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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 MARCH 31, 2003
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__
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes__ No X
As of May 09, 2003, there were 615,018,963 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
PART I FINANCIAL INFORMATION
ITEM 1
Financial Statements:
Consolidated Balance Sheets......................................................................................1
Consolidated Statements of Operations............................................................................2
Consolidated Statements of Cash Flows............................................................................3
Consolidated Statements of Shareholders' Equity (Deficit) and Other Comprehensive Income (Loss)..................4
Notes to Consolidated Financial Statements.......................................................................5
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operations...........................16
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk......................................................25
ITEM 4
Disclosure Controls and Procedures..............................................................................25
PART II OTHER INFORMATION
ITEM 1
Legal Proceedings...............................................................................................27
ITEM 6
Exhibits and Reports on Form 8-K................................................................................27
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
MARCH 31 DECEMBER 31
2003 2002
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents .......................... $ 7,487 $ 6,854
Accounts receivable, net of allowance for doubtful
accounts of $1,870 at December 31, 2002............. 10,962 16,807
Other current assets ............................... 3,820 3,286
--------- ---------
Total current assets ...................... 22,269 26,947
Property and equipment, net ............................. 37,349 41,855
Location contracts, net ................................. 16,869 18,043
Goodwill ................................................ 17,455 17,455
Other assets, net ....................................... 2,525 2,316
--------- ---------
Total assets .............................. $ 96,467 $ 106,616
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and obligations
under capital leases $ 9,972 $ 11,449
Accrued interest ................................... 41 104
Accrued commissions payable ........................ 11,278 11,986
Accounts payable and other accrued expenses ........ 20,011 21,158
--------- ---------
Total current liabilities ................. 41,302 44,697
Long-term debt and obligations under capital leases ..... 116,217 118,229
--------- ---------
Total liabilities ......................... 157,519 162,926
--------- ---------
Commitments and contingencies ........................... -- --
Shareholders' deficit:
Preferred Stock - $0.01 par value, 1,000,000 shares -- --
authorized, no shares outstanding
Common Stock - $0.01 par value, 1,000,000,000 shares
authorized, 615,018,963 shares
issued and outstanding at March 31, 2003 6,150 6,150
and December 31, 2002
Additional paid-in capital ......................... 144,210 144,210
Accumulated deficit ................................ (211,412) (206,670)
--------- ---------
Total shareholders' deficit ............... (61,052) (56,310)
--------- ---------
Total liabilities and shareholders' deficit $ 96,467 $ 106,616
========= =========
The accompanying notes are an integral part of these financial statements
1
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
THREE MONTH ENDED MARCH 31
-----------------------------------------------
2003 2002
--------------- --------------
REVENUES:
Coin calls ................................... $ 13,179 $ 12,222
Non-coin calls ............................... 5,811 5,040
Dial-around compensation adjustment .......... 3,928 --
------------- -------------
Total revenues ................ 22,918 17,262
------------- -------------
OPERATING EXPENSES:
Telephone charges ............................ 7,055 4,080
Commissions .................................. 4,024 3,887
Service, maintenance and network costs ....... 6,316 4,846
Depreciation and amortization ................ 5,860 4,969
Selling, general and administrative .......... 2,554 2,772
Exit and disposal activities ................. 311 --
------------- -------------
Total costs and expenses ...... 26,120 20,554
------------- -------------
Operating loss ................ (3,202) (3,292)
OTHER INCOME (EXPENSE):
Interest expense (net) ....................... (1,586) (4,553)
Other ........................................ 46 4
------------- -------------
Total other income (expense) .. (1,540) (4,549)
------------- -------------
NET LOSS ........................................... $ (4,742) $ (7,841)
============= =============
LOSS PER SHARE CALCULATION:
Net loss per common share, basic and diluted ....... $ ( 0.01) $ (0.70)
============= =============
Weighted average number of shares, basic and diluted 615,018,963 11,169,440
============= =============
The accompanying notes are an integral part of these financial statements
2
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
-----------------------
2003 2002
--------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................................................. $(4,742) $(7,841)
Adjustments to reconcile net income (loss) to net cash flow from operating activities:
Depreciation and amortization ................................................... 5,860 4,969
Amortization of deferred financing costs and non-cash interest .................. 1,288 15
Loss on disposal of assets ...................................................... 7 7
Deferred revenue ................................................................ -- (41)
Changes in assets and liabilities, net of assets acquired:
Accounts receivable ............................................................. 5,845 2,440
Other current assets ............................................................ (534) (2,187)
Accrued commissions payable ..................................................... (708) (1,056)
Accounts payable and accrued expenses ........................................... (1,140) (5,102)
Accrued interest ................................................................ (70) 4,265
------- -------
Net cash from operating activities .......................................... 5,806 (4,531)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets ......................................................... (2) --
Capital expenditures ................................................................. (99) (88)
Payments for location contracts ...................................................... (41) (84)
Increase in other assets ............................................................. (299) --
------- -------
Net cash from investing activities .......................................... (441) (172)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from Senior Credit Agreement ............................................ -- 5,000
Debt issuance costs .................................................................. -- (186)
Payments on long-term debt ........................................................... (4,666) --
Principal payments under capital leases .............................................. (66) (156)
------- -------
Net cash from financing activities .............................................. (4,732) 4,658
------- -------
Net increase (decrease) in cash and cash equivalents ............................ 633 (45)
Cash and cash equivalents, beginning of period ............................................. 6,854 5,333
------- -------
Cash and cash equivalents, end of period ................................................... $ 7,487 $ 5,288
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST PAID .............................................................................. $ 261 $ 83
======= =======
The accompanying notes are an integral part of these financial statements
3
DAVEL COMMUNICATIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
AND OTHER COMPREHENSIVE LOSS
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
- --------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
--------------------------- PAID-IN ACCUMULATED COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT LOSS
------------- ------------ ----------- -------------- -------------
Balances December 31, 2001 11,169,440 $ 112 $ 128,503 $ (358,421) $ (7)
Issuance of common stock --
debt exchange ........... 380,612,730 3,806 9,896 -- --
Issuance of common stock --
PhoneTel merger ......... 223,236,793 2,232 5,805 -- --
Issuance of stock options --
PhoneTel merger ......... -- -- 6 -- --
Market change on interest
collar .................... -- -- -- -- 7
Net income ................ -- -- -- 151,751 --
------------- ------------- ------------- ------------- -------------
Balances December 31, 2002 615,018,963 6,150 144,210 (206,670) --
Net loss .................. -- -- -- (4,742) --
------------- ------------- ------------- ------------- -------------
Balances March 31, 2003 ... 615,018,963 $ 6,150 $ 144,210 $ (211,412) $ --
============= ============= ============= ============= =============
TOTAL
SHAREHOLDERS'
EQUITY COMPREHENSIVE
(DEFICIT) LOSS
------------- --------------
Balances December 31, 2001 $ (229,813)
Issuance of common stock --
debt exchange ........... 13,702 --
Issuance of common stock --
PhoneTel merger ......... 8,037 --
Issuance of stock options --
PhoneTel merger ......... 6 --
Market change on interest
collar .................... 7 $ 7
Net income ................ 151,751 151,751
-------------- -------------
Balances December 31, 2002 (56,310) $ 151,758
=============
Net loss .................. (4,742) (4,742)
-------------- -------------
Balances March 31, 2003 ... $ (61,052) $ (43,421)
============== =============
The accompanying notes are an integral part of these financial statements
4
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
1. BASIS OF PRESENTATION
Davel Communications, Inc. ("Davel" or 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 65,000 payphones in 48
states and the District of Columbia. The Company's headquarters is located in
Cleveland, Ohio (having been relocated from Tampa, Florida after completion of
the PhoneTel Merger - see Note 4 for exit and disposal activities), with field
service offices in 36 geographically dispersed locations.
The accompanying consolidated balance sheet of Davel Communications, Inc.
and its subsidiaries at March 31, 2003 and the related consolidated statements
of operations and cash flows for the three month periods ended March 31, 2003
and 2002 and the consolidated statements of shareholders' deficit and other
comprehensive income (loss) for the period ended March 31, 2003 are unaudited.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. 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, 2002.
The results of operations for the three month period ended March 31, 2003 are
not necessarily indicative of the results for the full year.
On July 24, 2002, the Company restructured its long-term debt by
completing the debt-for-equity exchange described in Note 3. Immediately
thereafter, on that same date, the Company and PhoneTel Technologies, Inc.
("PhoneTel") completed the merger described in Note 4 (the "PhoneTel Merger"),
which has been accounted for as a purchase business combination. Accordingly,
the results of operations of PhoneTel are included in the accompanying financial
statements since the effective date of the 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. Excluding the gain
on debt extinguishment of $181.0 million in 2002 (see Note 3), the Company has
incurred losses of approximately $29.2 million and $4.7 million for the year
ended December 31, 2002 and for the three months ended March 31, 2003,
respectively. As of March 31, 2003, the Company had a working capital deficit of
$19.0 million and its liabilities exceeded its assets by $61.1 million.
Further, as discussed in Note 8, the Company was not in compliance with the
adjusted earnings (EBITDA) financial covenant included in the Junior Credit
Facility in the first quarter of 2003. In addition, the Company did not pay a
$0.8 million principal payment that was due on its Senior Credit Facility on
December 31, 2002; such violation was cured by payment on January 28, 2003 from
the proceeds of certain regulatory receipts and an additional prepayment of $2.2
million was made in March 2003 from the proceeds of a sale of the Company's
WorldCom bankruptcy claim (see Note 7). On May 2, 2003, the Company paid the
remaining balance due under its Senior Credit Facility. As a result, however,
the Company was in default under these credit agreements during the first
quarter of 2003. The Company has obtained an amendment or written waivers from
its lenders that waive all noncompliance with the financial covenants for
periods sufficient in management's view to bring the Company into compliance.
Failure to maintain compliance with the terms, conditions and covenants of the
Junior Credit Facility could result in the Junior indebtedness becoming
immediately due
5
and payable to the Junior Lenders. These conditions raise substantial doubt
about the Company's ability to continue as a going concern.
Management has been actively engaged in the execution of a plan to mitigate
these negative conditions and, ultimately, return the Company to profitability.
Significant elements of the plan executed during 2002 and 2003 included (i) the
payment of the remaining principal balance of the Company's Senior Credit
Facility, (ii) continuing cost savings and efficiencies resulting from the
merger with PhoneTel discussed in Note 4, (iii) the removal of unprofitable
payphones and (iv) the curtailment of operating expenses. Significant elements
of management's plans for 2003 to bring the Company into a state of
profitability include the further removals of unprofitable payphones, the
further curtailment of operating expenses including reductions in telephone
charges, and new business initiatives being planned by the Company.
Notwithstanding these activities and plans, the Company may continue to
face liquidity shortfalls and, as a result, might be required to dispose of
assets to fund its operations or curtail its capital and other expenditures 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. DEBT RESTRUCTURING
On July 24, 2002 (the "closing date"), immediately prior to the merger
discussed in Note 4, the existing 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, which was subsequently
exchanged for 204,659,064 shares of the Company in the PhoneTel Merger. Also, on
this date, the existing Davel junior lenders exchanged $237.2 million of
outstanding indebtedness and $45.7 million of related accrued interest for
380,612,730 shares of common stock (with a value of $13.7 million, based upon
market prices around the closing date), which reduced Davel's junior
indebtedness to $63.5 million. Upon completion of the debt exchanges, Davel and
PhoneTel amended, restated and consolidated their respective junior credit
facilities into a combined restructured junior credit facility with a principal
balance, excluding fees, of $100.0 million (the "Junior Credit Facility") due
December 31, 2005 (the "maturity date").
Davel has accounted for its debt-for-equity exchange as a troubled debt
restructuring. Accordingly, the Company has recognized a gain on extinguishment
of the old debt based upon the difference between the carrying value of its old
credit facility (including accrued interest) and the amount of the equity
interest and new debt, including interest, issued by Davel to its lenders. The
gain on debt extinguishment, included in other income (expense) in the
consolidated statements of operations for the year ended December 31, 2002, is
as follows (in thousands):
Old Credit Facility:
Principal balance ........................................... $ 237,255
Accrued interest ............................................ 45,704
---------
Carrying value .............................................. 282,959
Common stock issued (380,612,730 shares at $0.036) ........... (13,702)
Principal balance of new debt ................................ (63,500)
Interest, costs and fees on new debt (payable through maturity) (24,780)
---------
Gain on debt extinguishment .................................. $ 180,977
=========
Following the PhoneTel Merger and the debt exchanges, the combined junior
indebtedness of the Company has a face value of $101.0 million (including $1.0
million in loan origination fee), 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 have been recorded at the net present value of such payments in
accordance with the purchase method of accounting. Interest expense is
recognized on
6
the PhoneTel portion of the restructured debt over the term of the debt using
the interest method of accounting at a fair market rate of 15%.
Following the debt-for-equity exchange and the PhoneTel Merger, the
creditors of the Company in the aggregate own 90.81% of the common stock of the
Company on a fully diluted basis.
4. PHONETEL MERGER
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 its subsidiary. PhoneTel
was a payphone service provider, based in Cleveland, Ohio, that operated an
installed base of approximately 28,000 payphones in 45 states and the District
of Columbia. Management believes the PhoneTel Merger will result in expansion of
its market presence and further reduce its operating costs by leveraging the
combined infrastructure. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations", the results of operations
of PhoneTel are included in the accompanying financial statements since the date
of acquisition.
In connection with the PhoneTel Merger, 100% of the voting shares in
PhoneTel were acquired and each share of common stock of PhoneTel was converted
into 1.8233 shares of common stock of the Company, or an aggregate of
223,236,793 shares with a fair value of approximately $8.0 million. The fair
value of the Davel common stock was derived using an average market price per
share of Davel common stock of $0.036, which was based on an average of the
closing prices for a range of trading days (July 19, 2002 through July 29, 2002)
around the closing date of the merger. In addition 1,077,024 warrants and
339,000 options of PhoneTel were converted into 1,963,738 warrants and 618,107
stock options of the Company, respectively, with an aggregate value of $6,000.
The warrants subsequently expired by their terms in November 2002. Direct costs
and expenses of the merger amounted to $1.1 million and were included in the
purchase price.
In accordance with SFAS No. 141, Davel allocated the purchase price of
PhoneTel to tangible assets and liabilities and identifiable intangible assets
acquired based on their estimated fair values. The excess of the purchase price
over those fair values was recorded as goodwill. The fair value assigned to
intangible assets acquired is based upon estimates and assumptions of
management. The goodwill recorded is not expected to be deductible for tax
purposes. In accordance with SFAS No. 142, the goodwill acquired will not be
amortized but will be reviewed annually for impairment. The first impairment
review was completed as of September 30, 2002 and no impairment was present.
There were no indicators of impairment present at March 31, 2003. Purchased
intangibles will be amortized on a straight-line basis over their respective
useful lives.
The PhoneTel Merger has been accounted for as a purchase business
combination and the purchase price has been allocated as follows (in thousands):
Cash and cash equivalents ................. $ 3,884
Accounts receivable ....................... 4,612
Other current assets ...................... 1,552
Property and equipment .................... 11,347
Intangible assets (location contracts) .... 19,821
Goodwill .................................. 17,455
Other assets .............................. 765
--------
Assets acquired ........................... 59,436
--------
Accounts payable and other accrued expenses (9,238)
Accrued commissions payable ............... (3,367)
Senior credit facility (See Note 8) ....... (4,583)
Junior credit facility (See Note 8) ....... (32,206)
Other long-term debt (See Note 8) ......... (928)
--------
Liabilities assumed ...................... (50,322)
--------
Net assets acquired ....................... $ 9,114
========
7
AMORTIZABLE INTANGIBLE ASSETS
Of the total purchase price, $19.8 million has been allocated to
amortizable intangible assets for commission agreements with owners of
facilities where the Company's payphones are located ("Location Contracts"). The
Company will amortize the fair value of these assets over the weighted average
estimated remaining term of these contracts, including certain renewals, of
approximately 5 years.
UNAUDITED PRO FORMA RESULTS
The following unaudited pro forma financial information (in thousands of
dollars, except for per share amounts) gives effect to the PhoneTel Merger and
the debt exchanges described in Note 3 and above as if they had occurred at the
beginning of the period 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 the beginning of the
period.
UNAUDITED PRO FORMA
INFORMATION
FOR THE THREE MONTHS ENDED
MARCH 31, 2002
--------------------------
Revenue ............................................... $ 26,014
Loss from operations before gain on debt extinguishment (8,050)
Gain on debt extinguishment ........................... 172,657
---------
Net income ............................................ $ 164,607
=========
Net loss per common share, basic and diluted: ......... $ 0.27
=========
EXIT AND DISPOSAL ACTIVITIES
In connection with the PhoneTel Merger, the Company terminated its Tampa,
FL headquarters facility lease, abandoned or disposed of certain furniture,
fixtures and leasehold improvements and incurred severance costs related to
terminated employees. Exit activities related to the Company were expensed as
incurred or as otherwise provided in SFAS No. 146. Substantially all exit
activities were completed prior to December 31, 2002 and, accordingly,
management does not currently expect that any significant additional amounts
will be incurred in connection with the closing of the Company's former
headquarters facility. The following table reflects the components of exit and
disposal activities included in the Company's consolidated statements of
operations in the third and fourth quarters of 2002 (in thousands):
Abandonment or disposals of property and equipment $1,308
Lease termination ................................ 600
Employee severance ............................... 667
Other merger related expenses .................... 344
------
$2,919
======
Subsequent to December 31, 2002, the Company also outsourced the assembly
and repair of its payphone equipment and closed its warehouse and repair
facility in Tampa, Florida. The Company incurred a loss from exit and disposal
activities relating to this facility of approximately $0.3 million in the first
quarter of 2003.
5. RECENT ACCOUNTING PRONOUNCEMENTS
8
During December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure". Statement No. 148 establishes standards for two alternative methods
of transition to the fair value method of accounting for stock-based employee
compensation of SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS
No. 148 also amends and augments the disclosure provisions of SFAS No. 123 and
APB No. 28, "Interim Financial Reporting", to require disclosure in the summary
of significant accounting policies for all companies of the effects of an
entity's accounting policy with respect to stock based employee compensation on
reported net income and earnings per share in annual and interim financial
statements. The transitions standards and disclosure requirements of SFAS No.
148 are effective for fiscal years and interim periods ending after December 15,
2002.
SFAS No. 148 does not require the Company to transition from the intrinsic
value approach provided in APB Opinion No. 25, "Accounting for Employee Stock
Based Compensation". In addition, the Company does not currently plan to
transition to the fair value approach in SFAS No. 123. However, the Company
adopted the additional disclosure requirements of SFAS No. 148 in 2002.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("Interpretation No. 45"). Under
Interpretation No. 45, guarantees, contracts and indemnification agreements are
required to be initially recorded at fair value. Current practice provides for
the recognition of a liability only when a loss is probable and reasonably
estimable, as those terms are defined under SFAS No. 5, "Accounting for
Contingencies". In addition, Interpretation No. 45 requires significant new
disclosures for all guarantees even if the likelihood of the guarantor's having
to make payments under the guarantee is remote. The disclosure requirements are
effective for financial statements of interim and annual periods ending after
December 15, 2002. The initial recognition and measurement provisions of
Interpretation No. 45 are applicable on a prospective basis to guarantees,
contracts or indemnification agreements issued or modified after December 31,
2002.
The Company currently has no guarantees, contracts or indemnification
agreements that would require fair value treatment under the new standard. The
Company's current policy is to disclose all material guarantees and contingent
arrangements, similar to the disclosure requirements of Interpretation No. 45,
which provide for disclosure of the approximate term, nature of guarantee,
maximum potential amount of exposure, and the nature of recourse provisions and
collateral.
6. DIAL-AROUND COMPENSATION
On September 20, 1996, the Federal Communications Commission (FCC) adopted
rules in a docket entitled In the Matter of Implementation of the Payphone
Reclassification and Compensation Provisions of the Telecommunications Act of
1996, FCC 96-388 (the "1996 Payphone Order"), implementing the payphone
provisions of Section 276 of the Telecom Act. The 1996 Payphone Order, which
became effective November 7, 1996, mandated dial-around compensation for both
access code calls and 800 subscriber calls. 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. 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.
On October 9, 1997, the FCC adopted and released its Second Report and
Order in the same docket, FCC 97-371 (the "1997 Payphone Order"). This order
addressed the per-call compensation rate for 800 subscriber and access code
calls that originate from payphones in light of the decision of the Court which
vacated and remanded certain portions of the FCC's 1996 Payphone Order. The FCC
concluded that the rate for per-call compensation for 800 subscriber and access
code calls from payphones is the deregulation local coin rate adjusted for
certain cost differences. Accordingly, the FCC established a rate of $0.284
($0.35 - $0.066) per call for the first two years of per-call compensation
(October 7, 1997, through October 6, 1999). The IXCs were required to pay this
per-call amount to payphone service providers ("PSPs"), including the Company,
beginning October 7, 1997. Based on the FCC's tentative conclusion in the 1997
Payphone Order,
9
the Company during 1997 adjusted the amounts of dial-around compensation
previously recorded related to 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).
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 Regional Bell
Operating Company ("RBOC") payphones for corresponding payment periods. Accurate
payments made at the flat rate are not subject to subsequent adjustment for
actual call counts from the applicable payphone.
On May 15, 1998, the Court again remanded the per-call compensation rate to
the FCC for further explanation without vacating the $0.284 per call rate. The
Court opined that the FCC had failed to explain adequately its derivation of the
$0.284 default rate. The Court stated that any resulting overpayment 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. 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. The new 24-cent rate became effective April 21, 1999. The 24-cent rate was
also 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.
In a decision released January 31, 2002 (the "2002 Payphone Order") the FCC
partially addressed the remaining issues concerning the "true-up" required for
the earlier dial-around compensation periods. The FCC adjusted the per-call rate
to $.229, for the period commencing November 7, 1996 and ending on October 6,
1997 ("the interim period"), 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 2002 Payphone
Order deferred to a later order its determination of the allocation of this
total compensation rate among the various carriers required to pay compensation
for the interim period. In addition to addressing the rate level for dial-around
compensation, the FCC has also addressed the issue of carrier responsibility
with respect to dial-around compensation payments.
On October 23, 2002 the FCC released its Fifth Order on Reconsideration and
Order on Remand (the "Interim Order"), which resolved all the remaining issues
surrounding the interim/intermediate period true-up and specifically how flat
rate monthly per-phone compensation owed to PSPs would be allocated among the
relevant dial-around carriers. The Interim Order also resolved how certain
offsets to such payments would be handled and a host of other issues raised by
parties in their remaining FCC challenges to the 1999 Payphone Order and the
2002 Payphone Order. In the Interim Order, the FCC ordered a true-up for the
interim period and increased the adjusted monthly rate to $35.22 per payphone
per month, to compensate for the three-month payment delay inherent in the
dial-around payment system. The new rate of $35.22 per payphone per month is a
composite rate, allocated among approximately five hundred carriers based on
their estimated dial-around traffic during the interim period. The FCC also
ordered a true-up requiring the PSPs, including the Company, to refund an amount
equal to $.046 (the difference between the old $.284 rate and the current $.238
rate) to each carrier that compensated the PSP on a per-call basis during the
intermediate period. Interest on additional payments and refunds is to be
computed from the original payment date, at the IRS prescribed rate applicable
to late tax payments. The FCC further ruled that a carrier claiming a refund
from a PSP for the Intermediate Period must first offset the amount claimed
against any additional payment due to the PSP from that carrier. Finally, the
Interim Order provided that any net claimed refund amount owing to carriers
cannot be offset against future dial-around payments (1) without prior
10
notification and an opportunity to contest the claimed amount in good faith
(only uncontested amounts may be withheld); and (2) absent an opportunity to
"schedule" payments over a reasonable period of time.
The Company and its billing and collection clearinghouse are currently
reviewing the order and preparing the data necessary to determine the precise
dollar impact of the Interim Order on the Company. Based upon currently
available information, the Company recorded a $3.8 million adjustment to
revenues from dial-around compensation in the fourth quarter of 2002 for the
estimated amount due to certain dial-around carriers under the Interim Order.
The Company also estimates that it is entitled to receive in excess of $15.0
million of dial-around compensation refunds from other carriers, excluding
WorldCom (see Note 7). However, the amount the Company will ultimately be able
to collect is dependent upon the willingness and ability of such carriers to
pay, including the resolution of any disputes that may arise under the Interim
Order. Subsequent to December 31, 2002, the Company received $4.9 million
relating to the sale of a portion of the Company's accounts receivable
bankruptcy claim for dial-around compensation due from WorldCom, of which $3.9
million relates to the amount due from WorldCom under the Interim Order. In
accordance with the Company's policy on regulated rate actions, this revenue
from dial-around compensation was recognized in the first quarter of 2003, the
period such revenue was received (see Note 7).
On August 2, 2002 and September 2, 2002 respectively, the APCC and the
RBOCs filed petitions with the FCC to revisit and increase the dial around
compensation rate level. Using the FCC's existing formula and adjusted only to
reflect current costs and call volumes, the APCC and RBOCs' petitions support an
approximate doubling of the current $0.24 rate. In response to the petitions, on
September 2, 2002 the FCC placed the petitions out for comment and reply comment
by interested parties, seeking input on how the Commission should proceed to
address the issues raised by the filings. The Company believes that the "fair
compensation" requirements of Section 276 of the Telecom Act mandate that the
FCC promptly review and adjust the dial around compensation rate level. While no
assurances can be given as to the timing or amount of any increase in the dial
around rate level, the Company believes an increase in the rate is reasonably
likely given the significant reduction in payphone call volumes, continued
collection difficulties and other relevant changes since the FCC set the $0.24
rate level.
Regulatory actions and market factors, often outside the Company's control,
could significantly affect the Company's dial-around compensation revenues.
These factors include (i) the possibility of administrative proceedings or
litigation seeking to modify the dial-around compensation rate, and (ii) 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.
7. SALE OF WORLDCOM CLAIM AND REGULATORY REFUNDS
On March 10, 2003, the Company received $4.9 million relating to the
third-party sale of a portion of the Company's accounts receivable bankruptcy
claim for dial-around compensation due from WorldCom. The amount received by the
Company is equal to 51% of the amount listed in the debtor's schedule of
liabilities (the "Scheduled Debt") filed by WorldCom (approximately $9.6
million), which amount is materially less than the balance included in the
Company's proof of claim relating to the portion of the claim sold
(approximately $17.7 million). Under the sale agreement, the Company will be
entitled to 51% of the amount of the allowed claim in excess of the Scheduled
Debt, if any, included in WorldCom's plan of reorganization as confirmed by the
U. S. Bankruptcy Court. If the amount of the allowed claim is less than the
Scheduled Debt, the Company would be required to refund 51% of any such
shortfall to the purchaser. The Company is not entitled to receive and is not
required to reimburse the purchaser if the actual distribution percentage
pursuant to WorldCom's plan of reorganization is more or less than 51% of the
allowed claim. No assurance can be made that the bankruptcy court will allow the
amount of the Company's proof of claim, or even the amount of the Scheduled
Debt.
Of the $4.9 million of proceeds from the sale of the WorldCom bankruptcy
claim, approximately $1.0 million related to the recovery of the Company's
accounts receivable for unpaid dial-around compensation for the second and third
quarters of 2002, for which the Company had previously provided an allowance for
doubtful accounts, and approximately $3.9 million related to the Interim Order
described in Note 6. In accordance with the Company's policy on regulated rate
actions, the amount relating to the Interim Order was recognized as an
adjustment to dial-around revenue in the accompanying consolidated statements of
operations during the first quarter of 2003, the period in which such revenue
was received. In March 2003, the Company used $3.0 million of the sales proceeds
to pay a portion of the Company's balance due under the Company's Senior Credit
Facility (including a $2.2 million prepayment of such debt) and plans to use
$1.0
11
million, which is being held in escrow by the Company's lenders, to fund new
business initiatives. Any amounts not used for such purposes would be applied to
the balance due under the Company's Junior Credit Facility.
During the first quarter of 2003, the Company received $4.6 million of
refunds of prior period telephone charges relating to the recently adopted "New
Services Test" in certain states. Of this amount, $3.8 million and $0.8 million
were recognized as reductions in telephone charges in the fourth quarter of 2002
and first quarter of 2003, respectively. Under the Telecom Act and related FCC
Rules, LECs are required to make access lines that are provided for their own
payphones equally available to PSPs to ensure that the cost to PSPs for
obtaining local lines and service meet the FCCs new services test guidelines.
The FCC's new services test guidelines require LECs to price payphone access
lines at the direct cost to the LEC plus a reasonable allocation of overhead.
The Company previously recognized $3.2 million of refunds pursuant to the "New
Services Test" as a reduction of telephone charges in the Company's consolidated
statements of operations in the first quarter of 2002.
8. LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES
Following is a summary of long-term debt and obligations under capital
leases as of March 31, 2003 and December 31, 2002 (in thousands):
MARCH 31 DECEMBER 31
2003 2002
--------- -----------
SENIOR CREDIT FACILITY, due in monthly installments of $833.3 plus interest at
15% through June 30, 2003 .................................................... $ 1,167 $ 5,833
JUNIOR CREDIT FACILITY, due December 31, 2005:
TERM NOTE A, ($50,000 face value) plus unamortized premium, discount and
capitalized interest of $10,442 at March 31, 2003 ............................ 60,442 59,869
TERM NOTE B, ($51,000 face value) plus unamortized premium, discount and
capitalized interest of $12,302 at March 31, 2003 ............................ 63,302 62,681
NOTE PAYABLE, ($1,188 face value) due November 16, 2004 ...................... 1,024 987
CAPITAL LEASE obligations with various interest rates and maturity dates
through 2005 ................................................................. 254 308
--------- ---------
126,189 129,678
Less-- Current maturities .................................................... (9,972) (11,449)
--------- ---------
$ 116,217 $ 118,229
========= =========
SENIOR CREDIT FACILITY
Effective as of February 19, 2002, Madeleine L.L.C. and ARK CLO 2000-1,
Limited (the "Senior Lenders") entered into a credit agreement (the "Senior
Credit Facility") with Davel Financing Company, L.L.C., PhoneTel and Cherokee
Communications, Inc., a wholly owned subsidiary of PhoneTel. On that date, the
existing Junior Lenders of the Company and PhoneTel also agreed to a substantial
debt-for-equity exchange with respect to their outstanding indebtedness (see
Note 3). The Senior Credit Facility provided for a combined $10 million line of
credit which the Company and PhoneTel shared $5 million each. The Company and
PhoneTel each borrowed the amounts available under their respective lines of
credit on February 20, 2002, which amounts were used to pay merger related
expenses and accounts payable. Davel and PhoneTel agreed to remain jointly and
severally liable for all amounts due under the Senior Credit Facility. On May 2,
2003, the Company paid the remaining balance, including interest, due under the
Senior Credit Facility.
Interest on the funds loaned pursuant to the Senior Credit Facility accrued
at the rate of fifteen percent (15%) per annum and was payable monthly in
arrears. A principal amortization payment in the amount of $833,333 was due on
the last day of each month, beginning July 31, 2002 and ending on the maturity
date of June 30, 2003. The Senior Credit Facility included covenants that
require the Company and PhoneTel to maintain a minimum level of combined
earnings (EBITDA and Adjusted EBITDA, as defined in the Senior Credit Facility)
and limits the incurrance of cash and capital expenditures, the payment of
dividends and certain asset disposals.
12
The Senior Credit Facility was secured by substantially all assets of the
Company. Pursuant to an Intercreditor and Subordination Agreement, dated as of
February 19, 2002 and reaffirmed on July 24, 2002, the existing Junior Lenders
agreed to subordinate their security interest in Company collateral to the
security interest of the Senior Lenders in such collateral. Upon the repayment
in full of the amounts owing under the Senior Credit Facility on May 2, 2003,
the senior security interests of the Senior Lenders terminated and the Junior
Lenders obtained a first priority security interests in the Company collateral.
On May 14 and July 23, 2002 and April 3, 2003, the Company and PhoneTel
executed amendments to the Senior Credit Facility that reduced the minimum level
of combined earnings that the companies were required to maintain. The Company
did not pay the $833,333 principal payment that was due on December 31, 2002
until January 28, 2003 and was not in compliance with the financial covenant
that limits the amount of cash expenses the Company is permitted to pay during
January 2003. In March 2003, the Company also made a $3.0 million principal
payment from the proceeds of sale of a dial-around receivable bankruptcy claim,
which includes a $2.2 million prepayment of such debt, as required under the
Senior Credit Facility (see Note 7). The Company was also required to deposit
approximately $1.0 million in escrow with the Senior Lenders to be used for new
business initiatives planned by the Company. The Senior Lenders' rights with
respect to these escrowed funds have transferred to the Junior Lenders upon
payment in full of the Senior Debt in accordance with the agreements executed
among the Junior and Senior Lenders. The Company has obtained waivers from its
Senior Lenders which waive all defaults, including a waiver from the Company's
Senior Lenders and Junior Lenders to permit the Company to sell its dial-around
receivable bankruptcy claim.
JUNIOR CREDIT FACILITY
On July 24, 2002, immediately prior to the PhoneTel Merger, Davel and
PhoneTel amended, restated and consolidated their respective junior credit
facilities. The combined restructured Junior Credit Facility of $101.0 million
due December 31, 2005 (the "maturity date") consists of: (i) a $50.0 million
cash-pay term loan ("Term Note A") with interest payable in kind monthly through
June 30, 2003, and thereafter to be paid monthly in cash from a required payment
of $1.25 million commencing on August 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 $51.0 million payment-in-kind
term loan (the "PIK term loan" or "Term Note B") 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 percent (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). During the year ended December 31, 2002, approximately $4.6 million of
interest was added to the principal balances as a result of the deferred payment
terms. Upon the occurrence and during the continuation of an event of default,
interest accrues at the rate of 14% per annum.
As discussed in Note 3, the Company has accounted for the debt exchange as
a troubled debt restructuring and recorded a $181.0 million gain relating to the
extinguishments of its Old Credit Facility and the issuance of additional common
stock to the creditors. For accounting and reporting purposes, with respect to
Davel's portion of the new Junior Credit Facility ($64.1 million), 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 as it relates to that portion. In
addition, the remaining amounts payable with respect to the PhoneTel portion of
the new Junior Credit Facility ($36.9 million) have been recorded at the net
present value of such payments in accordance with the purchase method of
accounting. Interest expense is 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 of 15%. The following tabular presentation
summarizes the establishment and current carrying value of the Junior Credit
Facility (amounts in thousands):
DAVEL PHONETEL TOTAL
--------- --------- ---------
Face value of credit facilities ........... $ 64,135 $ 36,865 $ 101,000
Premium: interest capitalization .......... 24,122 -- 24,122
Discount: present value of acquired debt... -- (4,658) (4,658)
--------- --------- ---------
Subtotal .................................. 88,257 32,207 120,464
Payment-in-kind interest .................. 4,629 2,672 7,301
Amortization of premiums and discounts .... (4,753) 732 (4,021)
--------- --------- ---------
$ 88,133 $ 35,611 $ 123,744
========= ========= =========
13
The Junior Credit Agreement is secured by substantially all assets of the
Company and was subordinate in right of payment to the Senior Credit Facility.
The Junior Credit Facility also provides for the payment of a 1% loan fee,
payment of a $30,000 monthly administrative fee to Foothill Capital Corporation,
as Agent for the Junior Lenders, and advanced payments of principal from excess
cash flow and certain types of cash receipts. The Junior Credit Facility
includes covenants that require the Company to maintain a minimum level of
combined earnings (EBITDA and Adjusted EBITDA, as defined in the Junior Credit
Facility) and limits the incurrance of cash and capital expenditures, the
payment of dividends and certain asset disposals.
As discussed above, the Company was not in compliance with certain
financial covenants under its Senior Credit Facility and, as a result, was in
default under its Junior Credit Facility from August 31, 2002 through January
31, 2003. In addition, the Company was not in compliance with the minimum EBITDA
and Adjusted EBITDA financial covenants under the Junior Credit Agreement at
December 31, 2002. On March 31, 2003 the Company executed an amendment to its
Junior Credit Facility (the "Amendment") that reduced the minimum amount of
EBITDA and Adjusted EBITDA that the Company is required to maintain through
December 31, 2003 and waives all defaults through the date of the amendment. It
also amends the timing and amount of individual payments (but not the aggregate
amount) due under Junior Credit Facility during 2003 to coincide with the early
retirement of the Senior Credit Facility resulting from the prepayment described
above. Under the Amendment, the Company is required to make monthly payments of
$1,041,667 from July 1 through December 1, 2003. Payments due after December 31,
2003 are not affected by the Amendment. As of March 31, 2003, the Company was
not in compliance with the minimum Adjusted EBITDA covenant, as amended. The
Company has obtained a waiver from its Junior Lenders that waives this default
as of March 31, 2003.
NOTE PAYABLE
In connection with the PhoneTel Merger, the Company assumed a $1.1 million
note payable to Cerberus Partners, L.P. that provides for payment of principal,
together with deferred interest at 5% per annum, on November 17, 2004. Cerberus
Partners, L.P. and its affilliates are also lenders under the Senior and Junior
Credit Facilities and a major shareholder of the Company. The note is secured by
substantially all of the assets of PhoneTel and is subordinate in right of
payment to the Company's Senior Credit Facility and the Junior Credit Facility.
The note has been recorded at the net present value of the note, including
capitalized interest, in accordance with the purchase method of accounting.
Interest expense is recognized over the term of the note using the interest
method of accounting at a fair market rate of 15%.
9. EARNINGS PER SHARE AND STOCK-BASED COMPENSATION
The treasury stock method was used to determine the dilutive effect of the
options and warrants on earnings per share data. Diluted income (loss) per share
is equal to basic income (loss) per share since the exercise of the outstanding
options and warrants would be anti-dilutive and resulted in no dilution for all
periods presented. In accordance with SFAS No. 128 and the requirement to report
"Earnings Per Share" data, the basic and diluted income (loss) from continuing
operations per weighted average common share outstanding were $(0.01) and
$(0.70) for the three months ended March 31, 2003 and 2002, respectively.
The following table reflects supplemental financial information related to
stock-based employee compensation as of March 31, 2003 and 2002, as required by
SFAS No. 148 (See Note 5, "Recent Accounting Pronouncements"); in thousands,
except per share amounts:
2003 2002
---------- --------
Net loss, as reported ........................................ $ (4,742) $(7,841)
Net loss per share, as reported .............................. (0.01) (0.70)
Stock-based employee compensation costs used in the
determination of net income (loss) ......................... -- --
Stock-based employee compensation costs that would have --
14
2003 2002
---------- --------
been included in the determination of net income (loss) if the
fair value method had been applied to all awards ............. -- (191)
Unaudited pro forma net loss, as if the fair value method had
been applied to all awards ................................... (4,742) (8,032)
Unaudited pro forma net loss per share, as if the fair value
method had been applied to all awards ........................ (0.01) (0.72)
10. COMMITMENTS & CONTINGENCIES
Litigation
In March 2000, the Company and its affiliate 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 the related case in
California brought by TCG and UST. 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 February 27, 2003 the parties agreed to a
settlement of this case, pursuant to which the case will be dismissed with
prejudice in exchange for four quarterly payments to the plaintiff in the amount
of $131,250, the total of which was recorded in the fourth quarter.
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 various pleadings and claims in this matter were consolidated in an
adversary proceeding and set for trial to begin on October 21, 2002. Prior to
the commencement of the trial, on October 9, 2002 Picus filed a motion in the
bankruptcy court to seek court approval of a settlement of all outstanding
claims between the parties. The settlement provides that (i) Picus will
cooperate with the Company to recover certain dial-around compensation
potentially owed to the Company for the calendar year of 2000 and the first
calendar quarter of 2001, (ii) within ten days after entry of an order approving
the settlement and December 15, 2002, the Company was required to and has paid
Picus $79,500, (iii) the Company paid Picus an additional $150,000 that was due
no later than May 15, 2003; and (iv) the Company will pay Picus forty percent
(40%) of the dial-around compensation for the calendar year of 2000 attributable
to the Picus lines, if any. If any of the aforementioned payments are not timely
paid by the Company, Picus will be entitled to obtain a judgment against Davel
for the full amount of its claim against the Company, plus interest, less any
amounts actually paid to Picus under the settlement agreement.
On or about October 15, 2002, Davel was served with a complaint, in an
action captioned Sylvia Sanchez et al. v. Leasing Associates Service, Inc.,
Armored Transport Texas, Inc., and Telaleasing Enterprises, Inc. Plaintiffs
claim that the Company was grossly negligent or acted with malice and such
actions proximately caused the death of Thomas Sanchez, Jr. a former Davel
employee. On or about January 8, 2002, the Plaintiffs filed their first amended
complaint adding a new defendant LAI Trust and on or about January 21, 2002
filed their second amended complaint adding new defendants Davel Communications,
Inc. DavelTel, Inc. and Peoples Telephone Company. DavelTel, Inc. and Peoples
Telephone Company are subsidiaries of the Company. The original complaint was
forwarded to Davel's insurance carrier for action; however, Davel's insurance
carrier denied coverage based upon the workers compensation coverage exclusion
contained in the insurance policy. The Company answered the complaint on or
about January 30, 2003. The second amended complaint was forwarded to Davel's
insurance carrier for action; however Davel's insurance carrier subsequently
denied coverage. While Davel believes that it has meritorious defenses to the
allegations contained in the second amended complaint and intends to vigorously
defend itself, the matter is in its initial stages. Accordingly, Davel cannot at
this time predict its likelihood of success on the merits.
The Company is also 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 in the form of a monthly
15
commission payment, 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 identified certain discrepancies between
its calculations and the underlying call data information provide 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 notification of its
objections to the underlying data, and upon further investigation, has
discovered numerous operational deficiencies in Sprint's provision of operator
services that have resulted in a loss of revenue to the Company, thus negatively
impacting the Company's performance relating to the gross annual operator
service revenue requirement set forth in the contract. Furthermore, the Company
advised Sprint that its analysis indicated that not only had it complied with
the provisions of the gross annual operator service revenue requirement it also
believed that Sprint had underpaid commissions to the Company during the same
time period. The Company notified Sprint of the details surrounding the
operational deficiencies and advised that its failure to correct such
operational deficiencies would result in a material breach of the contract.
Notwithstanding the Company's objections, Sprint advised the Company, based
upon its calculation of the Company's performance in connection with the gross
annual operator services revenue requirement, it would retroactively reduce the
percentage of commission paid to the Company in connection with the contract for
the twelve-month period ended June 30, 2002. Sprint withheld $418,000 from the
commission due and owing the Company in the month of September 2002 and failed
to address the operational deficiencies discovered by the Company. As a result
of these actions, during the month of October 2002, the Company advised Sprint
that the contract was terminated due to Sprint's continuing and uncured breaches
and the Company shifted its traffic to an alternative operator service provider.
In response, Sprint withheld $380,170 from the commissions due and owing the
Company in the month of October 2002. Thereafter, the Company made a demand for
any and all amounts due it under the terms of the contract. In response, Sprint
has asserted its claim for payment of approximately $5.9 million representing
the amount it had calculated as owing under the gross annual operator services
revenue requirement for the twelve-month period ended June 30, 2002.
The parties are continuing to attempt to negotiate a mutually agreeable
resolution to this matter. While the Company believes that its objections to
Sprint's calculation of the gross annual operator service revenue requirement
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.
The Company is involved in other litigation arising in the normal course of
its business which it believes will not materially affect its financial position
or results of operations.
11. RELATED PARTY TRANSACTIONS
The Company's Chief Executive Officer is a Director, Executive Vice
President and a 49% shareholder of Urban Telecommunications, Inc. ("Urban").
During the quarter ended March 31, 2003, the Company earned revenue of $481,000
from various telecommunication contractor services provided to Urban,
principally residence and small business facility provisioning and inside
wiring. During the first quarter of 2003, the Company also incurred $32,000 of
costs relating to payphone service and management charged by Urban. The net
amount of accounts receivable due from Urban, including the remaining
outstanding amount acquired in the PhoneTel Merger, was $841,000 and $799,000 at
March 31, 2003 and December 31, 2002, respectively.
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.
16
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.
DEBT RESTRUCTURING AND PHONETEL ACQUISITION
On July 24, 2002 (the "closing date"), the Company restructured its
long-term debt by completing the debt-for-equity exchange described in Note 3 to
the consolidated financial statements. Immediately thereafter, on that same
date, the Company and PhoneTel Technologies, Inc. ("PhoneTel") completed a
merger transaction (the "PhoneTel Merger"), which has been accounted for as a
purchase business combination (see Note 4). Accordingly, the results of
operations of PhoneTel are included in the accompanying financial statements
since the date of acquisition.
GENERAL
During the first three months of 2003, 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
local exchange carriers 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 Independent Payphone Providers
("IPPs"), including the Company, increased rates for local coin calls from $0.25
to $0.35 after October 7, 1997 and to $0.50, beginning in November 2001. In
2002 and 2003, the Company 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.
17
Dial-around Compensation
On September 20, 1996, the Federal Communications Commission (FCC) adopted
rules in a docket entitled In the Matter of Implementation of the Payphone
Reclassification and Compensation Provisions of the Telecommunications Act of
1996, FCC 96-388 (the "1996 Payphone Order"), implementing the payphone
provisions of Section 276 of the Telecom Act. The 1996 Payphone Order, which
became effective November 7, 1996, mandated dial-around compensation for both
access code calls and 800 subscriber calls. 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. 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.
On October 9, 1997, the FCC adopted and released its Second Report and
Order in the same docket, FCC 97-371 (the "1997 Payphone Order"). This order
addressed the per-call compensation rate for 800 subscriber and access code
calls that originate from payphones in light of the decision of the Court which
vacated and remanded certain portions of the FCC's 1996 Payphone Order. The FCC
concluded that the rate for per-call compensation for 800 subscriber and access
code calls from payphones is the deregulation local coin rate adjusted for
certain cost differences. Accordingly, the FCC established a rate of $0.284
($0.35 - $0.066) per call for the first two years of per-call compensation
(October 7, 1997, through October 6, 1999). The IXCs were required to pay this
per-call amount to payphone service providers ("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 related to 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).
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 Regional Bell
Operating Company ("RBOC") payphones for corresponding payment periods. Accurate
payments made at the flat rate are not subject to subsequent adjustment for
actual call counts from the applicable payphone.
On May 15, 1998, the Court again remanded the per-call compensation rate to
the FCC for further explanation without vacating the $0.284 per call rate. The
Court opined that the FCC had failed to explain adequately its derivation of the
$0.284 default rate. The Court stated that any resulting overpayment 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. 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. The new 24-cent rate became effective April 21, 1999. The 24-cent rate was
also 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.
In a decision released January 31, 2002 (the "2002 Payphone Order") the FCC
partially addressed the remaining issues concerning the "true-up" required for
the earlier dial-around compensation periods. The FCC adjusted the per-call rate
to $.229, for the period commencing November 7, 1996 and ending on October 6,
1997 ("the interim period"), to reflect a different method of calculating the
delay in IXC payments to PSPs for the interim period, and determined that the
18
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 2002 Payphone
Order deferred to a later order its determination of the allocation of this
total compensation rate among the various carriers required to pay compensation
for the interim period. In addition to addressing the rate level for dial-around
compensation, the FCC has also addressed the issue of carrier responsibility
with respect to dial-around compensation payments.
On October 23, 2002 the FCC released its Fifth Order on Reconsideration and
Order on Remand (the "Interim Order"), which resolved all the remaining issues
surrounding the interim/intermediate period true-up and specifically how flat
rate monthly per-phone compensation owed to PSPs would be allocated among the
relevant dial-around carriers. The Interim Order also resolved how certain
offsets to such payments would be handled and a host of other issues raised by
parties in their remaining FCC challenges to the 1999 Payphone Order and the
2002 Payphone Order. In the Interim Order, the FCC ordered a true-up for the
interim period and increased the adjusted monthly rate to $35.22 per payphone
per month, to compensate for the three-month payment delay inherent in the
dial-around payment system. The new rate of $35.22 per payphone per month is a
composite rate, allocated among approximately five hundred carriers based on
their estimated dial-around traffic during the interim period. The FCC also
ordered a true-up requiring the PSPs, including the Company, to refund an amount
equal to $.046 (the difference between the old $.284 rate and the current $.238
rate) to each carrier that compensated the PSP on a per-call basis during the
intermediate period. Interest on additional payments and refunds is to be
computed from the original payment date, at the IRS prescribed rate applicable
to late tax payments. The FCC further ruled that a carrier claiming a refund
from a PSP for the Intermediate Period must first offset the amount claimed
against any additional payment due to the PSP from that carrier. Finally, the
Interim Order provided that any net claimed refund amount owing to carriers
cannot be offset against future dial-around payments (1) without prior
notification and an opportunity to contest the claimed amount in good faith
(only uncontested amounts may be withheld); and (2) absent an opportunity to
"schedule" payments over a reasonable period of time.
The Company and its billing and collection clearinghouse are currently
reviewing the order and preparing the data necessary to determine the precise
dollar impact of the Interim Order on the Company. Based upon currently
available information, the Company recorded a $3.8 million adjustment to
revenues from dial-around compensation in the fourth quarter of 2002 for the
estimated amount due to certain dial-around carriers under the Interim Order.
The Company also estimates that it is entitled to receive in excess of $15.0
million of dial-around compensation refunds from other carriers, excluding
WorldCom (see Note 7). However, the amount the Company will ultimately be able
to collect is dependent upon the willingness and ability of such carriers to
pay, including the resolution of any disputes that may arise under the Interim
Order. Subsequent to December 31, 2002, the Company received $4.9 million
relating to the sale of a portion of the Company's accounts receivable
bankruptcy claim for dial-around compensation due from WorldCom, of which $3.9
million relates to the amount due from WorldCom under the Interim Order. In
accordance with the Company's policy on regulated rate actions, this revenue
from dial-around compensation was recognized in the first quarter of 2003, the
period such revenue was received (see Note 7).
On August 2, 2002 and September 2, 2002 respectively, the APCC and the
RBOCs filed petitions with the FCC to revisit and increase the dial around
compensation rate level. Using the FCC's existing formula and adjusted only to
reflect current costs and call volumes, the APCC and RBOCs' petitions support an
approximate doubling of the current $0.24 rate. In response to the petitions, on
September 2, 2002 the FCC placed the petitions out for comment and reply comment
by interested parties, seeking input on how the Commission should proceed to
address the issues raised by the filings. The Company believes that the "fair
compensation" requirements of Section 276 of the Telecom Act mandate that the
FCC promptly review and adjust the dial around compensation rate level. While no
assurances can be given as to the timing or amount of any increase in the dial
around rate level, the Company believes an increase in the rate is reasonably
likely given the significant reduction in payphone call volumes, continued
collection difficulties and other relevant changes since the FCC set the $0.24
rate level.
Regulatory actions and market factors, often outside the Company's control,
could significantly affect the Company's dial-around compensation revenues.
These factors include (i) the possibility of administrative proceedings or
litigation seeking to modify the dial-around compensation rate, and (ii) 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.
19
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
On July 24, 2002, the Company acquired approximately 28,000 phones in the
PhoneTel Merger. The revenues and expenses associated with these phones are
included in the results of operations for periods following the date of
acquisition. Accordingly, the operating results for the three months ended March
31, 2003 include the revenues and expenses of PhoneTel. Offsetting these revenue
and expense increases in the first quarter of 2003 is the reduction in revenues
and expenses resulting from the impact of the Company's ongoing program to
remove unprofitable phones. The Company's average number of phones in service
during the first quarter of 2003 was approximately 67,000 phones compared to
54,000 phones in service during the first quarter of 2002.
For the three months ended March 31, 2003, total revenues increased
approximately $5.6 million, or 32.8%, to approximately $22.9 million from
approximately $17.3 million in the same period of 2002. This increase was
primarily attributable to a favorable adjustment to dial-around compensation of
approximately $3.9 million in the first quarter of 2003, as discussed below. The
increase in revenues was also due to the additional revenues relating to the
PhoneTel acquisition offset by the reduction in revenues attributable to the
removal of unprofitable phones and lower call volumes, due to the harsh winter
weather in 2003 and increased competition from the wireless communications
industry, resulting in lower average revenue per phone.
Coin call revenues increased approximately $1.0 million, or 8.2%, to
approximately $13.2 million in the three months ended March 31, 2003 from
approximately $12.2 million in the first quarter of 2002. The increase in coin
call revenues was primarily attributable to the increase in the number of
average payphones resulting from the PhoneTel acquisition offset by lower
revenues per phone as a result of lower call volumes on the Company's payphones
caused by the colder winter weather in the north and increased competition from
wireless communication services.
Non-coin call revenues, which is comprised primarily of dial-around revenue
and operator service revenue, increased approximately $0.7 million, or 15.3%, to
approximately $5.8 million in the three months ended March 31, 2003 from
approximately $5.1 million in the three months ended March 31, 2002. The
increase was primarily attributable to the additional revenues relating to the
PhoneTel Merger offset by a $1 million reduction in dial-around revenue as
discussed below. This increase was also offset by the reduction in revenues
relating to the removal of unprofitable phone locations and lower call volumes
resulting from weather conditions in the north and the growth in wireless
communication services. Dial-around revenue increased approximately $0.8
million, to approximately $4.3 million in the three months ended March 31, 2003
from approximately $3.5 million in the first quarter of 2002. The dial-around
increase is primarily attributable to the revenues resulting from the PhoneTel
acquisition offset by a $1.0 million adjustment to accounts receivable in the
first quarter of 2003 to reflect a change in accounting estimate of prior
quarter dial-around revenues. Long-distance revenues increased approximately $.6
million, to approximately $2.0 million in the first quarter of 2003 from
approximately $1.4 million in the three months ended March 31, 2002. The
increase is attributable to more payphones in service offset by fewer long
distance calls made per phone, and reduced call time per call. Non-carrier
revenues increased $0.3 million during the period.
In the three months ended March 31, 2003, the Company recorded a $3.9
million dial-around revenue adjustment relating to the sale of a portion of the
Company's accounts receivable bankruptcy claim due from WorldCom. Of the $4.9
million received in the first quarter of 2003, $3.9 million related to the
amount due from WorldCom under the Interim Order applicable to dial-around
compensation (see Note 7 to the consolidated financial statements).
Telephone charges increased approximately $2.9 million, or 70.7%, to
approximately $7.0 million for the quarter ended March 31, 2003 from
approximately $4.1 million in the three months ended March 31, 2002. This
increase is primarily due to the net increase in payphones relating to the
PhoneTel Merger. In addition, telephone charges for the 2003 and 2002 quarters
were reduced due to net credits totaling $ 0.8 and $1.9 million, respectively,
related to amounts received under the FCC's "New Services Test" in certain
states and the resolution of disputes over line charges which have been
substantially settled. The Company is currently negotiating contracts and
pursuing 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 increased approximately $0.1 million, or 3.5%, to approximately
$4.0 million in the three months ended March 31, 2003 from approximately $3.9
million in the three months ended March 31, 2002. The increase was primarily
20
attributable to higher commissionable revenues from the increased number of
Company payphones and 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 increased approximately $1.5
million, or 31.3%, to approximately $6.3 million in the three months ended March
31, 2003 from approximately $4.8 million in the three months ended March 31,
2002. The increase was primarily attributable to costs relating to the higher
phone count associated with the PhoneTel Merger.
Depreciation expense in the three months ended March 31, 2003 increased to
approximately $4.6 million from approximately $4.4 million recorded in the three
months ended March 31, 2002. Amortization expense in the three months ended
March 31, 2003 increased to approximately $1.3 million from approximately $0.5
million recorded in the three months ended March 31, 2002. These increases were
primarily attributable to additional depreciation and amortization on assets
acquired in the PhoneTel Merger.
Selling, general and administrative expenses decreased approximately $0.2
million, or 7.9%, to approximately $2.6 million in the three months ended March
31, 2003 from approximately $2.8 million in the three months ended March 31,
2002. The decrease in expense was attributable to the lower cost resulting from
the relocation of the Company's headquarters from Tampa, FL to Cleveland, OH
after the PhoneTel Merger at the end of the third quarter of 2002 and the
elimination in redundant personnel and headquarter facilities.
Interest expense in the three months ended March 31, 2003 was approximately
$1.6 million compared $4.6 million in the first quarter of 2002. The decrease in
recorded interest is due to the reduction in debt relating to the debt
restructuring in connection with the PhoneTel Merger (see Note 3 to the
consolidated financial statements). In addition, no interest is recognized on
the Davel portion of the Company's Junior Credit Facility as a result of
accounting for the debt-for-equity exchange as a troubled debt restructuring. In
connection with this debt restructuring, the Company also recognized a gain of
approximately $181.0 million in the third quarter of 2002 resulting from the
extinguishment of the Company's Old Credit Facility.
The Company has not accrued any provision for Federal and State income
taxes because it has tax loss carryforward balances which exceed the amount of
income for the quarter.
Net loss decreased approximately $3.1 million, or 39.5%, to approximately
$4.7 million in the three months ended March 31, 2003 from approximately $7.8
million in the first quarter of 2002.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Historically, the Company's primary sources of liquidity have been cash
from operations and borrowings under various credit facilities.
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
year, 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 three months ended March 31, 2003, operating activities provided
approximately $5.8 million of net cash, primarily due to collections of accounts
receivable, including $3.9 million of receipts relating to refunds of telephone
charges under the FCC's "New Services Test" as discussed above. The Company also
received $4.9 million in March 2003 relating to the sale of a portion of the
Company's bankruptcy claim due from WorldCom. Approximately $1.8 million of
21
these amounts were used to reduce the Company's current liabilities for accounts
payable, commissions, and accrued expenses and $4.7 million was used for
payments on the Company's Senior Credit Facility. In the first quarter of 2002,
operating activities used $4.5 million of net cash that was funded from the
$4.8 million received from the Senior Credit Facility, which amount is net of
the $0.2 million cost of issuing that debt. Net cash used in operating
activities in the first three months of 2002 included a $6.2 million reduction
in accounts payable and accrued expenses.
Capital expenditures for the three months ended March 31, 2003 and 2002
were $0.1 million in both periods. 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. Payments
relating to new and existing location contracts for the three months ended March
31, 2003 and 2002 were both less than $0.1 million.
The Company made payments under capital lease obligations totaling
approximately $0.1 million. Cash balances increased approximately $0.6 million
during the three months ended March 31, 2003.
The Company's principal source of liquidity in the three months ended March
31, 2003 came from cash received pursuant to the FCC's "New Services Test" and
the Company's WorldCom bankruptcy claim. On March 10, 2003, the Company received
$4.9 million relating to the third-party sale of a portion of the Company's
accounts receivable bankruptcy claim for dial-around compensation due from
WorldCom. The amount received by the Company is equal to 51% of the amount
listed in the debtor's schedule of liabilities (the "Scheduled Debt") filed by
WorldCom (approximately $9.6 million), which amount is materially less than the
balance included in the Company's proof of claim relating to the portion of the
claim sold (approximately $17.7 million). Under the sale agreement, the Company
will be entitled to 51% of the amount of the allowed claim in excess of the
Scheduled Debt, if any, included in WorldCom's plan of reorganization as
confirmed by the U. S. Bankruptcy Court. If the amount of the allowed claim is
less than the Scheduled Debt, the Company would be required to refund 51% of any
such shortfall to the purchaser. The Company is not entitled to receive and is
not required to reimburse the purchaser if the actual distribution percentage
pursuant to WorldCom's plan of reorganization is more or less than 51% of the
allowed claim. No assurance can be made that the bankruptcy court will allow the
amount of the Company's proof of claim, or even the amount of the Scheduled
Debt.
Of the $4.9 million of proceeds from the sale of the WorldCom bankruptcy
claim, approximately $1.0 million related to the recovery of the Company's
accounts receivable for unpaid dial-around compensation for the second and third
quarters of 2002, for which the Company had previously provided an allowance for
doubtful accounts, and approximately $3.9 million related to the Interim Order
described in Note 6. In accordance with the Company's policy on regulated rate
actions, the amount relating to the Interim Order was recognized as an
adjustment to dial-around revenue in the accompanying consolidated statements
of operations during the first quarter of 2003, the period in which such revenue
was received. In March 2003, the Company used $3.0 million of the sales proceeds
to pay a portion of the Company's balance due under the Company's Senior Credit
Facility (including a $2.2 million prepayment of such debt) and plans to use
$1.0 million, which is being held in escrow by the Company's lenders, to
fund new business initiatives. Any amounts not used for such purposes would be
applied to the balance due under the Company's Junior Credit Facility.
During the first quarter of 2003, the Company received $4.6 million of
refunds of prior period telephone charges relating to the recently adopted "New
Services Test" in certain states. Of this amount, $3.8 million and $0.8 million
were recognized as reductions in telephone charges in the fourth quarter of 2002
and first quarter of 2003, respectively. Under the Telecom Act and related FCC
Rules, LECs are required to make access lines that are provided for their own
payphones equally available to PSPs to ensure that the cost to PSPs for
obtaining local lines and service meet the FCCs new services test guidelines.
The FCC's new services test guidelines require LECs to price payphone access
lines at the direct cost to the LEC plus a reasonable allocation of overhead.
The Company previously recognized $3.2 million of refunds pursuant to the "New
Services Test" as a reduction of telephone charges in the Company's consolidated
statements of operations in the first quarter of 2002.
In the first quarter 2002 the Company's principal source of liquidity was
from the new Senior Credit Facility. See "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.
22
Senior Credit Facility
Effective as of February 19, 2002, Madeleine L.L.C. and ARK CLO 2000-1,
Limited (the "Senior Lenders") entered into a credit agreement (the "Senior
Credit Facility") with Davel Financing Company, L.L.C., PhoneTel and Cherokee
Communications, Inc., a wholly owned subsidiary of PhoneTel. On that date, the
existing Junior Lenders of the Company and PhoneTel also agreed to a substantial
debt-for-equity exchange with respect to their outstanding indebtedness (see
Note 3). The Senior Credit Facility provided for a combined $10 million line of
credit which the Company and PhoneTel shared $5 million each. The Company and
PhoneTel each borrowed the amounts available under their respective lines of
credit on February 20, 2002, which amounts were used to pay merger related
expenses and accounts payable. Davel and PhoneTel agreed to remain jointly and
severally liable for all amounts due under the Senior Credit Facility. On May 2,
2003, the Company paid the remaining balance, including interest, due under the
Senior Credit Facility.
Interest on the funds loaned pursuant to the Senior Credit Facility accrued
at the rate of fifteen percent (15%) per annum and was payable monthly in
arrears. A principal amortization payment in the amount of $833,333 was due on
the last day of each month, beginning July 31, 2002 and ending on the maturity
date of June 30, 2003. The Senior Credit Facility included covenants that
required the Company and PhoneTel to maintain a minimum level of combined
earnings (EBITDA and Adjusted EBITDA, as defined in the Senior Credit Facility)
and limited the incurrance of cash and capital expenditures, the payment of
dividends and certain asset disposals.
The Senior Credit Facility was secured by substantially all assets of the
Company. Pursuant to an Intercreditor and Subordination Agreement, dated as of
February 19, 2002 and reaffirmed on July 24, 2002, the existing Junior Lenders
agreed to subordinate their security interest in Company collateral to the
security interest of the Senior Lenders in such collateral. Upon the repayment
in full of the amounts owing under the Senior Credit Facility on May 2, 2003,
the senior security interests of the Senior Lenders terminated and the Junior
Lenders obtained a first priority security interests in the Company collateral.
On May 14 and July 23, 2002 and April 3, 2003, the Company and PhoneTel
executed amendments to the Senior Credit Facility that reduced the minimum level
of combined earnings that the companies were required to maintain. The Company
did not pay the $833,333 principal payment that was due on December 31, 2002
until January 28, 2003 and was not in compliance with the financial covenant
that limits the amount of cash expenses the Company is permitted to pay during
January 2003. In March 2003, the Company also made a $3.0 million principal
payment from the proceeds of sale of a dial-around receivable bankruptcy claim,
which includes a $2.2 million prepayment of such debt, as required under the
Senior Credit Facility (see Note 7). The Company was also required to deposit
approximately $1.0 million in escrow with the Senior Lenders to be used for new
business initiatives planned by the Company. The Senior Lenders' rights with
respect to these escrowed funds have transferred to the Junior Lenders upon
payment in full of the Senior Debt in accordance with the agreements executed
among the Junior and Senior Lenders. The Company has obtained waivers from its
Senior Lenders which waive all defaults, including a waiver from the Company's
Senior Lenders and Junior Lenders to permit the Company to sell its dial-around
receivable bankruptcy claim.
Junior Credit Facility
On July 24, 2002, immediately prior to the PhoneTel Merger, Davel and
PhoneTel amended, restated and consolidated their respective junior credit
facilities. The combined restructured Junior Credit Facility of $101.0 million
due December 31, 2005 (the "maturity date") consists of: (i) a $50.0 million
cash-pay term loan ("Term Note A") with interest payable in kind monthly through
June 30, 2003, and thereafter to be paid monthly in cash from a required payment
of $1.25 million commencing on August 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 $51.0 million payment-in-kind
term loan (the "PIK term loan" or "Term Note B") 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 percent (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). During the year ended December 31, 2002, approximately $4.6 million of
interest was added to the principal balances as a result of the deferred payment
terms. Upon the occurrence and during the continuation of an event of default,
interest accrues at the rate of 14% per annum.
23
As discussed above, the Company has accounted for the debt exchange as a
troubled debt restructuring and recorded a $181.0 million gain relating to the
extinguishments of its Old Credit Facility and the issuance of additional common
stock to the creditors. For accounting and reporting purposes, with respect to
Davel's portion of the new junior credit facility ($64.1 million), 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 as it relates to that portion. In
addition, the remaining amounts payable with respect to the PhoneTel portion of
the new junior credit facility ($36.9 million) have been recorded at the net
present value of such payments in accordance with the purchase method of
accounting. Interest expense is 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 of 15%. The following tabular presentation
summarizes the establishment and current carrying value of the Junior Credit
Facility (amounts in thousands):
DAVEL PHONETEL TOTAL
--------- --------- ---------
Face value of credit facilities ........ $ 64,135 $ 36,865 $ 101,000
Premium: interest capitalization ....... 24,122 -- 24,122
Discount: present value of acquired debt -- (4,658) (4,658)
--------- --------- ---------
Subtotal ............................... 88,257 32,207 120,464
Payment-in-kind interest ............... 4,629 2,672 7,301
Amortization of premiums and discounts . (4,753) 732 (4,021)
--------- --------- ---------
$ 88,133 $ 35,611 $ 123,744
========= ========= =========
The Junior Credit Agreement is secured by substantially all assets of the
Company and was subordinate in right of payment to the Senior Credit Facility.
The Junior Credit Facility also provides for the payment of a 1% loan fee,
payment of a $30,000 monthly administrative fee to Foothill Capital Corporation,
as Agent for the Junior Lenders, and advanced payments of principal from excess
cash flow and certain types of cash receipts. The Junior Credit Facility
includes covenants that require the Company to maintain a minimum level of
combined earnings (EBITDA and Adjusted EBITDA, as defined in the Junior Credit
Facility) and limits the incurrance of cash and capital expenditures, the
payment of dividends and certain asset disposals.
As discussed above, the Company was not in compliance with certain
financial covenants under its Senior Credit Facility and, as a result, was in
default under its Junior Credit Facility from August 31, 2002 through January
31, 2003. In addition, the Company was not in compliance with the minimum EBITDA
and Adjusted EBITDA financial covenants under the Junior Credit Agreement at
December 31, 2002. On March 31, 2003 the Company executed an amendment to its
Junior Credit Facility (the "Amendment") that reduced the minimum amount of
EBITDA and Adjusted EBITDA that the Company is required to maintain through
December 31, 2003 and waives all defaults through the date of the amendment. It
also amends the timing and amount of individual payments (but not the aggregate
amount) due under Junior Credit Facility during 2003 to coincide with the early
retirement of the Senior Credit Facility resulting from the prepayment described
above. Under the Amendment, the Company is required to make monthly payments of
$1,041,667 from July 1 through December 1, 2003. Payments due after December 31,
2003 are not affected by the Amendment. As of March 31, 2003, the Company was
not in compliance with the minimum Adjusted EBITDA covenant, as amended. The
Company has obtained a waiver from its Junior Lenders that waives this default
as of March 31, 2003.
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. Excluding the gain
on debt extinguishment of $181.0 million in 2002 (see Note 3), the Company has
incurred losses of approximately $29.2 million and $4.7 million for the year
ended December 31, 2002 and for the three months ended March 31, 2003,
respectively. As of March 31, 2003, the Company had a working capital deficit of
$19.0 million and its liabilities exceeded it assets by $61.1 million.
Further, as discussed in Note 8, the Company was not in compliance with the
adjusted earnings (EBITDA) financial covenant included in the Junior Credit
Facility in the first quarter of 2003. In addition, the Company did not pay a
$0.8 million principal payment that was due on its Senior Credit Facility on
December 31, 2002; such violation was cured by payment on January 28, 2003 from
the proceeds of certain regulatory receipts and an additional prepayment of $2.2
million was made in March 2003 from the proceeds of a sale of the Company's
WorldCom bankruptcy claim (see Note 7). On May 2, 2003, the Company paid the
remaining balance due under its Senior Credit Facility. As a result, however,
the
24
Company was in default under these credit agreements during the first
quarter of 2003. The Company has obtained an amendment or written waivers from
its lenders that waive all noncompliance with the financial covenants for
periods sufficient in management's view to bring the Company into compliance.
Failure to maintain compliance with the terms, conditions and covenants of the
Junior Credit Facility could result in the Junior indebtedness becoming
immediately due and payable to the Junior Lenders. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management has been actively engaged in the execution of a plan to mitigate
these negative conditions and, ultimately, return the Company to profitability.
Significant elements of the plan executed during 2002 and 2003 included (i) the
payment of the remaining principal balance of the Company's Senior Credit
Facility, (ii) continuing cost savings and efficiencies resulting from the
merger with PhoneTel discussed in Note 4, (iii) the removal of unprofitable
payphones and (iv) the curtailment of operating expenses. Significant elements
of management's plans for 2003 to bring the Company into a state of
profitability include the further removals of unprofitable payphones, the
further curtailment of operating expenses including reductions in telephone
charges, and new business initiatives being planned by the Company.
Notwithstanding these activities and plans, the Company may continue to
face liquidity shortfalls and, as a result, might be required to dispose of
assets to fund its operations or curtail its capital and other expenditures 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.
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. Both the Senior Credit Facility and the 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."
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
within the 90 days prior to the filing date of this report, the Company carried
out an evaluation of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. This evaluation was carried out
under the supervision and with the participation of the
25
Company's management, including the Company's Chief Executive Officer along
with the Company's Interim Chief Financial Officer, who concluded that the
Company's disclosure controls and procedures are effective. There have been no
significant changes in the Company's internal controls or in other factors,
which could significantly affect internal controls subsequent to the date the
Company carried out its evaluation. Disclosure controls and procedures are
controls and other procedures that are designed to ensure that information
required to be disclosed in the Company reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in
Company reports filed under the Exchange Act is accumulated and communicated to
management, including the Company's Chief Executive Officer and Interim Chief
Financial Officer as appropriate, to allow timely decisions regarding required
disclosure.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 2000, the Company and its affiliate 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 the related case in
California brought by TCG and UST. 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 February 27, 2003 the parties agreed to a
settlement of this case, pursuant to which the case will be dismissed with
prejudice in exchange for four quarterly payments to the plaintiff in the amount
of $131,250, the total of which was recorded in the fourth quarter.
In addition to the legal proceedings disclosed in the Company's Form 10-K
for the year ended December 31, 2002, the Company is involved in routine
litigation arising in the normal course of its business which it believes will
not materially affect its financial position or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index.
(b) No Current Report on Form 8-K was filed by the Company during the
quarter ended March 31, 2003
27
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: May 15, 2003 /s/ DONALD L. PALIWODA
--------------------------------
Donald L. Paliwoda
Interim Chief Financial Officer
CERTIFICATION
I, John D. Chichester, certify that:
1. I have reviewed this quarterly report on Form 10-Q for the quarterly period
ended March 31, 2003 of Davel Communications, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls.
28
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ John D. Chichester
- --------------------------
John D. Chichester
Chief Executive Officer
CERTIFICATION
I, Donald L. Paliwoda, certify that:
1. I have reviewed this quarterly report on Form 10-Q for the quarterly period
ended March 31, 2003 of Davel Communications, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
29
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls.
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Donald L. Paliwoda
- -------------------------------
Donald L. Paliwoda
Interim Chief Financial Officer
30
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
10.1 Assignment of Claim Agreement dated as of March 7, 2003 by
and between Davel Communications Inc. and Deutsch Bank
Securities Inc.
10.2 Assignment of Claim Agreement dated as of March 3, 2003 by
and between Davel Communications Inc. and Deutch Bank
Securities Inc.
99.1 Certification of CEO and CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
31