018. Approximately $138 million of the
net operating loss carryforwards plus $.7 million of the capital loss
carryforwards relate to multiple business acquisitions for which annual
utilization will be limited. The net operating losses and capital losses will
be subject to limitations if future ownership changes occur. In addition, these
loss carryforwards can only be utilized against future taxable income, if any,
generated by these acquired companies as if these companies continued to file
separate income tax returns.
As of December 31, 1998, the deferred tax asset valuation allowance increased to
approximately $54.8 million from $26.6 million as of December 31, 1997. The
increase is attributable to $3.9 million of valuation allowance established on
existing CCI net operating losses at the purchase date and $24.3 million
recorded as a component of the Company's 1998 tax provision. Realization of
deferred tax assets is dependent upon sufficient future taxable income during
the periods that temporary differences and carryforwards are expected to be
available to reduce taxable income. As such, the Company has recorded a
valuation allowance to reflect the estimated amount of deferred tax assets which
may not be realized due to the expiration of its operating loss and capital loss
carryforwards.
55
16. 401(k) PROFIT SHARING PLAN:
---------------------------
Certain subsidiaries maintain 401(k) profit sharing plans (the Plans). The
Plans provide for matching contributions from the subsidiaries that are limited
to certain percentages of employee contributions. Additional discretionary
amounts may be contributed by the subsidiaries. The subsidiaries contributed
approximately $397, $153 and $146 for 1998, 1997 and 1996, respectively.
17. STATEMENT OF CASH FLOWS:
------------------------
Cash paid for interest and income taxes and non-cash activities during the years
ended December 31 was as follows:
1998 1997 1996
------- ------- -------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $26,445 $13,737 $13,010
======= ======= =======
Income tax payments $ 143 $ 447 $ 2,287
======= ======= =======
NON-CASH ACTIVITIES:
Fixed assets acquired under capital lease obligations $ 1,934 $ 224 $ 1,185
======= ======= =======
Common stock issued for retirement of preferred stock $17,906 $ - $ -
======= ======= =======
Series C preferred stock dividends accrued $ 1,464 $ 1,050 $ 1,050
======= ======= =======
Preferred stock issuance accretion $ 158 $ 156 $ 144
======= ======= =======
Sale of certain fixed assets and a life insurance policy to the Chairman of
the Board in exchange for phone switching equipment and the assumption of two
corporate loans $ - $ 148 $ -
======= ======= =======
Note received in exchange for Hospitality Division $ - $ - $ 2,300
======= ======= =======
18. PROVISION FOR DIAL-AROUND COMPENSATION:
---------------------------------------
On September 20, 1996, the Federal Communications Commission (FCC) adopted rules
in a docket entitled In the Matter of Implementation of the Payphone
-----------------------------------------------
Reclassification and Compensation Provisions of the Telecommunications Act of
- -----------------------------------------------------------------------------
1996, FCC 96-388 (the 1996 Payphone Order), implementing the payphone provisions
- ----
of Section 276 of the Telecommunications Act of 1996 (the Telcom Act). The 1996
Payphone Order, which became effective November 7, 1996, initially mandated
dial-around compensation for both access code calls and 800 subscriber calls at
a flat rate of $45.85 per payphone per month (131 calls multiplied by $0.35 per
call). Commencing October 7, 1997, and ending October 6, 1998, the $45.85 per
payphone per month rate was to transition to a per-call system at the rate of
$0.35 per call. Several parties filed petitions for judicial review of certain
of the FCC regulations including the dial-around compensation rate. On July 1,
1997, the U.S. Court of Appeals for the District of Columbia Circuit (the Court)
responded to appeals related to the 1996 Payphone Order by remanding certain
issues to the FCC for reconsideration. These issues included, among other
things, the manner in which the FCC established the dial-around compensation for
800 subscriber and access code calls, the manner in which the FCC established
the interim dial-around compensation plan and the basis upon which interexchange
carriers (IXCs) would be required to compensate payphone service providers
(PSPs). The Court remanded the issue to the FCC for further consideration, and
clarified on September 16, 1997, that it had vacated certain portions of the
FCC's 1996 Payphone Order, including the dial-around compensation rate.
Specifically, the Court determined that the FCC did not adequately justify (i)
the per-call compensation rate for 800 subscriber and access code calls at the
deregulated local coin rate of $0.35, because it did not sufficiently justify
its conclusion that the costs of local coin calls are
56
similar to those of 800 subscriber and access code calls; and (ii) the
allocation of the payment obligation among the IXCs for the period from November
7, 1996, through October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997, the FCC adopted and
released its Second Report and Order in the same docket, FCC 97-371 (the 1997
-----------------------
Payphone Order). This order addressed the per-call compensation rate for 800
subscriber and access code calls that originate from payphones in light of the
decision of the Court which vacated and remanded certain portions of the FCC's
1996 Payphone Order. The FCC concluded that the rate for per-call compensation
for 800 subscriber and access code calls from payphones is the deregulation
local coin rate adjusted for certain cost differences. Accordingly, the FCC
established a rate of $0.284 ($0.35 - $0.066) per call for the first two years
of per-call compensation (October 7, 1997, through October 6, 1999). The IXCs
are required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. After the first two years of per-call compensation,
the market-based local coin rate, adjusted for certain costs defined by the FCC
as $0.066 per call, is the surrogate for the per-call rate for 800 subscriber
and access code calls. These new rule provisions were made effective as of
October 7, 1997.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC 98-481,
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 from the effective date of the Court's decision.
In response to the Court's second remand, the FCC conducted further proceedings
and sought additional comment from interested parties to address the relevant
issues posed by the Court. On February 4, 1999, the FCC released its Third
Report and Order, and Order on Reconsideration of the Second Report and Order
(the "1999 Payphone Order"), in which the FCC abandoned its efforts to derive a
"market-based" default dial-around compensation rate and instead adopted a
"cost-based" rate of $0.24 per dial-around call. This new rate will become
effective April 21,1999, and will serve as the default rate through January 31,
2002. The new rate will also be applied retroactively to the period beginning
on October 7, 1997, less a $0.002 amount to account for FLEX ANI payphone
tracking costs, for a net compensation rate of $0.238. The 1999 Payphone Order
deferred a final ruling on the interim period (November 7, 1996 to October 6,
1997) treatment to a later, as yet unreleased, order, however, it appears from
the 1999 Payphone Order that the $0.238 per call rate will also be applied to
the initial interim period from November 7, 1996 to October 6, 1997. Upon
establishment of the interim period rate, the FCC has further ruled that a true-
up will be made for all payments or credits (with applicable interest) due and
owing between the IXCs and the PSPs, including Davel, for the payment period
commencing on November 7, 1996 through the effective date of the new $0.24 per
call rate.
Based on the FCC's tentative conclusion in the 1997 Payphone Order, the Company
during 1997 adjusted the amounts of dial-around compensation previously recorded
related to the period from November 7, 1996, through June 30, 1997, from the
initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). As a
result of this adjustment, the provision recorded for the year ended December
31, 1997, related to reduced dial-around compensation is approximately $3.3
million. Based on the reduction in the per-call compensation rate in the 1999
Payphone Order, the Company further reduced non-coin revenues by $9.0 million
during 1998. The adjustment included approximately $6.0 million to adjust
revenue recorded during the period November 7, 1996 to October 6, 1997 from
$37.20 per-phone per-month to $31.18 per phone per month
57
($0.238 per call multiplied by 131 calls). The remaining $3.0 million of the
adjustment was to adjust revenues recorded during the period October 7, 1997
through December 31, 1998 to actual dial-around call volumes for the period
multiplied by $0.238 per call.
The Company recorded dial-around compensation revenue, net of adjustments, of
approximately $4.4 million for the period from November 7, 1996 through December
31, 1996, approximately $24.9 million for the period from January 1, 1997
through December 31, 1997 and approximately $27.2 million for the period from
January 1, 1998 through December 31, 1998.
The Company's counsel, Rammelkamp, Bradney, Kuster, Fritsche & Lindsay, P.C., is
of the opinion that the Company is legally entitled to fair compensation under
the Telecom Act for dial-around calls the Company delivered to any carrier
during the period from November 7, 1996, through October 6, 1997. Based on the
information available, the Company believes that the minimum amount it is
entitled to as fair compensation under the Telcom Act for the period from
November 7, 1996, through October 6, 1997, is $31.18 per payphone per month and
the Company, based on the information available to it, does not believe that it
is reasonably possible that the amount will be materially less than $31.18 per
payphone per month. While the amount of $0.238 per call constitutes the
Company's position of the appropriate level of fair compensation, certain IXCs
have asserted in the past, are asserting and are expected to assert in the
future that the appropriate level of fair compensation should be lower than
$0.238 per call. If the level of fair compensation is ultimately determined to
be an amount less than $0.238 per call, such determination could result in a
material adverse impact on the Company's results of operations and financial
position.
19. COMMITMENTS AND CONTINGENCIES:
------------------------------
On September 29, 1998, the Company announced that it was exercising its
contractual rights to terminate a merger agreement (the "Davel/PhoneTel Merger
Agreement") with PhoneTel Technologies, Inc. ("PhoneTel"), based on breaches of
representations, warranties and covenants by PhoneTel. On October 1, 1998, the
Company filed a lawsuit in Delaware Chancery Court seeking damages, rescission
of the Davel/PhoneTel Merger Agreement and a declaratory judgment that such
breaches occurred. On October 27, 1998, PhoneTel answered the complaint and
filed a counterclaim against the Company alleging that the Davel/PhoneTel Merger
Agreement had been wrongfully terminated. At the same time, PhoneTel also filed
a third party claim against Peoples Telephone Company, Inc. (acquired by the
Company on December 23, 1998) alleging that Peoples wrongfully caused the
termination of the Davel/PhoneTel Merger Agreement. The counterclaim and third
party claim seek specific performance by the Company of the transactions
contemplated by the Davel/PhoneTel Merger Agreement and damages and other
equitable relief from the Company and Peoples. The Company believes that it has
meritorious claims against PhoneTel and intends to defend vigorously against the
counterclaim against Davel and the third party claim against Peoples initiated
by PhoneTel. The Company at this time cannot predict the outcome of this
litigation.
In December 1995, Cellular World, Inc. filed a complaint in Dade County Circuit
Court against Peoples and its subsidiary, PTC Cellular, Inc., alleging wrongful
interference with Cellular World's advantageous business relationship with Alamo
Rent-A-Car, and alleged misappropriation of Cellular World's trade secrets
concerning Cellular World's proprietary cellular car phone rental system
equipment. Cellular World is seeking damages alleged to exceed $10 million.
Formal discovery is nearly completed. Pending completion of discovery, the
Company expects the trial to be scheduled for May or June 1999. Based on the
proceedings conducted to date, Peoples continues to believe that it has several
meritorious legal and factual defenses. The Company at this time cannot predict
the outcome of this litigation.
The Company is involved in other litigation arising in the normal course of its
business which it believes will not materially affect its financial position or
results of operations.
20. SUBSEQUENT EVENT:
-----------------
On April 8, 1999, the Company and the Lenders agreed to the First Amendment to
Credit Agreement and Consent and Waiver (the "First Amendment") which waived
compliance, for the fiscal quarter ending March 31, 1999, with the financial
covenants set forth in the Senior Credit Facility. In addition, the First
Amendment waived any event of default related to two small acquisitions made by
the Company in the first quarter of 1999, and waived the requirement that the
Company deliver annual financial statements to the Lenders within 90 days of
December 31, 1998, provided that such financial statements shall be delivered no
later than April 15, 1999. The First Amendment contained amendments that
provided for the following:
58
. amendment of the applicable percentages for Eurodollar Loans for the period
between April 1, 1999 and June 30, 2000 at each pricing level to 0.25% higher
than those in the previous pricing grid
. prepayment of debt from receipt of dial-around compensation accounts
receivable related to the period November 1996 through October 1997
. further limitations on permitted acquisitions as defined in the Credit
Agreement through June 30, 2000
. during the period April 1, 1999 to June 30, 2000, required lenders consent
for the making of loans or the issuance of letters of credit if the sum of
revolving loans outstanding plus letter of credit obligations outstanding
exceeds $50.0 million
. the introduction of a new information covenant to provide certain operating
data to the Lenders on a monthly basis
. increases in the maximum allowable ratio of funded debt to EBITDA through the
quarter ended June 30, 2000
. decreases in the minimum allowable interest coverage ratio through the
quarter ended June 30, 2000
. decreases in the minimum allowable fixed charge coverage ratio through the
quarter ended June 30, 2000
The Company believes that it is probable that it will comply with the loan
covenants for the next twelve months and, as such, has not classified the
obligations under the Senior Credit Facility as current liabilities.
The First Amendment also limits capital expenditures and requires the payment of
an amendment fee equal to the product of each Lender's commitment multiplied by
0.35%.
21. NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
The Financial Accounting Standards Board recently issued SFAS No. 133 Accounting
for Derivative Instruments and Hedging Activities, which requires that all
derivatives be recognized as either assets or liabilities in the statement of
financial position at fair value unless specific hedge criteria are met. The
Company is required to adopt the provisions of SFAS No. 133 in 2000. Adoption
of this statement is not expected to significantly impact the Company's
consolidated financial position, results of operations or cash flows.
22. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
--------------------------------------------
Certain unaudited quarterly financial information for the year ended December
31, 1998 and 1997, is as follows:
Quarter Ended
------------------------------------------
Full
1998 March June September December Year
---- --------- --------- ---------- --------- ---------
Total revenues $47,197 $54,061 $54,190 $ 40,146 $195,594
Operating income (loss) (1,633) 1,155 1,583 (26,887) (25,782)
Net loss (5,354) (4,030) (3,903) (53,625) (66,912)
Net loss per share:
Basic and diluted $ (.67) $ (.55) $ (.44) $ (5.57) $ (7.59)
1997
----
Total revenues $38,730 $41,348 $38,332 $ 40,833 $159,243
Operating profit (loss) 1,947 3,539 (697) 1,254 6,043
Net income (loss) (2,776) (1,338) (4,665) 1,371 (7,408)
Net income (loss) per share:
Basic and diluted $ (.37) $ (.19) $ (.59) $ .13 $ (1.02)
59
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no reported disagreements on any matter of accounting
principles or practice or financial statement disclosure at any time during the
twenty-four months prior to December 31, 1998.
On January 30, 1998, the Company filed a Current Report on Form 8-K to
report that it had engaged Arthur Andersen LLP as its independent auditors for
the fiscal year ended December 31, 1997. The Registrant informed its previous
independent accountants, Kerber, Eck & Braeckel LLP of its dismissal on January
26, 1998.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this Item 10 will be contained in the Company's
definitive proxy materials to be filed with the Securities and Exchange
Commission and is incorporated in this Annual Report on 10-K by this reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 will be contained in the Company's
definitive proxy materials to be filed with the Securities and Exchange
Commission and is incorporated in this Annual Report on 10-K by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 will be contained in the Company's
definitive proxy materials to be filed with the Securities and Exchange
Commission and is incorporated in this Annual Report on 10-K by this reference.
ITEM 13. CERTAIN TRANSACTIONS
The information required by this Item 13 will be contained in the Company's
definitive proxy materials to be filed with the Securities and Exchange
Commission and is incorporated in this Annual Report on 10-K by this reference.
60
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed with, and as part of, this Annual
Report on Form 10-K.
1. Financial Statements
See Part II.
2. Financial Statement Schedules
None
3. Exhibits
See Exhibit Index on the following page.
(b) Reports on Form 8-K.
On January 6, 1999, the Company filed a Current Report on Form 8-K,
dated December 23, 1998, with the Securities and Exchange Commission reporting
the closing of the merger with Peoples Telephone and the adoption of a
stockholder rights plan.
61
EXHIBIT INDEX
Exhibits 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.
(incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K
filed with the Commission on June 23, 1998).
2.2 Agreement and Plan of Merger and Reorganization, dated as of July 5, 1998,
by and among Davel Communications Group, Inc., Davel Holdings, Inc. and
Peoples Telephone Company, Inc. (incorporated by reference to Exhibit 2.1
to Current Report on Form 8-K filed with the Commission on July 22, 1998).
3.1 Restated Certificate of Incorporation of Davel Communications, Inc.
(incorporated by reference to Exhibit 3.1 to Registration Statement on Form
S-4 (Registration No. 333-67617) dated November 20, 1998).
3.2 Restated By-laws of Davel Communications, Inc. (incorporated by reference
to Exhibit 3.2 to Registration Statement on Form S-4 (Registration No. 333-
67617) dated November 20, 1998.
4.1 Rights Agreement, dated as of December 15, 1998, between Davel
Communications, Inc. and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent, including the form of Certificate of Designation, Preferences
and Rights of Junior Participating Preferred Stock, Series A attached
thereto as Exhibit A, the form of Rights Certificate attached thereto as
Exhibit B and the Summary of Rights attached thereto as Exhibit C
(incorporated by reference to the Company's Registration Statement on Form
8-A, filed with the Commission on December 23, 1998).
10.1 Credit Agreement, dated as of February 3, 1998, by and among Davel
Communications Group, Inc., NationsBank, N.A., as Administrative Agent,
SunTrust Bank, Tampa Bay, as Documentation Agent, LaSalle National Bank, as
Co-Agent, and the other Lenders party thereto (incorporated by reference to
Exhibit 10.1 to Current Report on Form 8-K filed with the Commission on
February 18, 1998).
10.2 Form of Revolving Note, dated February 3, 1998, made by Davel
Communications Group, Inc. in favor of NationsBank, N.A., in the principal
amount of $6,300,000 (incorporated by reference to Exhibit 10.2 to Current
Report on Form 8-K filed with the Commission on February 18, 1998).
10.3 Form of Revolving Note, dated February 3, 1998, made by Davel
Communications Group, Inc. in favor of SunTrust Bank, Tampa Bay, in the
principal amount of $6,300,000 (incorporated by reference to Exhibit 10.3
to Current Report on Form 8-K filed with the Commission on February 18,
1998).
62
Exhibits Description
- -------- -----------
10.4 Form of Revolving Note, dated February 3, 1998, made by Davel
Communications Group, Inc. in favor of LaSalle National Bank, in the
principal amount of $2,400,000 (incorporated by reference to Exhibit 10.4
to Current Report on Form 8-K filed with the Commission on February 18,
1998).
10.5 Form of Term Note, dated February 3, 1998, made by Davel Communications
Group, Inc. in favor of NationsBank, N.A., in the principal amount of
$46,200,000 (incorporated by reference to Exhibit 10.5 to Current Report
on Form 8-K filed with the Commission on February 18, 1998).
10.6 Form of Term Note, dated February 3, 1998, made by Davel Communications
Group, Inc. in favor of SunTrust Bank, Tampa Bay, in the principal amount
of $46,200,000 (incorporated by reference to Exhibit 10.6 to Current
Report on Form 8-K filed with the Commission on February 18, 1998).
10.7 Form of Term Note, dated February 3, 1998, made by Davel Communications
Group, Inc. in favor of LaSalle National Bank, in the principal amount of
$17,600,000 (incorporated by reference to Exhibit 10.7 to Current Report
on Form 8-K filed with the Commission on February 18, 1998).
10.8 Stock Purchase Agreement, dated May 14, 1998, by and between Davel
Communications Group, Inc. and Samstock, L.L.C. (incorporated by reference
to Exhibit 10.1 to Current Report on Form 8-K filed with the Commission on
June 23, 1998).
10.9 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and ING (U.S.) Investment Corporation (incorporated by reference to
Exhibit 10.2 to Current Report on Form 8-K filed with the Commission on
June 23, 1998).
10.10 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and Cerberus Partners, L.P. (incorporated by reference to Exhibit
10.3 to Current Report on Form 8-K filed with the Commission on June 23,
1998).
10.11 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and Mr. Peter Graf (incorporated by reference to Exhibit 10.4 to
Current Report on Form 8-K filed with the Commission on June 23, 1998).
10.12 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and Mr. George Henry (incorporated by reference to Exhibit 10.5 to
Current Report on Form 8-K filed with the Commission on June 23, 1998).
10.13 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and Mr. Steven Richman (incorporated by reference to Exhibit 10.6 to
Current Report on Form 8-K filed with the Commission on June 23, 1998).
63
Exhibits Description
- -------- -----------
10.14 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and Mr. Aron Katzman (incorporated by reference to Exhibit 10.7 to
Current Report on Form 8-K filed with the Commission on June 23, 1998).
10.15 Voting Agreement, dated June 11, 1998, between Davel Communications Group,
Inc. and Mr. Joseph Abrams (incorporated by reference to Exhibit 10.8 to
Current Report on Form 8-K filed with the Commission on June 23, 1998).
10.16 Corporate Governance, Liquidity and Voting Agreement, dated as of July 5,
1998, by and among UBS Capital II LLC, Davel Communications Group, Inc.,
Davel Holdings, Inc. and Peoples Telephone Company, Inc. (incorporated by
reference to Exhibit 10.1 to Current Report on Form 8-K filed with the
Commission on July 22, 1998).
10.17 Termination Option Agreement, dated as of July 5, 1998, by and among Davel
Communications Group, Inc. and Peoples Telephone Company, Inc.
(incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K
filed with the Commission on July 22, 1998).
10.18 Credit Agreement, dated as of December 23, 1998, among Davel Financing
Company, L.L.C., as Borrower, Davel Communications, Inc., the Domestic
Subsidiaries of the Borrower and Davel Communications, Inc., as
Guarantors, the Lenders identified therein, NationsBank, N.A., as
Administrative Agent, BancBoston Robertson Stephens Inc., as Syndication
Agent, The Chase Manhattan Bank, as Documentation Agent, and NationsBanc
Montgomery Securities, LLC, as Lead Arranger (incorporated by reference to
Exhibit 10.1 to Current Report on Form 8-K filed with the Commission on
January 6, 1999).
10.19 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and Scott C. Ambler
(incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.20 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and David A. Arvizu
(incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.21 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and William A. Baum
(incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
64
Exhibits Description
- -------- -----------
10.22 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and Neil N. Snyder
(incorporated by reference to Exhibit 10.5 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.23 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and E. Craig Sanders
(incorporated by reference to Exhibit 10.6 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.24 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and C. Keith Pressley
(incorporated by reference to Exhibit 10.7 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.25 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and Robert E. Lund
(incorporated by reference to Exhibit 10.8 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.26 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and Alan C. MacFarland
(incorporated by reference to Exhibit 10.9 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.27 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and Bruce W. Renard
(incorporated by reference to Exhibit 10.10 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
10.28 Employment and Non-Competition Agreement, dated as of December 23, 1998,
by and between Davel Communications, Inc. and Lawrence T. Ellman
(incorporated by reference to Exhibit 10.11 to Current Report on Form 8-K
filed with the Commission on January 6, 1999).
21.1 Subsidiaries of Davel Communications, Inc.
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule
65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
DAVEL COMMUNICATIONS, INC.
Date: April 15, 1999
/s/ Michael E. Hayes
---------------------------
Michael E. Hayes
Senior Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signatures Title Date
/s/ David R. Hill Chairman of the Board April 15, 1999
- --------------------------- of Directors
David R. Hill
/s/ Robert D. Hill President, Chief April 15, 1999
- --------------------------- Executive Officer
Robert D. Hill and Director
/s/ Michael E. Hayes Senior Vice President, April 15, 1999
- --------------------------- Chief Financial Officer
Michael E. Hayes and Director
/s/ F. Philip Handy Director April 15, 1999
- ---------------------------
F. Philip Handy
/s/ Justin S. Maccarone Director April 15, 1999
- ---------------------------
Justin S. Maccarone
/s/ Thomas M. Vitale Director April 15, 1999
- ---------------------------
Thomas M. Vitale
/s/ A. Jones Yorke Director April 15, 1999
- ---------------------------
A. Jones Yorke
/s/ Samuel Zell Director April 15, 1999
- ---------------------------
Samuel Zell
66