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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO _________
COMMISSION FILE NUMBER: 000-25207
DAVEL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-3538257
-------- ----------
(State or other jurisdiction of (I.R.S. Employer)
incorporation or organization) I.D. No.)
1001 LAKESIDE AVENUE, CLEVELAND, OH 44114
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (216) 241-2555
Indicate by check mark whether the Registrant has (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X NO
--- ---
As of August 10, 2002, there were 615,020,085 shares of the Registrant's Common
Stock outstanding.
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DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
RECENT DEVELOPMENTS...................................................................... 1
PART I FINANCIAL INFORMATION
ITEM 1
Financial Statements:
Consolidated Balance Sheets............................................................... 2
Consolidated Statements of Operations..................................................... 3
Consolidated Statements of Cash Flows..................................................... 5
Notes to Consolidated Financial Statements................................................ 6
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operations..... 14
Liquidity and Capital Resources........................................................... 20
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk................................ 27
PART II OTHER INFORMATION
ITEM 1
Legal Proceedings......................................................................... 28
ITEM 6
Exhibits and Reports on Form 8-K.......................................................... 29
RECENT DEVELOPMENTS
COMPLETION OF PHONETEL MERGER
On July 24, 2002, a wholly owned subsidiary of Davel Communications,
Inc. ("Davel" or the "Company") merged with and into PhoneTel Technologies, Inc.
("PhoneTel") pursuant to the Agreement and Plan of Reorganization and Merger,
dated February 19, 2002, between the Company and PhoneTel and certain of their
respective affiliates (the "PhoneTel Merger"). As a result of the PhoneTel
Merger, each share of common stock of PhoneTel was converted into the right to
receive 1.8233 shares of common stock of the Company.
Immediately prior to the PhoneTel Merger, PhoneTel exchanged
approximately $34 million of debt outstanding under its junior credit facility
for 112,246,511 shares of common stock of PhoneTel, which was subsequently
exchanged for 204,659,064 shares of the Company in the PhoneTel Merger. Also
immediately prior to the PhoneTel Merger, the Company exchanged approximately
$220 million of debt outstanding under its junior credit facility for 1,000
shares of DF Merger Corp., a wholly owned subsidiary of the Company, which was
subsequently merged with and into Davel Financing Company, L.L.C., a subsidiary
of the Company ("DFC"), in exchange for 380,612,730 shares of the Company's
common stock. Upon completion of the debt exchange and merger the Company had
approximately 615 million shares outstanding.
Simultaneously with the closing of the PhoneTel Merger, the remaining
debt outstanding under the Davel's and PhoneTel's existing junior credit
facilities in the aggregate amount of $100 million was restructured into a
single Amended, Restated and Consolidated Credit Agreement among the Company,
DFC, PhoneTel, Cherokee Communications, Inc., a subsidiary of PhoneTel, each of
the domestic subsidiaries of the Company and PhoneTel, each of the lenders
signatory thereto and Foothill Capital Corporation, as agent for the lenders
signatory thereto (the "New Junior Credit Facility").
John D. Chichester, formerly President and Chief Executive Officer of
PhoneTel, became Chief Executive Officer of the Company and joined Davel's Board
of Directors as Chairman. Bruce W. Renard stepped down as President of Davel
following the merger and joined the new board of directors.
In addition to Messrs. Chichester and Renard, the following individuals
will serve on the post-merger Board of Directors: Andrew C. Barrett, a former
commissioner with the Federal Communications Commission and the Illinois
Commerce Commission and currently a managing director of the Barrett Group, a
company providing consulting services to the telephone, media and cable
industries; James N. Chapman, an independent capital markets and strategic
planning consultant for private and public companies across a broad range of
industries; and Kevin P. Genda, a Managing Director of Cerberus Capital
Management, L.P. and Senior Vice President-Chief Credit Officer of Ableco
Finance LLC, both affiliates of Cerberus Partners, L.P., a principal shareholder
of and lender to Davel.
SECOND AMENDMENT TO SENIOR CREDIT FACILITY
In July 2002, the Company notified the lenders under its senior credit
agreement, dated as of February 19, 2002 and amended on May 14, 2002 (the "New
Senior Credit Facility"), that it had determined it would be unable to meet the
Minimum Adjusted EBITDA and Minimum EBITDA covenants set forth in the New Senior
Credit Facility through the maturity date of June 30, 2003. On July 23, 2002,
the Company entered into the Second Amendment to the New Senior Credit Facility
("Second Amendment"). Pursuant to the Second Amendment, which was effective July
1, 2002, the Minimum Adjusted EBITDA and Minimum EBITDA covenants were adjusted
through June 30, 2003.
1
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2002 2001
--------- ---------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 5,852 $ 5,333
Trade accounts receivable 8,837 11,757
Other current assets 2,165 629
--------- ---------
TOTAL CURRENT ASSETS 16,854 17,719
Property and equipment, net 38,945 47,448
Location contracts, net 1,319 1,983
Other assets 1,607 1,175
--------- ---------
TOTAL ASSETS $ 58,725 $ 68,325
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES
Current maturities of long-term debt and
obligations under capital leases $ 5,245 $ 237,726
Accrued interest - current portion 63 36,320
Accounts payable and other accrued expenses 15,101 23,784
--------- ---------
TOTAL CURRENT LIABILITIES 20,409 297,830
--------- ---------
Long-term debt and obligations under capital leases 282,447 308
--------- ---------
TOTAL LIABILITIES 302,856 298,138
--------- ---------
Shareholders' Deficit
Preferred stock - $0.01 par value, 1,000,000
shares authorized, no shares outstanding -- --
Common stock - $.01 par value, 50,000,000
shares authorized, 11,169,440 shares
issued and outstanding 112 112
Additional paid-in capital 128,503 128,503
Accumulated other comprehensive loss -- (7)
Accumulated deficit (372,746) (358,421)
--------- ---------
TOTAL SHAREHOLDERS' DEFICIT (244,131) (229,813)
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 58,725 $ 68,325
========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
2
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30
(IN THOUSANDS, EXCEPT SHARE DATA)
2002 2001
------------ ------------
REVENUES:
Coin calls $ 13,107 $ 15,806
Non-coin calls 4,293 7,688
------------ ------------
Total revenues 17,400 23,494
------------ ------------
COSTS AND EXPENSES:
Telephone charges 4,801 6,764
Commissions 3,022 6,509
Service, maintenance and network costs 4,652 5,376
Depreciation and amortization 4,789 4,621
Selling, general and administrative 1,951 3,194
------------ ------------
Total operating costs and expenses 19,215 26,464
------------ ------------
Operating loss (1,815) (2,970)
OTHER INCOME (EXPENSE):
Interest expense, net (4,712) (7,191)
Other 43 10
------------ ------------
LOSS BEFORE INCOME TAXES (6,484) (10,151)
Income tax expense -- --
------------ ------------
NET LOSS $ (6,484) $ (10,151)
============ ============
BASIC AND DILUTED LOSS PER SHARE $ (0.58) $ (0.91)
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 11,169,440 11,169,522
============ ============
The accompanying notes are an integral part
of these consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30
(IN THOUSANDS, EXCEPT SHARE DATA)
2002 2001
------------ ------------
REVENUES:
Coin calls $ 25,329 $ 31,380
Non-coin calls 9,333 15,349
------------ ------------
Total revenues 34,662 46,729
------------ ------------
COSTS AND EXPENSES:
Telephone charges 8,881 15,724
Commissions 6,908 11,773
Service, maintenance and network costs 9,498 11,597
Depreciation and amortization 9,758 9,254
Selling, general and administrative 4,723 6,267
------------ ------------
Total operating costs and expenses 39,768 54,615
------------ ------------
Operating loss (5,106) (7,886)
OTHER INCOME (EXPENSE):
Interest expense, net (9,266) (15,002)
Other 47 109
------------ ------------
LOSS BEFORE INCOME TAXES (14,325) (22,779)
Income tax expense -- --
------------ ------------
NET LOSS $ (14,325) $ (22,779)
============ ============
BASIC AND DILUTED LOSS PER SHARE $ (1.28) $ (2.04)
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 11,169,440 11,169,531
============ ============
The accompanying notes are an integral part
of these consolidated financial statements.
4
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30
(IN THOUSANDS)
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(14,325) $(22,779)
Adjustments to reconcile net loss to cash flows
from operating activities:
Depreciation and amortization 9,758 9,254
Amortization of deferred financing charges 54 1,850
Write-off of fixed assets/asset valuation charge 10 53
Changes in current assets and liabilities excluding
reclassifications to long-term debt:
Accounts receivable 2,920 539
Other assets (2,016) (30)
Accounts payable and accrued liabilities (8,600) (228)
Accrued interest 8,702 12,908
Deferred revenue (83) (104)
-------- --------
Net cash flows from operating activities (3,580) 1,463
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (170) (472)
Payments for location contracts (244) (136)
-------- --------
Net cash flows from investing activities (414) (608)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Term Loan 5,000 --
Debt issuance costs (186) --
Payments on long-term debt -- (941)
Payments under revolving line of credit -- (159)
Principal payments under capital leases (301) (385)
-------- --------
Net cash flows from financing activities 4,513 (1,485)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 519 (630)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,333 6,104
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,852 $ 5,474
======== ========
CASH PAID FOR INTEREST $ 271 $ --
======== ========
The accompanying notes are an integral part
of these consolidated financial statements.
5
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated balance sheet of Davel and its
subsidiaries as of June 30, 2002 and the related consolidated statements of
operations for the three-month and six-month periods ended June 30, 2002 and
2001 and of cash flows for the six-month periods ended June 30, 2002 and 2001
are unaudited. In the opinion of management, all adjustments necessary for a
fair presentation of such consolidated financial statements have been included.
Such adjustments consist only of normal, recurring items. Certain information
and footnote disclosures normally included in audited financial statements have
been omitted, in accordance with generally accepted accounting principles for
interim financial reporting. These interim consolidated financial statements
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations appearing elsewhere in this Form
10-Q and with the Company's audited consolidated financial statements and the
notes thereto in the Company's Form 10-K for the year ended December 31, 2001.
The results of operations for the three-month and six-month periods ended June
30, 2002 are not necessarily indicative of the results for the full year.
The Company was incorporated on June 9, 1998 under the laws of the
State of Delaware. The Company is the largest independent payphone service
provider in the United States. The Company operates in a single business segment
within the telecommunications industry, operating, servicing, and maintaining a
system of approximately 47,000 payphones in 44 states and the District of
Columbia (approximately 75,000 payphones in 48 states and the District of
Columbia after giving effect to the PhoneTel Merger (see Note 8) that was
completed on July 24, 2002). The Company's headquarters is located in Cleveland,
Ohio (having been relocated from Tampa, Florida after completion of the PhoneTel
Merger), with field service offices in 17 geographically dispersed locations (36
locations after the PhoneTel Merger).
2. LIQUIDITY
The accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
incurred losses of approximately $43.4 million and $14.3 million for the year
ended December 31, 2001 and six months ended June 30, 2002, respectively. In
addition, the Company was unable to make debt payments of approximately $237.7
million and interest payments of approximately $36.3 million, which became due
and payable on January 11, 2002 to the lenders (the "Junior Lenders") that are
party to the Company's secured credit facility, dated December 23, 1998 (as
amended, the "Old Credit Facility"). Effective February 19, 2002, the Company
signed a Seventh Amendment to the Old Credit Facility that waived the payment
default as of January 11, 2002 and extended the due date of all payment
obligations to August 31, 2002.
Effective February 19, 2002, the Company and PhoneTel entered into an
Agreement and Plan of Reorganization and Merger providing for the issuance of
the Company's common stock to acquire the issued and outstanding common stock
of PhoneTel (the "PhoneTel Merger"). PhoneTel is a payphone service provider
("PSP") that maintains and operates a payphone system of 28,000 payphones in 45
states and the District of Columbia. The Company and PhoneTel had entered into a
shared services agreement for the administration and operation of certain of the
Company's and PhoneTel's field offices across the United States in June 2001.
The effect of the Servicing Agreement has been to reduce monthly operating costs
substantially.
On July 24, 2002, the Company and PhoneTel completed the PhoneTel
Merger, with PhoneTel surviving as an indirect, wholly owned subsidiary of the
Company. Management believes the PhoneTel Merger will result in expansion of its
market presence and further reduce its operating costs by leveraging the
6
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
combined infrastructure. In order to pursue this strategy, the Company and
PhoneTel jointly entered into the New Senior Credit Facility with Madeline
L.L.C. and ARK-CLO 2000-1 Limited and agreed to a substantial debt-for-equity
exchange with the Junior Lenders. The New Senior Credit Facility, which became
effective February 19, 2002, provided for a combined $10 million line of credit
which the Company and PhoneTel share $5 million each. The Company and PhoneTel
each drew their available amounts under the line on February 20, 2002. In
addition to interest payments due monthly at the rate of 15% per year on the
unpaid balance, the line is repayable in twelve equal monthly installments
commencing July 31, 2002. On July 31, 2002, the Company made the required
payment of $833,333. The debt-for-equity exchange with the Company's current
Junior Lenders immediately preceded the merger with PhoneTel and effected the
exchange of approximately $230 million of indebtedness for 380,612,730 shares of
common stock. The terms of the remaining combined debt were modified and
extended pursuant to the New Junior Credit Facility. As a result of the
debt-for-equity exchange and the extension of the maturity date of the remaining
debt subsequent to June 30, 2002, the Company has classified the outstanding
balance under the Old Credit Facility, including accrued interest, as a
long-term liability at June 30, 2002. Following the exchange of debt and
immediately prior to the merger, the Company's lenders owned 93% of the common
stock of the Company on a fully diluted basis. Following the exchange and the
merger, the combined creditors of the Company and PhoneTel own 90.81% of the
common stock of the Company on a fully diluted basis.
As of June 30, 2002, the Company had a working capital deficit of $3.6
million and its liabilities exceeded it assets by $244.1 million.
Notwithstanding the New Senior Credit Facility and the debt-for-equity exchange,
the Company may face liquidity shortfalls and, as a result, might be required to
dispose of assets or operations to fund its operations, to make capital
expenditures and to meet its debt service and other obligations. There can be no
assurances as to the Company's ability to execute such dispositions, or the
timing thereof, or the amount of proceeds that the Company could realize from
such sales. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141, "Business Combinations"
("SFAS No. 141") and No. 142, "Goodwill and Other Intangible Assets" ("SFAS No.
142"). SFAS No. 141, which eliminated the use of the pooling-of-interests method
of accounting for business combinations initiated after June 30, 2001, is
effective for any business combination accounted for by the purchase method that
is completed after June 30, 2001. SFAS No. 142, which includes the requirements
to test for impairment goodwill and intangible assets of indefinite life rather
than amortize them, is effective for fiscal years beginning after December 15,
2001. Pursuant to SFAS No. 141 and SFAS No. 142, the PhoneTel Merger will be
accounted for as a purchase business combination and any related goodwill will
be assessed for impairment.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of". SFAS No. 144 retains the fundamental provisions of
SFAS No. 121 for the recognition and measurement of the impairment of long-lived
assets to be held and used and the measurement of long-lived assets to be
disposed of by sale. Under SFAS No. 144, long-lived assets are measured at the
lower of carrying amount or fair value less cost to sell. The Company adopted
this statement on January 1, 2002. The Company assessed the impact of this
statement on its results of operations, financial position and cash flows as of
June 30, 2002 and determined that no material impairment adjustment was
required.
In April 2002, the FASB issued SFAS No. 145 covering, among other
things, the rescission of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt." Under SFAS No. 4, all gains and losses from the
extinguishment of debt were required to be aggregated and, if material,
classified as an extraordinary item in the statement of operations. By
rescinding SFAS 4, SFAS No. 145 eliminates the requirement for treatment of
extinguishments as extraordinary items. The new standard is effective for
companies with fiscal years beginning after May 15, 2002, however, early
application of the provision is encouraged. As discussed
7
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
in Note 8, the Company has completed a series of transactions that will include
the extinguishment of debt and that will result in a material gain. The Company
is currently evaluating the merits of early adoption of the new standard.
In July 2002, the FASB issued SFAS No. 146, "Accounting Costs
Associated with Exit or Disposal Activities". SFAS No. 146 covers a wide range
of exit and disposal activities, including restructurings planned and controlled
by management that materially change the scope of the business undertaken by an
enterprise and disposal activities such as costs of terminating certain
contracts, costs of consolidating facilities and some types of termination
benefits provided to employees. SFAS 146 will be effective for exit and disposal
activities initiated after December 31, 2002. At this time, the Company does not
believe that his new standard will have a material effect on its financial
statements.
4. DIAL-AROUND COMPENSATION
On September 20, 1996, the Federal Communications Commission (the
"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 "Telecom
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 (the "IXCs") would be required to
compensate 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 explain its conclusion that the costs to provide local coin calls
are similar to those of 800 subscriber and access code calls and (ii) the
allocation of the dial-around payment obligations among the IXCs for the period
November 7, 1996 to October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997 the FCC
adopted and released its Second Report and Order in the same docket, FCC 97-371
(the "1997 Payphone Order"). This order addressed the per-call compensation rate
for 800 subscriber and access code calls that originate from payphones in light
of the decision of the Court which vacated and remanded certain portions of the
FCC's 1996 Payphone Order. The FCC concluded that the rate for per-call
compensation for 800 subscriber and access code calls from payphones is the
deregulated local coin rate adjusted for certain cost differences. Accordingly,
the FCC established a rate of $0.284 ($0.35 - $0.066) per call for the first two
years of per-call compensation (October 7, 1997 to October 6, 1999). The IXCs
were required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. 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 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 for the year
ended December 31, 1997 for reduced dial-around compensation was approximately
$3.3 million.
8
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
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 local exchange carriers ("LECs") of payphone-specific coding digits,
which identify a call as originating from a payphone. Without the transmission
of payphone-specific coding digits, some of the IXCs have claimed they are
unable to identify a call as a payphone call eligible for dial-around
compensation. With the stated purpose of ensuring the continued payment of
dial-around compensation, the FCC, by Memorandum and Order issued on April 3,
1998, left in place the requirement for payment of per-call compensation for
payphones on lines that do not transmit the requisite payphone-specific coding
digits, but gave the IXCs a choice for computing the amount of compensation for
payphones on LEC lines not transmitting the payphone-specific coding digits of
either accurately computing per-call compensation from their databases or paying
per-phone, flat-rate compensation computed by multiplying the $0.284 per call
rate by the nationwide average number of 800 subscriber and access code calls
placed from RBOC payphones for corresponding payment periods. Accurate payments
made at the flat rate are not subject to subsequent adjustment for actual call
counts from the applicable payphone.
On May 15, 1998, the Court again remanded the per-call compensation
rate to the FCC for further explanation without vacating the $0.284 per call
rate. The Court determined that the FCC had failed to explain adequately its
derivation of the $0.284 default rate. The Court stated that any resulting
overpayment may 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 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, which was adjusted to
$.238 effective April 21, 2002. Both PSPs and IXCs petitioned the Court for
review of the 1999 Payphone Order's determination of the dial-around
compensation rate. On June 16, 2000, the Court affirmed the 1999 Payphone Order
setting a 24-cent dial-around compensation rate. On all the issues, including
those raised by the IXCs and the payphone providers, the Court applied the
"arbitrary and capricious" standard of review, and found that the FCC's rulings
were lawful and sustainable under that standard. The FCC has stated its
intention to conduct a third-year review of the rate, but no review has yet been
commenced. There is pending a Petition for Reconsideration of the 1999 Payphone
Order filed with the FCC by the independent payphone providers (the "IPPs"),
which has yet to be ruled on by the FCC. In view of the Court's affirmation of
the 1999 Payphone Order, it is unlikely that the FCC will adopt material changes
to the key components of the Order (other than the pending retroactive
application issue, discussed below) pursuant to the pending Reconsideration
Petition, although no assurances can be given.
On April 5, 2001, the FCC released an order that is expected to have a
significant impact on the obligations of telecommunications carriers to pay
dial-around compensation to PSPs. Under this order, the first long distance
carrier to handle a dial-around call originating from a payphone has the
obligation to track and pay compensation on the call, regardless of whether
other carriers may subsequently transport or complete the call. This modified
rule became effective on November 23, 2001. The Company believes that this
modification to the dial-around compensation system will result in a significant
increase to the number of calls for which the Company is able to collect such
compensation. Because, however, the FCC ruling is subject to a pending petition
for court review and the system modification is as yet untested, no assurances
can be given as to the precise timing or magnitude of revenue impact that may
result from the decision.
The 24-cent rate that became effective April 21, 1999 will be applied
retroactively to the period beginning on October 7, 1997 and ending on April 20,
1999 (the "intermediate period"), less a $0.002 amount to account for FLEX ANI
payphone tracking costs, for a net compensation of $0.238. There is, however, a
9
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
pending petition for reconsideration of this retroactive application of the
rate. The 1999 Payphone Order deferred a final ruling on the treatment of the
period beginning on November 7, 1996 and ending on October 6, 1997 (the "interim
period") to a later order. The FCC further ruled that, after the establishment
of an interim period compensation rate and an allocation of the rate among
carriers, a true-up may be made for all payments or credits (with applicable
interest) due and owing between the IXCs and the PSPs, including Davel, for both
the interim and intermediate periods. 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 ($0.238 per call multiplied by 131 calls). The Company recorded
dial-around compensation revenue, net of adjustments from the 1997 Payphone
Order and the 1999 Payphone Order, of approximately $22.9 million and $35.9
million for 2000 and 1999, respectively.
In a decision released January 31, 2002, which remains subject to
reconsideration, the FCC partially addressed the remaining issues concerning
interim and intermediate period compensation. The FCC adjusted the per-call rate
to $.229, for the interim period only, to reflect a different method of
calculating the delay in IXC payments to PSPs for the interim period, and
determined that the total interim period compensation rate should be $33.89 per
payphone per month ($.229 times an average of 148 calls per payphone per month).
The FCC deferred to a later, as yet unreleased, order its determination of the
allocation of this total compensation rate among the various carriers required
to pay compensation for the interim period. It is possible that the final
resolution of the timing and other issues relating to these retroactive
adjustments and the outcome of any related administrative or judicial review of
such adjustments could have a material adverse effect on the Company.
Market forces and factors outside the Company's control could
significantly affect the Company's dial-around compensation revenues. These
factors include the following: (i) the final resolution by the FCC of the "true
up" of the initial interim period flat-rate and "per call" assessment periods,
(ii) the possibility of administrative proceedings or litigation seeking to
modify the dial-around compensation rate, and (iii) 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.
5. EARNINGS PER SHARE
The treasury stock method was used to determine the dilutive effect of
the options and warrants on earnings per share data. Diluted loss per share is
equal to basic loss per share since the exercise of the 680,000 outstanding
options and the 427,323 warrants outstanding would be anti-dilutive for all
periods presented. In accordance with SFAS No. 128 and the requirement to report
"Earnings Per Share" data, the basic and diluted loss from continuing operations
per weighted average common shares outstanding were $(0.58) and $(0.91) for the
three months ended June 30, 2002 and 2001, respectively, and $(1.28) and $(2.04)
for the six months ended June 30, 2002 and 2001, respectively.
6. COMMITMENTS & CONTINGENCIES
Litigation
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, 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
10
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
wrongfully terminated. At the same time, PhoneTel also filed a third party claim
against Peoples Telephone Company (acquired by the Company on December 23, 1998)
alleging that Peoples Telephone 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 Telephone. Effective February 19, 2002, the parties to the
lawsuit signed a Settlement Agreement and Mutual Release ("Settlement
Agreement"). The Settlement Agreement provides that, upon the closing of the
PhoneTel Merger, all parties to the lawsuit will release and discharge all
claims and liability against all other parties, without an admission of
liability by any party. Pursuant to the Settlement Agreement, on August 7,
2002, the parties executed a Joint Stipulation and Order for Dismissal with
Prejudice requesting that the Delaware Chancery Court dismiss the lawsuit in its
entirety, with prejudice.
In March 2000, the Company and its wholly owned subsidiary Telaleasing
Enterprises, Inc. were sued in Maricopa County, Arizona Superior Court by CSK
Auto, Inc. ("CSK"). The suit alleges that the Company breached a location
agreement between the parties. CSK's complaint alleges damages in excess of $5
million. The Company removed the case to the U.S. District Court for Arizona and
moved to have the matter transferred to facilitate consolidation with a related
case in California, which was settled in the third quarter of 2001. On October
16, 2000, the U.S. District Court for Arizona denied the Company's transfer
motion and ordered the case remanded back to Arizona state court. On November
13, 2000, the Company filed its Notice of Appeal of the remand order with the
United States Court of Appeals for the Ninth Circuit. On May 17, 2002, the Court
of Appeals affirmed the remand order, thus allowing the case to proceed in
Arizona state court. The underlying suit is now in the pretrial discovery phase,
and no trial date has been set. The Company intends to vigorously defend itself
in the case. While the Company believes it possesses certain meritorious
defenses to the claims, the matter remains in its initial stages. Accordingly,
the Company cannot at this time predict the likelihood of an unfavorable result
or the amount or range of potential loss.
In February 2001, Picus Communications, LLC ("Picus"), a debtor in
Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern
District of Virginia, brought suit against Davel and its wholly owned
subsidiary, Telaleasing Enterprises, Inc., in the United States District Court
for the Eastern District of Virginia, claiming unpaid invoices of over $600,000
for local telephone services in Virginia, Maryland, and the District of
Columbia. The Company sought relief from the bankruptcy court to assert claims
against Picus and answered Picus' complaint in the district court, denying its
material allegations. On or about April 2, 2001, Picus moved the district court
to dismiss its case and indicated that it may file its claim as an adversary
proceeding with the bankruptcy court. On March 13, 2001, the Company filed a
proof of claim in the bankruptcy court to recover damages based on Picus's
breach of contract and failure to secure and pay federally mandated dial-around
compensation. On May 10, 2001, the district court entered an order dismissing
Picus' complaint without prejudice. On September 21, 2001, the Company filed an
application for administrative payment with the bankruptcy court seeking
approximately $1.5 million in post-petition damages incurred by the Company as a
result of Picus's actions. On May 9, 2002, Picus filed an objection to the
Company's administrative claim and a counterclaim seeking to recover
approximately $717,000 in damages. The bankruptcy court has scheduled all
matters for final hearing in October 2002. The Company believes it has
meritorious defenses and counterclaims against Picus and intends to vigorously
defend itself and pursue recovery from Picus on its counterclaims. The Company
cannot at this time predict its likelihood of success on the merits.
On or about January 27, 2002, Davel was served with a complaint, in an
action captioned Sanchez et al. v. DavelTel, Inc. d/b/a Davel Communications,
Inc. et. al., brought in the district court for Cameron County, Texas.
Plaintiffs accuse the defendants of negligence in the death of the father of
Thomas Sanchez, a former Davel employee. As the Company believes the matter
falls within its insurance coverage, the matter has been forwarded to Davel's
insurance carrier for action. While Davel believes it possesses adequate
insurance coverage for the case and has meritorious defenses, the matter is in
its initial stages. Accordingly, the Company cannot at this time predict its
likelihood of success on the merits.
11
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
On June 12, 2002, the Company settled outstanding litigation with
Sprint Corporation related to certain telephone line charges. The settlement
provides for a cash payment to the Company of $578,000. This amount has been
recorded in the accompanying financial statements as a reduction of telephone
charges.
The Company is involved in other litigation arising in the normal
course of its business which it believes will not materially affect its
financial condition or results of operations.
Operator Services Contract
The Company is a party to a contract with Sprint Communications Company
L.P. ("Sprint") that provides for the servicing of operator-assisted calls.
Under this arrangement, Sprint has assumed responsibility for tracking, rating,
billing and collection of these calls and remits a percentage of the gross
proceeds to the Company, as defined in the contract. The contract also requires
the Company to achieve certain minimum gross annual operator service revenue,
measured for the twelve-month period ended June 30 of each year. In making its
June 30, 2002 compliance calculation under the minimum gross annual operator
service revenue provision, the Company has identified certain discrepancies
between its calculations and the underlying call data information provided
directly by Sprint. If the data, as presented by Sprint, is utilized in the
calculation, a shortfall could result. The Company has provided Sprint with an
informal notification of its preliminary objections to the underlying data.
However, due to the recent nature of this matter, Sprint and the Company have
not reached resolution on the integrity of the underlying data. While the
Company believes that its objections are justifiable and has not recorded any
amounts associated with any minimum liability, it is possible that some
liability or receivable for this matter may ultimately be determined as a result
of the dispute, the amount of which, if any, is not presently determinable.
7. RELATED PARTY TRANSACTIONS
In connection with the PhoneTel Merger, discussed in Note 8, a major
shareholder agreed to forgo payment of certain accrued management fees amounting
to $436,000. Such amount is reflected in the accompanying financial statements
as a reduction of selling, general and administrative expenses.
8. SUBSEQUENT EVENTS
PhoneTel Merger and Debt Exchanges:
On July 24, 2002, a wholly owned subsidiary of Davel merged with and
into PhoneTel pursuant to the Agreement and Plan of Reorganization and Merger,
dated February 19, 2002, between the Company and PhoneTel and certain of their
respective affiliates. PhoneTel is a payphone service provider, based in
Cleveland, Ohio, that operates an installed base of approximately 28,000
payphones in 45 states and the District of Columbia. In connection with the
PhoneTel Merger, each share of common stock of PhoneTel was converted into
1.8233 shares of common stock of the Company, or an aggregate of 223,238,000
shares. The merger will be accounted for as a purchase business combination
where the purchase price, including the fair value of the common stock issued
(currently estimated to be $7.5 million, based upon market prices) and other
merger expenses (currently estimated to be $3.1 million), will be allocated to
the assets acquired and liabilities assumed of PhoneTel, generally based upon
their respective fair values on the date acquired. As of the date of this
filing, the purchase price allocation has not been completed.
As a condition to the PhoneTel Merger, on July 24, 2002 (the
"closing date") the Davel junior lenders exchanged $237.2 million of outstanding
indebtedness and approximately $ 45.0 million of related accrued interest for
380,612,730 shares of common stock (with an estimated value of $11.8 million,
based upon market prices) which reduced Davel's junior indebtedness to $63.5
million. As a further condition to the PhoneTel Merger, on July 24, 2002, the
PhoneTel junior lenders exchanged an amount of indebtedness that reduced the
junior indebtedness of PhoneTel to $36.5 million for 112,246,511 shares of
PhoneTel common stock. Upon completion of the debt exchange and merger, the
Company had approximately 615 million shares outstanding.
On July 24, 2002, Davel and PhoneTel also amended, restated and
consolidated their respective junior credit facilities. The combined
restructured junior credit facility of $100.0 million due December 31, 2005 (the
"maturity date") consists of: (i) a $50.0 million cash-pay term loan with
interest payable in kind monthly through May 31, 2003, and thereafter to be paid
monthly in cash from a required payment of $1.25 million commencing on July 1,
2003, with such monthly payment increasing to $1.5 million beginning January 1,
2005, and the unpaid balance to be repaid in full on the maturity date; and (ii)
a $50.0 million payment-in-kind term loan (the "PIK term loan") to be repaid in
full on the maturity date. Amounts outstanding under the term loans will accrue
interest from and after the closing date at the rate of ten (10%) per annum.
Interest on the PIK term loan will accrue from the closing date and will be
payable in kind. All interest payable in kind will be added to the principal
amount of the respective term loan on a monthly basis and thereafter treated as
principal for all purposes (including the accrual of interest upon such
amounts).
12
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(CONTINUED)
Following the PhoneTel Merger and the debt exchanges, the combined
junior indebtedness of the Company will have a face value of $100.0 million,
which amount may be prepaid without penalty. However, for accounting and
reporting purposes, with respect to Davel's portion of the debt exchange,
all future cash payments under the modified terms will be accounted for as
reductions of indebtedness and no interest expense will be recognized for any
period between the closing date and the maturity date. In addition, the
remaining amounts payable with respect to the PhoneTel portion will be recorded
at the net present value of such payments in accordance with the purchase method
of accounting. Interest expense will be recognized on the PhoneTel portion of
the restructured debt over the term of the debt using the interest method of
accounting, at a fair market rate.
The following pro forma financial information (in thousands of dollars
except for per share amounts) gives effect to the PhoneTel Merger and the debt
exchanges as if they had occurred at the beginning of the periods presented. Pro
forma financial information is not intended to be indicative of the results of
operations that the Company would have reported had the transactions been
consummated as of January 1, 2001 and 2002.
Pro Forma Information
For the Six Months Ended June 30
--------------------------------
2002 2001
--------- ---------
Revenue $ 51,953 $ 70,365
--------- ---------
Loss from continuing operations before
extraordinary gain (13,543) (21,765)
Extraordinary gain 178,617 143,937
--------- ---------
Net income 165,074 122,172
--------- ---------
(Loss) income per common shares, basic
and diluted:
Loss from continuing operations before
extraordinary gain $ (0.02) $ (0.04)
Extraordinary gain $ 0.29 0.23
--------- ---------
Net income $ 0.27 $ 0.19
========= =========
Estimated Effects of the WorldCom, Inc. Bankruptcy:
On July 21, 2002, WorldCom, Inc., whose subsidiary MCI is one of the
major payors of dial-around revenue to the Company, filed for protection under
Chapter 11 of the United States Bankruptcy Code. As a result of this filing, the
Company reduced its accrual of dial-around revenues for the second quarter of
2002 by $0.9 million from the amount it would have normally accrued, as the
bankruptcy may impair the Company's ability to receive pre-petition dial-around
payments for the quarter from MCI. The Company is actively pursuing its rights
in the Bankruptcy Court to receive the normal quarterly payment from MCI.
However, no assurance can be given at this time regarding the ultimate outcome
of this action. The Company does not believe that the WorldCom bankruptcy filing
will materially impair the Company's ability to collect dial-around payments
from MCI post-petition. For post-petition periods, the Company will resume its
normal accrual of dial-around revenue attributable to MCI unless additional
information is obtained which would suggest that the ability to collect such
revenues is unlikely.
13
ITEM 2. 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.
With the exception of historical information (information relating to
the Company's financial condition and results of operations at historical dates
or for historical periods), the matters discussed in this Management's
Discussion and Analysis of Financial Condition and Result of Operations ("MD&A")
are forward-looking statements that necessarily are based on certain assumptions
and are subject to certain risks and uncertainties. The forward-looking
statements are based on management's expectations as of the date hereof. Actual
future performance and results could differ materially from that contained in or
suggested by these forward-looking statements as a result of the factors set
forth in this MD&A and its other filings with the SEC. The Company assumes no
obligation to update any such forward-looking statements.
GENERAL
During the first six months of 2002, 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 Company's payphones. Coin
call revenues are recorded in the amount of coins deposited in the payphones.
Non-coin calls include credit card, calling card, collect, and
third-party billed calls, net of applicable tax, which are handled by operator
service providers selected by the Company. Non-coin call revenues are recognized
based upon the commission received by the Company from the carriers of 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 Company's presubscribed carrier to make traditional "toll free" calls
(dial-around calls). Revenues from dial-around calls are recognized based on
estimates of calls made using most recent actual historical data and the FCC
mandated dial-around compensation rate in effect.
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 line charges and use of their networks.
Commission expense represents payments to owners of locations at which the
Company's payphones are installed ("Location Owners"). Service, maintenance and
network costs represent the cost of servicing and maintaining the payphones on
an ongoing basis.
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 IPPs, including the Company,
increased rates for local coin calls from $0.25 to $0.35 after October 7, 1997
and, beginning in November 2001, to $0.50. In 2002, the Company
14
experienced lower coin call volumes on its payphones resulting from the
increased rates, as well as from continued growth in wireless communication
services, changes in call traffic and the geographic mix of the Company's
payphones.
Dial-around Compensation
On September 20, 1996, the 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 Telecom 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 IXCs would be required to compensate 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 explain its conclusion that the costs to provide local coin
calls are similar to those of 800 subscriber and access code calls and (ii) the
allocation of the dial-around payment obligations among the IXCs for the period
November 7, 1996 to October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997 the FCC
adopted and released its SECOND REPORT AND ORDER in the same docket, FCC 97-371
(the "1997 Payphone Order"). This order addressed the per-call compensation rate
for 800 subscriber and access code calls that originate from payphones in light
of the decision of the Court which vacated and remanded certain portions of the
FCC's 1996 Payphone Order. The FCC concluded that the rate for per-call
compensation for 800 subscriber and access code calls from payphones is the
deregulated local coin rate adjusted for certain cost differences. Accordingly,
the FCC established a rate of $0.284 ($0.35 - $0.066) per call for the first two
years of per-call compensation (October 7, 1997, through October 6, 1999). The
IXCs were required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. 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 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 for the year
ended December 31, 1997 for reduced dial-around compensation was approximately
$3.3 million.
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
15
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 determined that the FCC had failed to explain adequately its
derivation of the $0.284 default rate. The Court stated that any resulting
overpayment may 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 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, which was adjusted to
$.238 effective April 21, 2002. Both PSPs and IXCs petitioned the Court for
review of the 1999 Payphone Order's determination of the dial-around
compensation rate. On June 16, 2000, the Court affirmed the 1999 Payphone Order
setting a 24-cent dial-around compensation rate. On all the issues, including
those raised by the IXCs and the payphone providers, the Court applied the
"arbitrary and capricious" standard of review, and found that the FCC's rulings
were lawful and sustainable under that standard. The FCC has stated its
intention to conduct a third-year review of the rate, but no review has yet been
commenced. There is pending a Petition for Reconsideration of the 1999 Payphone
Order filed with the FCC by the IPPs, which has yet to be ruled on by the FCC.
In view of the Court's affirmation of the 1999 Payphone Order, it is unlikely
that the FCC will adopt material changes to the key components of the Order
(other than the pending retroactive application issue, discussed below) pursuant
to the pending Reconsideration Petition, although no assurances can be given.
On April 5, 2001, the FCC released an order that is expected to have a
significant impact on the obligations of telecommunications carriers to pay
dial-around compensation to PSPs. Under this order, the first long distance
carrier to handle a dial-around call originating from a payphone has the
obligation to track and pay compensation on the call, regardless of whether
other carriers may subsequently transport or complete the call. This modified
rule became effective on November 23, 2001. The Company believes that this
modification to the dial-around compensation system will result in a significant
increase to the number of calls for which the Company is able to collect such
compensation. Because, however, the FCC ruling is subject to a pending petition
for court review and the system modification is as yet untested, no assurances
can be given as to the precise timing or magnitude of revenue impact that may
result from the decision.
The 24-cent rate that became effective April 21, 1999 will be applied
retroactively to the period beginning on October 7, 1997 and ending on April 20,
1999 (the "intermediate period"), less a $0.002 amount to account for FLEX ANI
payphone tracking costs, for a net compensation of $0.238. There is, however, a
pending petition for reconsideration of this retroactive application of the
rate. The 1999 Payphone Order deferred a final ruling on the treatment of the
period beginning on November 7, 1996 and ending on October 6, 1997 (the "interim
period") to a later order. The FCC further ruled that, after the establishment
of an interim period compensation rate and an allocation of the rate among
carriers, a true-up may be made for all payments or credits (with applicable
interest) due and owing between the IXCs and the PSPs, including Davel, for both
the interim and intermediate periods. 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 ($0.238 per call multiplied by 131 calls). The Company recorded
dial-around compensation revenue, net of adjustments from the 1997 Payphone
Order and the 1999 Payphone Order, of approximately $22.9 million and $35.9
million for 2000 and 1999, respectively.
16
In a decision released January 31, 2002, which remains subject to
reconsideration, the FCC partially addressed the remaining issues concerning
interim and intermediate period compensation. The FCC adjusted the per-call rate
to $.229, for the interim period only, to reflect a different method of
calculating the delay in IXC payments to PSPs for the interim period, and
determined that the total interim period compensation rate should be $33.89 per
payphone per month ($.229 times an average of 148 calls per payphone per month).
The FCC deferred to a later, as yet unreleased, order its determination of the
allocation of this total compensation rate among the various carriers required
to pay compensation for the interim period. It is possible that the final
resolution of the timing and other issues relating to these retroactive
adjustments and the outcome of any related administrative or judicial review of
such adjustments could have a material adverse effect on the Company.
Market forces and factors outside the Company's control could
significantly affect the Company's dial-around compensation revenues. These
factors include the following: (i) the final resolution by the FCC of the "true
up" of the initial interim period flat-rate and "per call" assessment periods,
(ii) the possibility of administrative proceedings or litigation seeking to
modify the dial-around compensation rate, and (iii) 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.
Operator Services Contract
The Company is a party to a contract with Sprint Communications Company
L.P. ("Sprint") that provides for the servicing of operator-assisted calls.
Under this arrangement, Sprint has assumed responsibility for tracking, rating,
billing and collection of these calls and remits a percentage of the gross
proceeds to the Company, as defined in the contract. The contract also requires
the Company to achieve certain minimum gross annual operator service revenue,
measured for the twelve-month period ended June 30 of each year. In making its
June 30, 2002 compliance calculation under the minimum gross annual operator
service revenue provision, the Company has identified certain discrepancies
between its calculations and the underlying call data information provided
directly by Sprint. If the data, as presented by Sprint, is utilized in the
calculation, a shortfall could result. The Company has provided Sprint with an
informal notification of its preliminary objections to the underlying data.
However, due to the recent nature of this matter, Sprint and the Company have
not reached resolution on the integrity of the underlying data. While the
Company believes that its objections are justifiable and has not recorded any
amounts associated with any minimum liability, it is possible that some
liability or receivable for this matter may ultimately be determined as a result
of the dispute, the amount of which, if any, is not presently determinable.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
For the three months ended June 30, 2002, total revenues decreased
approximately $6.1 million, or 25.9%, to approximately $17.4 million from
approximately $23.5 million in the same period of 2001. This decrease was
primarily attributable to the removal of unprofitable phones and lower call
volumes, due to increased competition from the wireless communications industry,
resulting in lower average revenue per phone.
Coin call revenues decreased approximately $2.7 million, or 17.1%, to
approximately $13.1 million in the three months ended June 30, 2002 from
approximately $15.8 million in the second quarter of 2001. The decrease in coin
call revenues was primarily attributable to a reduction in the number of average
payphones per month from approximately 64,000 phones during the period ended
June 30, 2001 to approximately 50,000 during the period ended June 30, 2002.
This is a result of the Company's ongoing strategy to remove unprofitable
phones, and from lower call volumes on the Company's payphones resulting from
increased competition from wireless communication services and changes in call
traffic. Average monthly coin call revenue per phone increased by $5.37, or
6.5%, to $87.66 from $82.29 in the second quarter of 2001. This partially
reflects the impact of the increase in local coin calling rates for most of the
Company's payphones from $0.35 to $0.50 that was fully implemented by the end of
the first quarter of 2002, along with the impact of the ongoing low revenue
phone removal program.
Non-coin call revenues, which is comprised primarily of dial-around
revenue and operator service revenue, decreased approximately $3.4 million, or
44.2%, to approximately $4.3 million in the three months ended June 30, 2002
from approximately $7.7 million in the three months ended June 30, 2001. The
decrease was primarily attributable to the removal of unprofitable phone
locations, and lower call volumes on the Company's payphones resulting from the
growth in wireless communication services and changes in call traffic.
Dial-around revenue decreased approximately $2.8 million, to approximately $2.7
million in the three months ended June 30, 2002 from approximately $5.5 million
in the second quarter of 2001. The dial-around decrease is primarily
attributable to the net removal of approximately 14,000 low margin phones, or
22.2% of the total payphone base over the 12-month period, and lower calls per
phone due to increased competition from wireless services. In addition, the
Company reduced its accrual of dial-around revenues for the second quarter of
2002 by $0.9 million from the amount it would have normally accrued, due to the
risk that it may not receive payments for the quarter from MCI, whose affiliate
WorldCom, Inc. filed for protection under Chapter 11 of the United States
Bankruptcy Code on July 21, 2002. Long-distance revenues decreased approximately
$0.7 million, to
17
approximately $1.5 million in the second quarter of 2002 from approximately $2.2
million in the three months ended June 30, 2001. The decrease is attributable to
fewer payphones in service, fewer long distance calls made per phone, and
reduced call time per call. Non-carrier revenues increased $0.1 million during
the period.
Telephone charges decreased approximately $2.0 million, or 29.0%, to
approximately $4.8 million for the quarter ended June 30, 2002 from
approximately $6.8 million in the three months ended June 30, 2001. This
reduction was primarily due to the net removal of 14,000 unprofitable phones and
to the on-going impact on monthly bills of recent regulatory changes. Telephone
charges in the second quarter of 2002 were favorably affected by the receipt of
approximately $0.1 million of refunds relating to prior years, while the second
quarter of 2001 was favorably affected by the receipt of $1.3 million of refunds
relating to New Service Test ("NST") regulations of the FCC. In addition, the
Company recognized a favorable settlement of $0.6 million with one carrier
relating to prior year charges. Excluding the impact of these items on both
years, telephone charges decreased by $2.6 million, or 32.0%, from the second
quarter of 2001 to the second quarter of 2002. The Company is continuing to
negotiate contracts and pursue additional regulatory relief that it believes
will further reduce local access charges on a per-phone basis, but is unable to
estimate the impact of further telephone charge reductions at this time.
Commissions decreased approximately $3.5 million, or 53.6%, to
approximately $3.0 million in the three months ended June 30, 2002 from
approximately $6.5 million in the three months ended June 30, 2001. The decrease
was primarily attributable to lower commissionable revenues from the reduced
number of Company payphones and the impact of management actions to re-negotiate
contracts with lower rates upon renewal. The Company continues to actively
review its strategies related to contract renewals in order to maintain its
competitive position while retaining its customer base.
Service, maintenance and network costs decreased approximately $0.7
million, or 13.0%, to approximately $4.7 million in the three months ended June
30, 2002 from approximately $5.4 million in the three months ended June 30,
2001. The decrease was primarily attributable to the lower phone count and
savings associated with the PhoneTel servicing agreement. Wage-related cost
reductions resulting from personnel reductions and better route densities were
the predominant cause of the decrease.
Depreciation and amortization expense in the three months ended June
30, 2002 increased by $0.2 million to approximately $4.8 million from
approximately $4.6 million recorded in the three months ended June 30, 2001.
Selling, general and administrative expenses decreased approximately
$1.2 million, or 37.5%, to approximately $2.0 million in the three months ended
June 30, 2002 from approximately $3.2 million in the three months ended June 30,
2001. The decrease in expense was attributable to a reduction in salaries and
salary-related expenses of approximately $0.2 million, a reduction in
professional fees of approximately $0.9 million, which includes a rescission of
management fees of approximately $0.4 million which are no longer due, and
reductions in all other expense categories totaling $0.1 million.
Interest expense in the three months ended June 30, 2002 declined
approximately $2.5 million, or 34.5%, compared to the prior-year period, to
approximately $4.7 million in the second quarter of 2002 from approximately $7.2
million in the second quarter of 2001. The decrease in recorded interest is due
to lower interest rates and a reduction of $0.9 million for the amortization of
loan origination fees charged to interest expense.
Net loss decreased approximately $3.7 million, or 36.1%, to
approximately $6.5 million in the three months ended June 30, 2002 from
approximately $10.2 million in the second quarter of 2001.
18
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
For the six months ended June 30, 2002, total revenues decreased
approximately $12.0 million, or 25.8%, to approximately $34.7 million from
approximately $46.7 million in the same period of 2001. This decrease was
primarily attributable to the removal of unprofitable payphones and lower call
volumes due to increased competition from the wireless communications industry,
resulting in lower average revenue per payphone.
Coin call revenues decreased approximately $6.1 million, or 19.3%, to
approximately $25.3 million in the six months ended June 30, 2002 from
approximately $31.4 million in the first half of 2001. The decrease in coin call
revenues was primarily attributable to a reduction in the number of average
payphones per month from approximately 65,000 phones for the six months ended
June 30, 2001 to approximately 52,000 for the six months ended June 30, 2002.
This is the result of the Company's ongoing strategy to remove unprofitable
payphones, and from lower call volumes on the Company's payphones resulting from
increased competition from wireless communication services and changes in call
traffic. Average monthly coin call revenue per phone increased by $1.32, or
1.6%, to $81.67 from $80.35 in the first six months of 2001, partially
reflecting the impact of the increase in local coin calling rates for most of
the Company's base from $0.35 to $0.50 that the Company fully implemented by the
end of the first quarter of 2002, along with the impact of the ongoing low
revenue phone removal program.
Non-coin call revenues, which is comprised primarily of dial-around
revenue and long distance revenue, decreased approximately $6.0 million, or
39.2%, to approximately $9.3 million in the six months ended June 30, 2002 from
approximately $15.3 million in the six months ended June 30, 2001. The decrease
was primarily attributable to the removal of unprofitable payphone locations and
lower call volumes on the Company's payphones resulting from the growth in
wireless communication services and changes in call traffic. Dial-around revenue
decreased approximately $3.8 million, to approximately $6.2 million in the six
months ended June 30, 2002 from approximately $10.0 million in the first half of
2001. The dial-around revenue decrease is primarily attributable to the net
removal of approximately 13,000 low margin payphones, or 20.6% of the total
payphone base over the 12-month period, lower calls per payphone due to
increased competition from wireless services and the $0.9 million revenue
reduction noted above relating to the WorldCom bankruptcy filing in July 2002.
Long-distance revenues decreased approximately $2.4 million, to approximately
$2.9 million in the first half of 2002 from approximately $5.3 million in the
six months ended June 30, 2001. The decrease is attributable to fewer payphones
in service, fewer long distance calls made per payphone, and reduced call time
per call. Non-carrier revenues increased $0.3 million during the period.
Telephone charges decreased approximately $6.8 million, or 43.5%, to
approximately $8.9 million for the six months ended June 30, 2002 from
approximately $15.7 million in the six months ended June 30, 2001. In the first
six months of 2002, telephone charges were favorably affected by adjustments
related to NST regulatory changes which totaled $3.3 million and other carrier
charges for years prior to 2002 which totaled $0.6 million. Telephone charges
were favorably affected in the first six months of 2001 by the receipt of $1.3
million of refunds from LECs relating to NST orders regarding prior years'
telephone charges. The Company continues to negotiate contracts and pursue
additional regulatory relief that it believes will further reduce local access
charges on a per-phone basis, but is unable to estimate the impact of further
telephone charge reductions at this time.
Commissions decreased approximately $4.9 million, or 41.3%, to
approximately $6.9 million in the six months ended June 30, 2002 from
approximately $11.8 million in the six months ended June 30, 2001. The decrease
was primarily due to lower commissionable revenues from the reduced number of
payphones and the lower rates obtained by the Company in negotiating contract
renewals. Commissions for the six months ended June 30, 2001 also included
favorable adjustments of $0.6 million resulting from a contract termination. The
Company continues to actively review its strategies related to contract renewals
in order to maintain its competitive position while retaining its customer base.
Service, maintenance and network costs decreased approximately $2.1
million, or 18.1%, to approximately $9.5 million in the six months ended June
30, 2002 from approximately $11.6 million in the six
19
months ended June 30, 2001. The decrease was primarily attributable to
reductions in headcount and wage related costs of approximately $1.0 million
generated from rationalization of field office expenses, increased geographic
and route density of the phones and the Company's ability to improve efficiency
under the PhoneTel servicing agreement. Reductions in service and collection
expenses of approximately $0.2 million, vehicle servicing expenses of
approximately $0.1 million, field office expenses of approximately $0.5 million
occurred as a result of lower phone count and field office reorganizations,
property and franchise tax reductions of approximately $0.2 million, and
reductions in all other line items netting to a favorable $0.1 million.
Depreciation and amortization expense of $9.8 million in the six months
ended June 30, 2002 was $0.5 million higher than the $9.3 million expense for
the six months ended June 30, 2001.
Selling, general and administrative expenses decreased approximately
$1.5 million, or 24.6%, to approximately $4.8 million in the six months ended
June 30, 2002 from approximately $6.3 million in the six months ended June 30,
2001. The decrease in expense was attributable to a reduction in salaries and
salary-related expenses of approximately $0.4 million, which occurred as a
result of continued rationalization of overhead expenses in light of a declining
revenue base. Professional fees were approximately $1.2 million favorable,
including a rescission of management fees of approximately $0.4 million which
are no longer due, while several other expense items netted to an increase of
approximately $0.1 million as compared to the same period last year.
Interest expense in the six months ended June 30, 2002 decreased
approximately $5.7 million, or 38.2%, compared to the prior-year period, to
approximately $9.3 million in the first half of 2002 from approximately $15.0
million in the first half of 2001. The decrease in recorded interest is the
result of lower interest rates and a reduction of $1.8 million for the
amortization of loan origination fees charged to interest expense.
Net loss decreased approximately $8.5 million, or 37.1%, to
approximately $14.3 million in the six months ended June 30, 2002 from
approximately $22.8 million in the first half of 2001.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Historically, the Company's primary sources of liquidity have been cash
from operations, borrowings under various credit facilities and, periodically,
proceeds from the issuance of common stock and proceeds from the issuance of
preferred stock. There was no stock issued for cash in the most recent two
years, and borrowings under the Company's Old Credit Facility ceased after the
third quarter of 2000.
The Company's payphone revenues by operating region are affected by
seasonal variations, geographic distribution of payphones, removal of
unprofitable phones and type of location. Because many of the 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.
Payphones located in the southern United States produce substantially higher
call volume in the first and second quarters than at other times during the
years, while the Company's payphones throughout the midwestern and eastern
United States produce their highest call volumes during the second and third
quarters.
In the six months ended June 30, 2002, operating activities used
approximately $3.6 million of net cash which was funded from the $4.8 million
received from the New Senior Credit Facility, net of the $0.2 million cost of
issuing the debt. Operating activities provided approximately $1.5 million of
net cash in the six months ended June 30, 2001. Cash used in operating
activities in the first half of 2002 included the operating loss of $14.3
million, increases in other assets of $2.0 million for prepaid insurance and
expenses associated with the PhoneTel Merger, reductions in accounts
20
payable and accrued liabilities of $8.6 million and a decrease in deferred
revenue of $0.1 million. Such cash uses exceeded total sources, which included
depreciation and amortization of $9.8 million, a reduction in accounts
receivable of $2.9 million and an increase in accrued interest of $8.7 million.
Capital expenditures for the six months ended June 30, 2002 were $0.2
million, compared to the $0.5 million in the six months ended June 30, 2001. The
on-going strategy of removing underperforming phones, combined with the
existence of an extensive inventory of phone components, allows for minimal
capital equipment expenditures.
The Company made payments under capital lease obligations totaling
approximately $0.3 million. Cash balances increased approximately $0.5 million
during the six month period.
The Company's principal source of liquidity in the six months ended
June 30, 2002 came from cash received pursuant to the New Senior Credit
Facility. See "New Senior Credit Facility" below for a description of this
indebtedness. The Company's primary uses of liquidity are to provide working
capital and to meet debt service requirements. At June 30, 2002, the Company no
longer had borrowing availability through a revolving line of credit under the
Old Credit Facility. See "Old Credit Facility" below for a discussion of the
amendments that have restructured the Old Credit Facility and a description of
current indebtedness. All outstanding debt in connection with the Old Credit
Facility, including accrued interest, has been reclassified to long-term
liabilities at June 30, 2002 as a result of the debt-for-equity exchange and the
extension of the maturity date of the remaining junior debt that occurred
subsequent to the end of the second quarter of 2002.
Old Credit Facility
In connection with the merger with Peoples Telephone Company in 1998,
the Company entered into a secured credit facility ("Old Credit Facility") with
Bank of America, formerly known as NationsBank, N.A. (the "Administrative
Agent"), and the other lenders named therein ("Junior Lenders"). The Old Credit
Facility provided for borrowings by the Company's wholly owned subsidiary, Davel
Financing Company, L.L.C., from time to time of up to $245.0 million, including
a $45 million revolving facility, for working capital and other corporate
purposes.
Indebtedness of the Company under the Old Credit Facility was 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 was guaranteed by the
Company and all of its subsidiaries.
The Company's borrowings under the original Old Credit Facility bore
interest at a floating rate and may be maintained as Base Rate Loans (as defined
in the Old Credit Facility) or, at the Company's option, as Eurodollar Loans (as
defined in the Old Credit Facility). Base Rate Loans bear interest at the Base
Rate (defined as the higher of (i) the applicable prime lending rate of Bank of
America or (ii) the Federal Reserve reported certificate of deposit rate plus
1%). Eurodollar Loans bear interest at the Eurodollar Rate (as defined in the
Old Credit Facility).
The Company was required to pay the lenders under the Old Credit
Facility a commitment fee, payable in arrears on a quarterly basis, on the
average unused portion of the Old Credit Facility during the term of the
facility. The Company was 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 Old Credit Facility. The Administrative Agent and the other lenders were
entitled to such other fees as have been separately agreed upon with the
Administrative Agent.
The Old Credit Facility required the Company to meet certain financial
tests and contained certain covenants that, among other things, limited the
incurrence of additional indebtedness, prepayments of other indebtedness, liens
and encumbrances and other matters customarily restricted in such agreements.
21
First Amendment
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 Old 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 ended June 30, 1999,
with the financial covenants set forth in the Old 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 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
- Payment 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.
The First Amendment also places limits on capital expenditures and required
the payment of an amendment fee equal to the product of the Lender's commitment
multiplied by 0.35%.
Second Amendment
In the first quarter of 2000, the Company gave notice to the Administrative
Agent that lower than expected performance in the first quarter of 2000 would
result in the Company's inability to meet certain financial covenants contained
in the Old Credit Facility. Effective March 9, 2000, the Company and the Lenders
agreed to the Second Amendment to Credit Agreement and Consent and Waiver (the
"Second Amendment"), which waived certain covenants through January 15, 2001. In
exchange for the covenant relief, the Company agreed to a lowering of the
available credit facility to $245 million (through a permanent reduction of the
revolving line of credit to $45 million), placement of a block on the final $10
million of borrowing under the revolving credit facility (which requires that
all of the Lenders be notified in order to access the final $10.0 million of
availability on that facility), a fee of 35 basis points of the Lenders
22
commitment and a moratorium on acquisitions. The Second Amendment contained
amendments that provided for the following:
- Amendment of the applicable percentages for Eurodollar Loans
to:
(a) 3.50% for all Revolving Loans which are Eurodollar
Loans, all Tranche A Term Loans which are Eurodollar
Loans, and all Letter of Credit Fees;
(b) 4.25% for all Tranche B Term Loans which are
Eurodollar Loans;
(c) 2.00% for all Revolving Loans which are Base Rate
Loans and all Tranche A Term Loans which are Base
Rate Loans;
(d) 2.75% for all Tranche B Term Loans which are Base
Rate Loans; and
(e) 0.75% for all Commitment Fees;
- After March 9, 2000, introduction of a new covenant requiring
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 $35.0
million;
- The addition of a new covenant to provide financial statements
to the Lenders on a monthly basis;
- Increases in the maximum allowable ratio of funded debt to
EBITDA through the maturity date of the loan;
- Decreases in the minimum allowable interest coverage ratio
through the maturity date of the loan;
- Decreases in the minimum allowable fixed charge coverage ratio
through the maturity date of the loan;
- Decreases in permitted capital expenditures to $10 million
annually; and
- Reduction of the maximum interest period for Eurodollar loans
to 30 days.
Third Amendment
In the second quarter of 2000, the Company gave notice to the
Administrative Agent that lower than expected performance during the first six
months of 2000 would result in the Company's inability to meet certain financial
covenants contained in the Old Credit Facility as well as the June 30, 2000 debt
amortization and interest payments. On June 22, 2000, the Company and the
Lenders who are party to the agreement agreed to the Third Amendment to Credit
Agreement (the "Third Amendment"), which eliminated the financial covenant
compliance test for the fiscal quarter ended June 30, 2000, as was set forth in
the Old Credit Facility. The Third Amendment also provided for the following:
- Term Loan A amortization payments totaling $5.0 million
scheduled for June 30, 2000 would be due on September 30, 2000
together with the $5.0 million amortization payment scheduled
for that date. The total Term A amortization payments due on
September 30, 2000 were $10.0 million;
- Term Loan B amortization payments totaling approximately $0.2
million scheduled for June 30, 2000 would be due on September
30, 2000 together with the approximately $0.2 million
amortization payment scheduled for that date. The total Term B
amortization payments due on September 30, 2000 were
approximately $0.5 million;
- Interest payments due on June 30, 2000 became due and were
paid on July 10, 2000; and
23
- All interest otherwise due and payable on each interest
payment date occurring after June 30, 2000 and before
September 30, 2000 continued to accrue on the applicable loans
from and after such interest payment date and were to have
been due and payable in arrears on September 30, 2000.
Fourth Amendment
In the third quarter of 2000, the Company gave notice to the
Administrative Agent that lower than expected performance during the first nine
months of 2000 would result in the Company's inability to meet certain financial
covenants contained in the Old Credit Facility as well as the September 30, 2000
debt amortization and interest payments. On September 28, 2000, the Company and
the Lenders who are party to the agreement agreed to the Fourth Amendment to
Credit Agreement, which eliminated the financial covenants in their entirety
with respect to all periods ending on and after September 30, 2000 and also
provided for the following:
- Term Loan A, Term Loan B and Revolving Loan amortization payments
totaling $15.7 million were to have been due on January 12, 2001. In
addition, amortization payments of approximately $7.7 million are due on
each of March 31, June 30, September 30 and December 31, 2001, and the
balance of the then outstanding principal amount of all loan obligations
was to be due on January 11, 2002;
- Interest payments otherwise due and payable on any interest payment date
prior to January 12, 2001 will continue to accrue were to have been
payable in arrears on January 12, 2001;
- Applicable percentages for adjusted LIBOR interest rates after September
29, 2000 were generally lowered from those set forth in the Third
Amendment to 2.75% for all Loans, except that rates will continue to
equal 3.50% for all Letter of Credit Fees and 0.75% for all Commitment
Fees;
- Positive net cash on hand in excess of $2.0 million at the end of each
month will be paid to the Lenders as a prepayment of the Loans;
- The Revolving Loan commitment was terminated;
- Capital expenditures for the period October 1, 2000 to January 12,
2001 were limited to $400,000; and
- The provision regarding the application of prepayments was modified, and
a new provision was added requiring the Company to submit to the Lenders
bi-weekly cash flow forecasts and a revised business plan for the 2001
fiscal year.
Fifth Amendment
On November 29, 2000, the Borrower requested that the Lenders waive its
noncompliance with the requirements of the Credit Agreement resulting from the
Borrower's non-delivery of a revised business plan to the Lenders on or before
November 15, 2000. In exchange, the Borrower agreed to amend certain provisions
of the Credit Agreement that had permitted the Borrower to dispose of certain
property outside the ordinary course of business and to make certain investments
outside the ordinary course of business so as to require, in each case, the
Lenders' prior written approval for any such disposition or investment.
Sixth Amendment
In the fourth quarter of 2000, the Company gave notice to the new
Administrative Agent that the Company would not be able to make the January 12,
2001 debt amortization and interest payments. On March
24
23, 2001, the Company and the Lenders entered into the Sixth Amendment to Credit
Agreement and Waiver, effective as of January 12, 2001 (the "Sixth Amendment"),
which provided for the following:
- Principal amortization payments would be made in the amounts of $1.1
million on April 15, 2001, $2.2 million on July 15, 2001 and $3.3
million on October 15, 2001;
- The remaining outstanding principal amount of all loans, together with
all accrued and unpaid interest, will be due on January 11, 2002;
- The Company will provide monthly budget reconciliation reports to the
Lenders;
- The Company will comply with an agreed-upon budget for expenses in 2001;
- The Company will be subject to a limit on capital expenditures and
certain location signing bonuses in 2001 and a minimum EBITDA covenant
for 2001; and
- The Company agreed to the substitution of a new administrative agent for
the Lenders, to pay such new agent a monthly fee of $30,000 and to pay
certain earned fees of the professional advisors to the Lenders.
Seventh Amendment
Effective as of February 19, 2002, the Company and the Junior Lenders
entered into the Seventh Amendment to Credit Agreement and Consent and
Waiver (the "Seventh Amendment"), which provided for the following:
- The payment defaults arising out of the Company's failure to make
scheduled principal payments on July 15, 2001, October 15, 2001 and
January 11, 2002 were waived effective as of the dates such payments
were due;
- The covenant violations arising out of the Company's failure to comply
with its minimum cumulative EBITDA covenant from May to December 2001
were waived effective as of the dates of such violations; and
- The Junior Lenders provided their consent to the New Senior Credit
Facility and the transactions contemplated by the merger agreement
with PhoneTel, including the debt-for-equity exchange described above.
The Old Credit Facility contained customary events of default, including
without limitation, payment defaults, defaults for breaches of representations
and warranties, covenant defaults, cross-defaults to certain other indebtedness,
defaults for certain events of bankruptcy and insolvency, judgment defaults,
failure of any guaranty or security document supporting the Old Credit Facility
to be in full force and effect, and defaults for a change of control of the
Company.
New Junior Credit Facility
Effective July 24, 2002, the New Junior Credit Facility, which matures on
December 31, 2005, replaced and superseded the Old Credit Facility. The New
Junior Credit Facility consists of (i) a $50 million principal amount cash-pay
term loan with interest payable in kind monthly through June 30, 2003, and
thereafter to be paid monthly in cash with a required payment of $1.25 million
commencing August 1, 2003, increasing to $1.5 million on January 1, 2005, and
(ii) a $50 million payment-in-kind term loan payable in full at maturity.
Interest under the New Junior Credit Facility accrues at a rate of 10% per
annum. Upon the occurrence and during the continuation of an event of default,
interest accrues at the rate of 14% per annum.
25
New Senior Credit Facility
Effective as of February 19, 2002, Madeleine L.L.C. and ARK CLO 2000-1,
Limited (the "New Senior Lenders") entered into the New Senior Credit Facility
with Davel Financing Company, L.L.C., PhoneTel and Cherokee Communications,
Inc., a wholly owned subsidiary of PhoneTel. The New Senior Credit Facility is
guaranteed by the Company and all of its domestic subsidiaries. Pursuant to the
New Senior Credit Facility, the New Senior Lenders loaned $10.0 million in the
aggregate on February 20, 2002, $5.0 million to each of Davel and PhoneTel.
Davel and PhoneTel agreed to remain jointly and severally liable for all amounts
owing under the New Senior Credit Facility.
Interest on the funds loaned pursuant to the New Senior Credit Facility
accrues at the rate of fifteen percent (15%) per annum and is payable monthly in
arrears. A principal amortization payment in the amount of $833,333, to be
shared equally by the Company and PhoneTel, is owing on the last day of each
month, beginning July 31, 2002 and ending on the maturity date of June 30, 2003.
Pursuant to an Intercreditor and Subordination Agreement, dated as of
February 19, 2002 and reaffirmed on July 24, 2002, the Junior Lenders agreed to
subordinate their security interest in Company collateral to the security
interest of the New Senior Lenders in such collateral. Upon the repayment in
full of the amounts owing under the New Senior Credit Facility, the senior
security interests of the New Senior Lenders will terminate and the Junior
Lenders will, once again, hold first priority security interests in the Company
collateral. Pursuant to the Seventh Amendment, the Junior Lenders consented to
the Company's entering into the New Senior Credit Facility.
First Amendment
On May 10, 2002, the Company notified the New Senior Lenders that Davel
had determined, in consultation with its independent auditors based on the best
available information regarding certain anticipated dial-around receivables,
that the Company would be unable to meet the Minimum Adjusted EBITDA and Minimum
EBITDA covenants set forth in the New Senior Credit Facility for at least the
first six months of 2002. On May 14, 2002, the Company entered into the First
Amendment to the New Senior Credit Facility ("First Amendment"). Pursuant to the
First Amendment, which is effective February 19, 2002, the Minimum Adjusted
EBITDA and Minimum EBITDA covenants were adjusted through June 30, 2002.
Second Amendment
In July 2002, the Company notified the New Senior Lenders that it had
determined that it would be unable to meet the Minimum Adjusted EBITDA and
Minimum EBITDA covenants set forth in the amended New Senior Credit Facility
through the maturity date of June 30, 2003. On July 23, 2002, the Company
entered into the Second Amendment to the New Senior Credit Facility ("Second
Amendment"). Pursuant to the Second Amendment, which is effective July 1, 2002,
the Minimum Adjusted EBITDA and Minimum EBITDA covenants were adjusted through
June 30, 2003.
The Company incurred losses of approximately $43.4 million and $14.3
million for the year ended December 31, 2001 and the six months ended June 30,
2002, respectively. These losses were primarily attributable to increased
competition from providers of wireless communication services and the impact on
the Company's revenue of certain regulatory changes. As of June 30, 2002, the
Company had a working capital deficit of $3.6 million and its liabilities exceed
its assets by $244.1 million. In addition, the Company was unable to make debt
payments of approximately $237.7 million and interest payments of approximately
$36.3 million, which became due and payable on January 11, 2002 to the lenders
of the Old Credit Facility. However, the Seventh Amendment extended the due date
of all payment obligations thereunder to August 31, 2002 (if not earlier
refinanced pursuant to the New Junior Credit Facility).
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Notwithstanding the New Senior Credit Facility and the debt-for-equity
exchange described above, the Company may face liquidity shortfalls and, as a
result, might be required to dispose of assets or operations to fund its
operations, to make capital expenditures and to meet its debt service and other
obligations. There can be no assurances as to the ability to execute such
dispositions, or the timing thereof, or the amount of proceeds that the Company
could realize from such sales. As a result of these matters, substantial doubt
exists about the Company's ability to continue as a going concern.
IMPACT OF INFLATION
Inflation is not considered 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 operation regions are affected
by seasonal variations, geographic distribution of payphones and type of
location. Because many of the Company's payphones are located outdoors, weather
patterns have differing effects on the Company's results depending on the region
of the country where they are located. Most of the Company's payphones in the
southeastern United States 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks inherent in the Company's
financial instruments that arise from transactions entered into in the normal
course of business. The Company was subject to variable interest rate risk on
the Old Credit Facility and any future financing requirements. Both the New
Senior Credit Facility and the New Junior Credit Facility bear interest at fixed
rates. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
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PART II - OTHER INFORMATION
ITEM 1. 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, 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 (acquired by the Company on December 23, 1998)
alleging that Peoples Telephone 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 Telephone. Effective February 19, 2002, the parties to the
lawsuit signed a Settlement Agreement and Mutual Release ("Settlement
Agreement"). The Settlement Agreement provides that, upon the closing of the
PhoneTel Merger, all parties to the lawsuit will release and discharge all
claims and liability against all other parties, without an admission of
liability by any party. Pursuant to the Settlement Agreement, on August 7,
2002, the parties executed a Joint Stipulation and Order for Dismissal with
Prejudice requesting that the Delaware Chancery Court dismiss the lawsuit in its
entirety, with prejudice.
In March 2000, the Company and its wholly owned subsidiary Telaleasing
Enterprises, Inc. were sued in Maricopa County, Arizona Superior Court by CSK
Auto, Inc. ("CSK"). The suit alleges that the Company breached a location
agreement between the parties. CSK's complaint alleges damages in excess of $5
million. The Company removed the case to the U.S. District Court for Arizona and
moved to have the matter transferred to facilitate consolidation with a related
case in California, which was settled in the third quarter of 2001. On October
16, 2000, the U.S. District Court for Arizona denied the Company's transfer
motion and ordered the case remanded back to Arizona state court. On November
13, 2000, the Company filed its Notice of Appeal of the remand order with the
United States Court of Appeals for the Ninth Circuit. On May 17, 2002, the Court
of Appeals affirmed the remand order, thus allowing the case to proceed in
Arizona state court. The underlying suit is now in the pretrial discovery phase,
and no trial date has been set. The Company intends to vigorously defend itself
in the case. While the Company believes it possesses certain meritorious
defenses to the claims, the matter remains in its initial stages. Accordingly,
the Company cannot at this time predict the likelihood of an unfavorable result
or the amount or range of potential loss.
In February 2001, Picus Communications, LLC ("Picus"), a debtor in
Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern
District of Virginia, brought suit against Davel and its wholly owned
subsidiary, Telaleasing Enterprises, Inc., in the United States District Court
for the Eastern District of Virginia, claiming unpaid invoices of over $600,000
for local telephone services in Virginia, Maryland, and the District of
Columbia. The Company sought relief from the bankruptcy court to assert claims
against Picus and answered Picus' complaint in the district court, denying its
material allegations. On or about April 2, 2001, Picus moved the district court
to dismiss its case and indicated that it may file its claim as an adversary
proceeding with the bankruptcy court. On March 13, 2001, the Company filed a
proof of claim in the bankruptcy court to recover damages based on Picus's
breach of contract and failure to secure and pay federally mandated dial-around
compensation. On May 10, 2001, the district court entered an order dismissing
Picus' complaint without prejudice. On September 21, 2001, the Company filed an
application for administrative payment with the bankruptcy court seeking
approximately $1.5 million in post-petition damages incurred by the Company as a
result of Picus's actions. On May 9, 2002, Picus filed an objection to the
Company's administrative claim and a counterclaim seeking to recover
approximately $717,000 in damages. The bankruptcy court has scheduled all
matters for final hearing in October 2002. The Company believes it has
meritorious defenses and counterclaims
28
against Picus and intends to vigorously defend itself and pursue recovery from
Picus on its counterclaims. The Company cannot at this time predict its
likelihood of success on the merits.
On or about January 27, 2002, Davel was served with a complaint, in an
action captioned Sanchez et al. v. DavelTel, Inc. d/b/a Davel Communications,
Inc. et. al., brought in the district court for Cameron County, Texas.
Plaintiffs accuse the defendants of negligence in the death of the father of
Thomas Sanchez, a former Davel employee. As the Company believes the matter
falls within its insurance coverage, the matter has been forwarded to Davel's
insurance carrier for action. While Davel believes it possesses adequate
insurance coverage for the case and has meritorious defenses, the matter is in
its initial stages. Accordingly, the Company cannot at this time predict its
likelihood of success on the merits.
On June 12, 2002, the Company settled outstanding litigation with
Sprint Corporation related to certain telephone line charges. The settlement
provides for a cash payment to the Company of $578,000. This amount has been
recorded in the accompanying financial statements as a reduction of telephone
charges.
The Company is involved in other litigation arising in the normal
course of its business which it believes will not materially affect its
financial condition or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index.
(b) No Current Reports on Form 8-K were filed by the Company
during the quarter ended June 30, 2002.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Form 10-Q to be signed on its behalf by the
undersigned thereunto duly authorized.
DAVEL COMMUNICATIONS, INC.
Date: August 14, 2002 /s/ RICHARD P. KEBERT
--------------------
Richard P. Kebert
Chief Financial Officer
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
2.1 Amendment No. 1, dated as of May 7, 2002, to Agreement and
Plan of Reorganization and Merger, dated as of February 19,
2002, by and among Davel Communications, Inc., Davel Financing
Company, L.L.C., DF Merger Corp., PT Merger Corp., and
PhoneTel Technologies, Inc. (incorporated by reference to
Exhibit 2.2 to Registration Statement on Form S-4
(Registration No. 333-87924) filed with the SEC on May 9,
2002).
10.1 First Amendment, dated as of May 14, 2002, to the Credit
Agreement, dated as of February 19, 2002, among Davel
Communications, Inc., Davel Financing Company, L.L.C., the
Domestic Subsidiaries thereof as Guarantors, PhoneTel
Technologies, Inc., Cherokee Communications, Inc., and the
lenders named therein (incorporated by reference to Exhibit
10.1 to Quarterly Report on Form 10-Q of Davel Communications,
Inc., filed with the SEC on May 15, 2002).
99.1 Certification of CEO and CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
31