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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 SEPTEMBER 30, 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.)
200 PUBLIC SQUARE, SUITE 700, 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 November 12 , 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............................. 19
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk........................................................ 26
ITEM 4
Disclosure Controls and Procedures................................................................................ 26
PART II OTHER INFORMATION
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)
SEPTEMBER 30
2003 DECEMBER 31
(UNAUDITED) 2002
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 6,674 $ 6,854
Accounts receivable, net of allowance for doubtful accounts
of $1,870 at December 31, 2002 9,328 16,807
Other current assets 2,684 3,286
---------- ---------
Total current assets 18,686 26,947
Property and equipment, net 26,912 41,855
Location contracts, net 7,816 18,043
Goodwill - 17,455
Other assets, net 2,376 2,316
---------- ---------
Total assets $ 55,790 $ 106,616
========== =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and obligations under capital leases $ 127,604 $ 11,449
Accrued interest 30 104
Accrued commissions payable 10,290 11,986
Accounts payable and other accrued expenses 13,315 21,158
---------- ---------
Total current liabilities 151,239 44,697
Long-term debt and obligations under capital leases - 118,229
---------- ---------
Total liabilities 151,239 162,926
---------- ---------
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 September 30, 2003 and December 31, 2002 6,150 6,150
Additional paid-in capital 144,210 144,210
Accumulated deficit (245,809) (206,670)
---------- ---------
Total shareholders' deficit (95,449) (56,310)
---------- ---------
Total liabilities and shareholders' deficit $ 55,790 $ 106,616
========== =========
The accompanying notes are an integral part of these financial statements
1
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
THREE MONTH ENDED SEPTEMBER 30 NINE MONTH ENDED SEPTEMBER 30
------------------------------- ---------------------------------
2003 2002 2003 2002
-------------- ------------ ---------------- -------------
REVENUES:
Coin calls $ 12,872 $ 15,829 $ 39,571 $ 41,158
Non-coin calls 6,632 7,062 18,645 16,395
Dial-around compensation adjustments 4,016 - 7,944
-------------- ------------ ---------------- -------------
Total revenues 23,520 22,891 66,160 57,553
-------------- ------------ ---------------- -------------
OPERATING EXPENSES:
Telephone charges 5,895 6,563 19,082 15,444
Commissions 3,603 4,401 11,083 11,309
Service, maintenance and network costs 6,204 6,143 18,957 15,641
Depreciation and amortization 3,843 4,803 15,742 14,560
Selling, general and administrative 3,045 3,503 8,235 8,227
Asset impairment charges - - 9,686 -
Goodwill impairment - - 17,455 -
Exit and disposal activities - 2,792 311 2,792
-------------- ------------ ---------------- -------------
Total costs and expenses 22,590 28,205 100,551 67,973
-------------- ------------ ---------------- -------------
Operating income (loss) 930 (5,314) (34,391) (10,420)
OTHER INCOME (EXPENSE):
Interest expense, net (1,485) (2,072) (4,734) (11,338)
Gain on debt extinguishment - 180,977 - 180,977
Other (126) 103 (14) 150
-------------- ------------ ---------------- -------------
Total other income (expense) (1,611) 179,008 (4,748) 169,789
-------------- ------------ ---------------- -------------
NET INCOME (LOSS) $ (681) $ 173,694 $ (39,139) $ 159,369
============== ============ ================ =============
EARNINGS (LOSS) PER SHARE:
Net income (loss) per common share, basic and diluted $ (0.01) $ 0.38 $ (0.06) $ 0.99
============== ============ ================ =============
Weighted average number of shares, basic and diluted 615,018,963 457,493,829 615,018,963 161,579,124
============== ============ ================ =============
The accompanying notes are an integral part of these financial statements
2
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
NINE MONTH ENDED SEPTEMBER 30
-----------------------------
2003 2002
---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (39,139) $ 159,369
Adjustments to reconcile net income (loss) to net cash flow from operating activities:
Depreciation and amortization 15,742 14,560
Amortization of deferred financing costs and non-cash interest 4,118 10,429
Gain from debt extinguishment - (180,977)
Non-cash exit and disposal activities - 1,309
Loss (gain) on disposal of assets 202 (105)
Increase in allowance for doubtful accounts - 1,044
Deferred revenue (113) (150)
Asset impairment charges 9,686 -
Goodwill impairment 17,455 -
Other 346 -
Changes in assets and liabilities, net of assets acquired:
Accounts receivable 7,479 2,931
Other current assets 602 (1,456)
Accrued commissions payable (1,696) (3,065)
Accounts payable and accrued expenses (7,730) (5,162)
Accrued interest (74) 165
---------- ---------
Net cash from operating activities 6,878 (1,108)
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received in PhoneTel merger, net of acquisition costs - 2,812
Proceeds from sale of assets 3 115
Capital expenditures (522) (207)
Payment of acquisition costs - (613)
Payments for location contracts (166) (314)
Increase in other assets (351) (142)
---------- ---------
Net cash from investing activities (1,036) 1,651
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Senior Credit Facility - 5,000
Debt issuance costs - (237)
Payments on long-term debt (5,864) (1,250)
Principal payments under capital leases (158) (407)
---------- ---------
Net cash from financing activities (6,022) 3,106
---------- ---------
Increase in cash and cash equivalents (180) 3,649
Cash and cash equivalents, beginning of period 6,854 5,333
---------- ---------
Cash and cash equivalents, end of period $ 6,674 $ 8,982
========== =========
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST PAID $ 707 $ 994
========== =========
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
PhoneTel Merger:
Common stock and options issued $ - $ (8,043)
Net assets acquired, net of cash and acquisition costs - 4,159
Debt-for-equity exchange:
Common stock issued - (13,702)
Issuance of Junior Credit Facility - (88,245)
Retirement of Old Credit Facility - 237,255
Accrued interest - Old Credit Facility - 45,704
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 INCOME (LOSS)
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
ACCUMULATED TOTAL
COMMON STOCK ADDITIONAL OTHER SHAREHOLDERS'
-------------------- PAID-IN ACCUMULATED COMPREHENSIVE EQUITY COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT LOSS (DEFICIT) INCOME (LOSS)
----------- ------- --------- ----------- ----- ---------- -------------
Balances December 31, 2001 11,169,440 $ 112 $ 128,503 $ (358,421) $ (7) $ (229,813) -
Issuance of common stock -
debt exchange 380,612,730 3,806 9,896 - - 13,702 -
Issuance of common stock -
PhoneTel merger 223,236,793 2,232 5,805 - - 8,037 -
Issuance of stock options -
PhoneTel merger - - 6 - - 6 -
Market change on interest collar - - - - 7 7 $ 7
Net income - - - 151,751 - 151,751 151,751
----------- ------- --------- ---------- --------- ---------- ---------
Balances December 31, 2002 615,018,963 6,150 144,210 (206,670) - (56,310) $ 151,758
=========
Net loss (Unaudited) - - - (39,139) - (39,139) $ (39,139)
----------- ------- --------- ---------- --------- ---------- ---------
Balances September 30, 2003 (Unaudited) 615,018,963 $ 6,150 $ 144,210 $ (245,809) $ - $ (95,449) $ (39,139)
=========== ======= ========= ========== ========= ========== =========
The accompanying notes are an integral part of these financial statements
4
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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 55,000 payphones in 45
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 32 geographically dispersed locations.
The accompanying consolidated balance sheet of Davel Communications, Inc.
and its subsidiaries at September 30, 2003 and the related consolidated
statements of operations and cash flows for the nine-month periods ended
September 30, 2003 and 2002 and the consolidated statements of shareholders'
deficit and other comprehensive income (loss) for the period ended September 30,
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 nine-month period ended September 30,
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 AND MANAGEMENT'S PLANS
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company
reported net income of $151.8 million and a net loss of $39.1 million for the
year ended December 31, 2002 and the nine months ended September 30, 2003,
respectively. Excluding the gain on debt extinguishment of $181.0 million in
2002 (see Note 3) and $27.1 million in asset impairment losses in 2003 (see Note
5), the Company has incurred operating losses of approximately $29.2 million and
$ 12.0 million, respectively. As of September 30, 2003, the Company had a
working capital deficit of $132.6 million and the Company's liabilities exceeded
its assets by $95.4 million.
As discussed in Note 9, the Company was not in compliance with certain
financial covenants under its Junior Credit Facility and did not make certain
debt payments totaling $5.1 million that were due in July through November
5
2003. On November 11, 2003 the Company executed an agreement with its Junior
Lenders (the "Forbearance Agreement") that grants forbearance with respect to
defaults and cash payments due under the terms of the Junior Credit Facility
through January 30, 2004. Under the Forbearance Agreement, the Company is
required to make a $600,000 cash payment to be applied against interest due
under the Junior Credit Facility and to make additional interest payments of
$100,000 on December 1, 2003 and January 1, 2004. The Company has also engaged
in discussions with its Junior Lenders regarding the possibility of
restructuring the debt outstanding under the Junior Credit Facility and related
payments due thereunder. Any such restructuring would anticipate amortization
payments based upon revised operating plans and cash flow projections to be
provided by the Company. While the Company's Junior Lenders have expressed a
willingness to negotiate the revision of future payments due under the Junior
Credit Facility, there can be no assurance that they will agree to a
restructuring of such payments or refrain from exercising their rights
thereunder. In the event the Company is unable to comply with the current loan
covenants or fails to make the debt payments as currently scheduled, the Junior
Lenders could declare this debt to be immediately due and payable and enforce
their rights with respect to the collateral. As a result, the Company has
classified the balance due on its debt as a current liability in the
accompanying consolidated balance sheets. In addition, the above conditions
raise substantial doubt about the Company's ability to continue as a going
concern.
In July 2003, a special committee of independent members of the Company's
Board of Directors (the "Special Committee") was formed to identify and evaluate
the strategic and financial alternatives available to the Company to maximize
value for the Company's stakeholders. Thereafter, the Board of Directors
appointed a new chief executive officer who has been actively engaged with
management in the execution of a plan to return the Company to profitability.
Significant elements of the plan executed or planned for 2003 include (i)
continuing cost savings and efficiencies resulting from the merger with PhoneTel
discussed in Note 4, (ii) the continued removal of unprofitable payphones, (iii)
reductions in telephone charges by changing to competitive local exchange
carriers ("CLECs"), (iv) the evaluation and sale of unprofitable district
operations, (v) outsourcing payphone collection, service and maintenance
activities in high cost areas, and (vi) the further curtailments of operating
expenses. The Company is also working toward the implementation of new business
initiatives and other strategic opportunities available to the Company.
Notwithstanding these activities and plans, the Company may continue to
face liquidity shortfalls and such other actions that its lenders may take with
respect to the Junior Credit Facility. 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").
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings",
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):
6
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 had a face value of $101.0 million (including a $1.0
million 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 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 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 at the time of the PhoneTel
Merger. The excess of the purchase price over those fair values was recorded as
goodwill. The fair value assigned to intangible assets acquired was based upon
estimates and assumptions of management. The goodwill recorded is not expected
to be deductible for income 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. The Company subsequently reviewed goodwill for
impairment and wrote-off the carrying value (see Note 5). Purchased intangibles
are amortized on a straight-line basis over their respective useful lives.
7
The PhoneTel Merger was accounted for as a purchase business combination
and the purchase price was 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 9).................... (4,583)
Junior Credit Facility (See Note 9).................... (32,206)
Other long-term debt (See Note 9)...................... (928)
-----------
Liabilities assumed.................................. (50,322)
-----------
Net assets acquired.................................... $ 9,114
===========
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 is amortizing the fair value of these assets over the weighted average
estimated remaining term of these contracts, including certain renewals, of
approximately 5 years (See Note 5 for Asset Impairment Charges).
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. (Amounts in thousands, except per share amounts.)
UNAUDITED PRO FORMA UNAUDITED PRO FORMA
INFORMATION INFORMATION
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
-------------------------- -------------------------
Revenue ................................................. $ 25,232 $ 77,186
------------ ---------
Loss from operations before gain on debt extinguishment.. (10,857) (38,252)
Gain on debt extinguishment ............................. 180,977 180,977
------------ ---------
Net income .............................................. $ 170,120 $ 142,725
============ =========
Net income per common share, basic and diluted: ......... $ 0.37 $ 0.88
============ =========
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. The following table
8
reflects the components of exit and disposal activities, of which, $2.8 million
was included in the Company's consolidated statements of operations in the third
quarter of 2002 (in thousands):
Abandonment or disposals of property and equipment.............. $1,309
Lease termination............................................... 600
Employee severance.............................................. 667
Other merger related expenses................................... 343
------
$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. ASSET IMPAIRMENT CHARGES
As of June 30, 2003, the Company completed a review of the carrying values
of its payphone assets, including Location Contracts and payphone equipment
(collectively "Payphone Assets"). The review was performed during the second
quarter when it became apparent to management that the effects of the continuing
decline in payphone usage required reconsideration of the Company's operating
projections. In accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" and SFAS No. 142, "Goodwill and Other Intangible
Assets", the Company compared the carrying value of its Payphone Assets in each
of the Company's operating districts to the estimated undiscounted future cash
inflows over the remaining useful lives of the assets. The Company's operating
districts are the lowest operational level for which discernable cash flows are
measurable. In certain operating districts, the carrying values of the Payphone
Assets exceeded the estimated undiscounted cash inflows projected for the
respective operating district. In these instances, the Company recorded an
aggregate impairment loss of $9.7 million to reduce the carrying value of such
assets to estimated fair value, less cost to sell. Fair value was determined
based on the higher of the present value of discounted expected future cash
flows or the estimated market value of the assets for each of the operating
districts in which an impairment existed.
As of June 30, 2003, the carrying value of the Company's net assets, after
taking into account the impairment charges described above, exceeded the fair
value of the Company, which amount is based upon the present value of expected
future cash flows. The facts and circumstances leading to this review were the
same as those described in the preceding paragraph. In accordance with SFAS No.
142, the Company then calculated the implied value of goodwill based upon the
difference between the fair value of the Company and the fair value of its net
assets, excluding goodwill. Because the fair value of the Company's net assets
without goodwill exceeded the fair value of the Company, no implied value could
be attributed to goodwill. As a result, the Company recorded a $17.5 million
non-cash impairment loss in the second quarter of 2003 to write-off the carrying
value of the goodwill.
6. RECENT ACCOUNTING PRONOUNCEMENTS
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 transition standards and disclosure requirements of SFAS No. 148
are effective for fiscal years and interim periods ending after December 15,
2002.
9
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" ("FIN No. 45"). Under FIN 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,
FIN 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 FIN 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 Fin 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.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". The statement amends and
clarifies accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities. This
statement is designed to improve financial reporting such that contracts with
comparable characteristics are accounted for similarly. The statement is
generally effective for contracts entered into or modified after June 30, 2003.
The Company currently has no such financial instruments outstanding or under
consideration and does not expect the adoption of this standard to effect the
Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity". This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003, and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The Company currently has no
such financial instruments outstanding or under consideration and therefore
adoption of this standard currently has no financial reporting implications.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN No. 46"). This interpretation clarifies
rules relating to consolidation where entities are controlled by means other
than a majority voting interest and instances in which equity investors do not
bear the residual economic risks. This interpretation is effective immediately
for variable interest entities created after January 31, 2003 and, for interim
periods beginning after December 15, 2003, for interests acquired prior to
February 1, 2003. The Company does not currently have relationships with
entities meeting the criteria set forth in FIN No. 46 and is not required to
include any such entities in its consolidated financial statements pursuant to
the provisions of FIN No. 46.
7. 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
10
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 was the deregulated local coin rate adjusted for
certain cost differences. Accordingly, the FCC established a rate of $0.284
($0.35 - $0.066) per call for the first two years of per-call compensation
(October 7, 1997, through October 6, 1999). The interexchange carriers ("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 local exchange carriers ("LECs") of payphone-specific coding digits which
identify a call as originating from a payphone. Without the transmission of
payphone-specific coding digits, some of the IXCs have claimed they are unable
to identify a call as a payphone call eligible for dial-around compensation.
With the stated purpose of ensuring the continued payment of dial-around
compensation, the FCC, by Memorandum and Order issued on April 3, 1998, left in
place the requirement for payment of per-call compensation for payphones on
lines that do not transmit the requisite payphone-specific coding digits, but
gave the IXCs a choice for computing the amount of compensation for payphones on
LEC lines not transmitting the payphone-specific coding digits of either
accurately computing per-call compensation from their databases or paying
per-phone, flat-rate compensation computed by multiplying the $0.284 per call
rate by the nationwide average number of 800 subscriber and access code calls
placed from 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
11
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 addressed
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 have reviewed the
order and prepared the data necessary to bill or determine the amount due to the
relevant dial-around carriers pursuant to the Interim Order. Based upon
available information, the Company recorded a $3.8 million charge as an
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. In March 2003, 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 (see Note 8). 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. The Company also received $4.0 million of net
receipts from other carriers that was recognized as revenue in the third quarter
of 2003 under the Company's accounting policy. Such revenues totaling $7.9
million have been reported as dial-around compensation adjustments in the
accompanying consolidated statements of operations for the nine months ended
September 30, 2003. The Company also estimates that it is entitled to receive in
excess of $10.0 million of dial-around compensation from certain carriers,
excluding WorldCom. 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.
In addition, there can be no assurance that the timing or amount of such
receipts, if any, will be sufficient to offset the liability to certain other
carriers that will be deducted from future dial-around payments.
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. On October 28, 2003 the FCC adopted an
Order and Notice of Proposed Rulemaking (the "October 2003 Rulemaking") to
determine whether a change to the dial-around rate is warranted, and if so, to
determine the amount of the revised rate. In the October 2003 Rulemaking, the
FCC tentatively concluded that the methodology adopted in the Third Report and
Order is the appropriate methodology to use in reevaluating the default
dial-around compensation rate and requested comments on, among other things, the
cost studies presented in the petitions. 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
12
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.
8. 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. The Company is currently negotiating with WorldCom to reconcile
the Scheduled Debt to the amount of the Company's proof of 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 7. 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), $1.0 million was
deposited in escrow, and $0.9 million was used to pay certain accounts payable.
The Company has used $0.2 million of the amount deposited in escrow and, to the
extent permitted by the Company's lenders, plans to use the remaining $0.8
million to fund new business initiatives and certain obligations of the Company.
Any amounts not used for such purposes would be applied to the balance due under
the Company's Junior Credit Facility.
During the nine months ended September 30, 2003, the Company received $4.7
million of refunds of prior period telephone charges relating to the recently
adopted new services test ("New Services Test" or "NST") in certain states. Of
this amount, $3.8 million, $0.8 million and $0.1 million were recognized as
reductions in telephone charges in the fourth quarter of 2002, first quarter of
2003, and third quarter of 2003, respectively. Approximately $2.8 million of
these refunds were used to pay a portion of the balance due on the Company's
Senior Credit Facility and the balance was used for working capital purposes.
Under the Telecom Act and related FCC Rules, LECs are required to ensure that
the cost to PSPs for obtaining local lines and service meet the FCC's NST
guidelines. The FCC's NST 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 $3.3 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 nine months ended September 30, 2002.
13
9. LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES
Following is a summary of long-term debt and obligations under capital
leases as of September 30, 2003 and December 31, 2002 (in thousands):
SEPTEMBER 30 DECEMBER 31
2003 2002
------------ -----------
SENIOR CREDIT FACILITY, due in monthly installments of $833.3 plus interest
at 15% through June 30, 2003 .................................................. $ - $ 5,833
JUNIOR CREDIT FACILITY, due December 31, 2005:
TERM NOTE A, ($50,000 face value) plus unamortized premium, discount and
capitalized interest of $11,692 at September 30, 2003 ....................... 61,692 59,869
TERM NOTE B, ($51,000 face value) plus unamortized premium, discount and
capitalized interest of $13,663 at September 30, 2003 ....................... 64,663 62,681
NOTE PAYABLE, ($1,149 face value) due November 16, 2004 ......................... 1,099 987
CAPITAL LEASE OBLIGATIONS with various interest rates and maturity dates
Through 2005 .................................................................. 150 308
--------- ---------
127,604 129,678
Less -- Current maturities ...................................................... (127,604) (11,449)
--------- ---------
$ - $ 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 $10.0 million line
of credit which the Company and PhoneTel shared $5.0 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.
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 amount 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 interest in the Company collateral.
In March 2003, the Company made a $3.0 million principal payment from the
proceeds of sale of a dial-around receivable bankruptcy claim due from WorldCom,
which included a $2.2 million prepayment of such debt, as required under the
Senior Credit Facility (see Note 8). Under the Senior Credit Facility, the
Company was required to deposit approximately $1.0 million of the sales proceeds
in escrow with the Senior Lenders. When released, the Company intends to use
these funds for new business initiatives. On May 2, 2003, the Company paid the
remaining balance, including interest, due under the Senior Credit Facility. The
Senior Lenders' rights with respect to these escrowed
14
funds have transferred to the Junior Lenders upon payment in full of the Senior
Debt in accordance with the agreements executed among the Junior Lenders and
Senior Lenders. The Company has obtained waivers from its Lenders which waive
all defaults, including a waiver from the 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 accrue interest from and
after the closing date at the rate of ten percent (10%) per annum. Interest on
the PIK term loan accrues 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....................................... 8,268 4,765 13,033
Interest paid.................................................. (63) (37) (100)
Amortization of premiums and discounts......................... (8,407) 1,365 (7,042)
---------- -------------- -----------
$ 88,055 $ 38,300 $ 126,355
========== ============== ===========
The Junior Credit Facility 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 Wells Fargo Foothill, 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
15
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 "First Amendment") that reduced the minimum amount
of EBITDA and Adjusted EBITDA that the Company is required to maintain through
December 31, 2003 and waived all defaults through the date of the amendment. It
also amended 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 obtained a waiver from its Junior Lenders that waived this default as of
March 31, 2003.
Notwithstanding the March 31, 2003 Amendment and waiver, the Company was
not in compliance with the minimum Adjusted EBITDA covenant under the Junior
Credit Agreement as of June 30 and September 30, 2003. In addition, the Company
did not make the $1,041,667 monthly payments that were due on August 1, 2003
through November 1, 2003 and only made a partial payment ($100,000) toward the
monthly payment of $1,041,667 that was due on July 1, 2003. On November 11, 2003
the Company executed an agreement with its Junior Lenders (the "Forbearance
Agreement") that grants forbearance with respect to defaults and cash payments
due under the terms of the Junior Credit Facility through January 30, 2004.
Under the Forbearance Agreement, the Company is required to make a $600,000 cash
payment to be applied against interest due under the Junior Credit Facility and
to make additional interest payments of $100,000 on December 1, 2003 and January
1, 2004. The Company has also engaged in discussions with its Junior Lenders
regarding the possibility of restructuring the debt outstanding under the Junior
Credit Facility and related payments due thereunder. Any such restructuring
would anticipate amortization payments based upon revised operating plans and
cash flow projections to be provided by the Company. While the Company's Junior
Lenders have expressed a willingness to negotiate the revision of future
payments due under the Junior Credit Facility, there can be no assurance that
they will agree to a restructuring of such payments or refrain from exercising
their rights thereunder. In the event the Company is unable to comply with the
current loan covenants or fails to make the debt payments as currently
scheduled, the Junior Lenders could declare this debt to be immediately due and
payable and enforce their rights with respect to the collateral. As a result,
the Company has classified the outstanding balance due on its this debt as a
current liability in the accompanying consolidated balance sheet.
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 affiliates 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 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%. The note also includes a cross default provision that permits the holder
to declare the note immediately due and payable if payments due under the Junior
Credit Facility are accelerated as a result of default. Due to the defaults
under the Junior Credit facility as described above, the balance due on this
note has been classified as a current liability in the accompanying consolidated
balance sheet.
10. 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 loss per share is equal
to basic loss per share since the exercise of the outstanding options and
warrants would be anti-dilutive and resulted in no dilution for the nine months
ended September 30, 2003. For the nine months ended September 30, 2002, the
number of additional shares from the assumed exercise of dilutive stock options
under the treasury stock method was not significant and diluted earnings per
share amounts are the same as basic earnings per share. In accordance with SFAS
No. 128 and the requirement to report "Earnings Per Share" data, the basic and
diluted income
16
(loss) from continuing operations per weighted average common share outstanding
for the three-month and nine-month periods ended September 30, 2003 and 2002 are
presented in the table below.
The following table reflects supplemental financial information related to
stock-based employee compensation as of September 30, 2003 and 2002, as required
by SFAS No. 148 (See Note 6, "Recent Accounting Pronouncements"); in thousands,
except per share amounts:
Three Months Nine Months
Ended September 30 Ended September 30
--------------------- ----------------------
2003 2002 2003 2002
-------- --------- --------- ---------
Net Income (loss), as reported $ (681) $ 173,694 $ (39,139) $ 159,369
Net Income (loss) per share, as reported (0.01) 0.38 (0.06) 0.99
Stock-based employee costs used in the
determination of net income (loss) _ _ _ _
Stock-based employee compensation costs
that would have been included in the
determination of net income (loss) if the fair
value method had been applied to all awards _ (385) _ (767)
Unaudited pro forma net income (loss), as if the fair
value method had been applied to all awards (681) 174,079 (39,139) 160,136
Unaudited pro forma net income (loss) per share, as if
the fair value method had been applied to all awards (0.01) 0.38 (0.06) 0.99
11. 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 alleged 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 of 2002. As
of September 30, 2003, the Company has paid the first three installments and the
remaining balance is included in accounts payable and accrued expenses in the
accompanying consolidated balance sheets.
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,
17
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. Thereafter, the Plaintiffs filed their third amended complaint.
While Davel believes that it has meritorious defenses to the allegations
contained in the third 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 assumed responsibility for tracking,
rating, billing and collection of these calls and remitted a percentage of the
gross proceeds to the Company in the form of a monthly 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.
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.
18
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.
12. RELATED PARTY TRANSACTIONS
The Company's former Chief Executive Officer is a Director, Executive Vice
President and a 49% shareholder of Urban Telecommunications, Inc. ("Urban").
During the nine months ended September 30, 2003, the Company earned revenue of
$1,845,000 from various telecommunication contractor services provided to Urban,
principally residence and small business facility provisioning and inside
wiring. During the first nine months of 2003, the Company also incurred $124,000
of costs relating to payphone and management services charged by Urban. The net
amount of accounts receivable due from Urban was $516,000 and $799,000 at
September 30, 2003 and December 31, 2002, respectively. In September 2003, the
Company terminated its business arrangements with Urban and no longer provides
or receives services from this company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
With the exception of historical information (information relating to the
Company's financial condition and results of operations at historical dates or
for historical periods), the matters discussed in this Management's Discussion
and Analysis of Financial Condition and Result of Operations ("MD&A") are
forward-looking statements that necessarily are based on certain assumptions and
are subject to certain risks and uncertainties. The forward-looking statements
are based on management's expectations as of the date hereof. Actual future
performance and results could differ materially from that contained in or
suggested by these forward-looking statements as a result of the factors set
forth in this MD&A and its other filings with the SEC. The Company assumes no
obligation to update any such forward-looking statements.
LIQUIDITY AND MANAGEMENT'S PLANS
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company
reported net income of $151.8 million and a net loss of $39.1 million for the
year ended December 31, 2002 and the nine months ended September 30, 2003,
respectively. Excluding the gain on debt extinguishment of $181.0 million in
2002 (see Note 3) and $27.1 million in asset impairment losses in 2003 (see Note
5), the Company has incurred operating losses of approximately $29.2 million and
$ 12.0 million, respectively. As of September 30, 2003, the Company had a
working capital deficit of $132.6 million and the Company's liabilities exceeded
its assets by $95.4 million.
As discussed in Note 9, the Company was not in compliance with certain
financial covenants under its Junior Credit Facility and did not make certain
debt payments totaling $5.1 million that were due in July through November 2003.
On November 11, 2003 the Company executed an agreement with its Junior Lenders
(the "Forbearance Agreement") that grants forbearance with respect to defaults
and cash payments due under the terms of the Junior Credit Facility through
January 30, 2004. Under the Forbearance Agreement, the Company is required to
make a $600,000 cash payment to be applied against interest due under the Junior
Credit Facility and to make additional interest payments of $100,000 on December
1, 2003 and January 1, 2004. The Company has also engaged in discussions with
its Junior Lenders regarding the possibility of restructuring the debt
outstanding under the Junior Credit Facility and related payments due
thereunder. Any such restructuring would anticipate amortization payments
19
based upon revised operating plans and cash flow projections to be provided by
the Company. While the Company's Junior Lenders have expressed a willingness to
negotiate the revision of future payments due under the Junior Credit Facility,
there can be no assurance that they will agree to a restructuring of such
payments or refrain from exercising their rights thereunder. In the event the
Company is unable to comply with the current loan covenants or fails to make the
debt payments as currently scheduled, the Junior Lenders could declare this debt
to be immediately due and payable and enforce their rights with respect to the
collateral. As a result, the Company has classified the balance due on its debt
as a current liability in the accompanying consolidated balance sheets. In
addition, the above conditions raise substantial doubt about the Company's
ability to continue as a going concern.
In July 2003, a special committee of independent, non-employee members of
the Company's Board of Directors (the "Special Committee") was formed to
identify and evaluate the strategic and financial alternatives available to the
Company to maximize value for the Company's stakeholders. As a result, the Board
of Directors appointed a new chief executive officer who has been actively
engaged with management in the execution of a plan to return the Company to
profitability. Significant elements of the plan executed or planned for 2003
include (i) continuing cost savings and efficiencies resulting from the merger
with PhoneTel discussed in Note 4, (ii) the continued removal of unprofitable
payphones, (iii) reductions in telephone charges by changing to competitive
local exchange carriers ("CLECs"), (iv) the evaluation and sale of unprofitable
district operations, (v) outsourcing payphone collection, service and
maintenance activities in high cost areas, and (vi) the further curtailments of
operating expenses. The Company is also working toward the implementation of new
business initiatives and other strategic opportunities available to the Company.
Notwithstanding these activities and plans, the Company may continue to
face liquidity shortfalls and such other actions that its lenders may take with
respect to the Company's Junior Credit Facility. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
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 nine 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
20
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.
Dial-around Compensation
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 addressed
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 have reviewed the
order and prepared the data necessary to bill or determine the amount due to the
relevant dial-around carriers pursuant to the Interim Order. Based upon
available information, the Company recorded a $3.8 million charge as an
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. In March 2003, 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 (see Note 8). 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. The Company also received $4.0 million of net
receipts from other carriers that was recognized as revenue in the third quarter
of 2003 under the Company's accounting policy. Such revenues totaling $7.9
million have been reported as dial-around compensation adjustments in the
accompanying consolidated statements of operations for the nine months ended
September 30, 2003. The Company also estimates
21
that it is entitled to receive in excess of $10.0 million of dial-around
compensation from certain carriers, excluding WorldCom. 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. In addition, there can be no assurance that
the timing or amount of such receipts, if any, will be sufficient to offset the
liability to certain other carriers that will be deducted from future
dial-around payments.
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. On October 28, 2003 the FCC adopted an
Order and Notice of Proposed Rulemaking (the "October 2003 Rulemaking") to
determine whether a change to the dial-around rate is warranted, and if so, to
determine the amount of the revised rate. In the October 2003 Rulemaking, the
FCC tentatively concluded that the methodology adopted in the Third Report and
Order is the appropriate methodology to use in reevaluating the default
dial-around compensation rate and requested comments on, among other things, the
cost studies presented in the petitions. 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.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
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 nine months ended
September 30, 2003 include the revenues and expenses of PhoneTel for the entire
period. Offsetting these revenue and expense increases in the first nine months
of 2003 is the decrease in revenues and expenses resulting from the reduction in
the number of payphones operated by the Company, including reductions relating
to the Company's ongoing program to remove unprofitable phones. The Company's
average number of phones in service during the first nine months of 2003 was
approximately 62,000 phones compared to 56,000 phones in service during the
first nine months of 2002.
For the nine months ended September 30, 2003, total revenues increased
approximately $ 8.6 million, or 15.0 %, to approximately $ 66.2 million from
approximately $57.6 million in the same period of 2002. This increase was mainly
attributable to a favorable adjustment to dial-around compensation of
approximately $7.9 million in the first nine months of 2003 and a $1.3 million
increase in non-carrier revenue as discussed below. These increases in revenues
were offset by the reduction in revenues attributable to the removal of
unprofitable phones and lower call volumes, due to the harsh winter weather in
the first quarter of 2003 and increased competition from the wireless
communications industry, resulting in lower average revenue per phone.
Coin call revenues decreased approximately $1.6 million, or 3.9%, to
approximately $39.6 million in the nine months ended September 30, 2003 from
approximately $41.2 million in the first nine months of 2002. The decrease in
coin call revenues was primarily attributable to lower revenues per phone as a
result of lower call volumes on the Company's payphones caused by the colder
winter weather in the first quarter of 2003 and increased competition from
wireless communication services, offset in part by the increase in the number of
average payphones resulting from the PhoneTel acquisition.
22
Non-coin call revenues, which is comprised primarily of dial-around revenue
and operator service revenue, increased approximately $2.2 million, or 13.7 %,
to approximately $18.6 million in the nine months ended September 30, 2003 from
approximately $16.4 million in the nine months ended September 30, 2002. The
increase was primarily attributable to the additional revenues relating to the
PhoneTel Merger offset by the reduction in revenues relating to the removal of
unprofitable phones, lower call volumes resulting from weather conditions during
the first quarter of 2003 and the growth in wireless communication services.
Dial-around revenue decreased approximately $0.2 million, to approximately $10.4
million in the nine months ended September 30, 2003 from approximately $10.6
million in the first nine months of 2002. The dial-around decrease is primarily
attributable to a $1.0 million reduction in accounts receivable in the first
quarter of 2003 to reflect a change in accounting estimate of prior quarter
dial-around revenues offset by a $0.9 million reduction in revenue in 2002 as a
result of the WorldCom bankruptcy. Long-distance revenues increased
approximately $ 1.2 million, to approximately $ 6.3 million in the first nine
months of 2003 from approximately $5.1 million in the nine months ended
September 30, 2002. The increase is attributable to more payphones in service as
a result of the PhoneTel Merger and higher revenues per phone resulting from
higher commissions received from the Company's new operator services provider.
Non-carrier revenues, which consists primarily of contractor services provided
to Urban, a related party and PhoneTel customer (see Note 12 to the consolidated
financial statements), increased $1.3 million over the same period in 2002. Such
services were discontinued in September 2003.
During the nine months ended September 30, 2003, the Company recorded $7.9
million of dial-around revenue adjustments from various carriers relating to the
industry-wide true-up required under the FCC's Interim Order (see Note 7 to the
consolidated financial statements). This additional revenue included 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 8).
Telephone charges increased approximately $3.7 million, or 23.6%, to
approximately $19.1 million for the nine months ended September 30, 2003 from
approximately $15.4 million in the nine months ended September 30, 2002. This
increase is partly due to the net increase in payphones relating to the PhoneTel
Merger. In addition, telephone charges for the nine months ended September 30,
2002 were favorably affected by credits totaling $3.3 million relating to
refunds received under the FCC's New Services Test in certain states, other
refunds of $0.6 million and a favorable adjustments related to a litigation
settlement which totaled $.0.8 million. The first nine months of 2003 were also
favorably affected by $0.9 million of NST credits and lower line charges
resulting from the conversion to CLECs. 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 decreased approximately $0.2 million, or 2.0%, to approximately
$ 11.1 million in the nine months ended September 30, 2003 from approximately
$11.3 million in the nine months ended September 30, 2002. The decrease was
primarily attributable to slightly lower commissionable revenues and commission
rates due to 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 $3.3
million, or 21.2%, to approximately $18.9 million in the nine months ended
September 30, 2003 from approximately $15.6 million in the nine months ended
September 30, 2002. The increase was primarily attributable to costs relating to
the higher phone count associated with the PhoneTel Merger. In August 2003, the
Company implemented several cost reduction measures, including a reduction in
the Company's work force. In October 2003, the Company also began to outsource
the service collection and maintenance of its payphones in certain higher cost
districts. These changes should have a favorable impact on operating results for
the remainder of 2003.
Depreciation expense in the nine months ended September 30, 2003 increased
to approximately $12.2 million from approximately $12.1 million recorded in the
nine months ended September 30, 2002. Amortization expense in the nine months
ended September 30, 2003 increased to approximately $3.5 million from
approximately $2.5 million recorded in the nine months ended September 30, 2002.
These increases were primarily attributable to additional depreciation and
23
amortization on assets acquired in the PhoneTel Merger offset in part by lower
depreciation and amortization in the third quarter of 2003 as a result of the
impairment charges described below.
Selling, general and administrative expenses were approximately $8.2
million in the nine months ended September 30, 2003 and 2002. The increase in
expense related to the PhoneTel Merger was offset by a substantial decrease in
the combined companies' post-merger costs resulting from the relocation of the
Company's headquarters from Tampa, FL to Cleveland, OH at the end of the third
quarter of 2002, and the elimination of redundant personnel and headquarter
facilities.
As of June 30, 2003, the Company completed an evaluation of the carrying
value of its payphone assets and goodwill and recorded impairment charges of
$9.7 million and $17.5 million, respectively. These charges were required to
write-down the carrying values of property and equipment, location contracts and
goodwill to their respective fair values as of June 30, 2003 (see Note 5 to the
consolidated financial statements).
In the nine months ended September 30, 2002, the Company incurred $2.8
million of exit and disposal activity costs. Such costs included a $0.6 million
lease termination fee, $0.7 million of employee severance costs, $0.2 million of
other merger related costs, and a $1.3 million charge for assets written-off as
a result of moving the Company's headquarters from Tampa, FL to Cleveland, OH
after the completion of the PhoneTel Merger. In the first quarter of 2003, the
Company incurred a $0.3 million loss from exit and disposal activities related
to the outsourcing and closing of the Company's warehouse and repair facility in
Tampa, FL.
Interest expense in the nine months ended September 30, 2003 was
approximately $4.7 million compared to $11.3 million in the first nine months 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
accordance with SFAS No. 15. 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 a taxable loss in the first nine months of 2003 and 2002 as
a result of the loss in 2003 and the tax exclusion relating to income from
cancellation of indebtedness in 2002.
The Company reported a net loss of $39.1 million and net income of $159.4
million for the nine months ended September 30, 2003 and 2002, respectively.
Excluding the gain on debt extinguishment of $181.0 million in 2002 and $27.1
million in asset impairment losses in 2003, the Company has incurred operating
losses of approximately $12.0 million and $21.6 million for the nine months
ended September 30, 2003 and 2002, respectively. This decrease in operating
losses is primarily due to the decrease in interest expense and the addition
revenue from the dial-around revenue adjustment in 2003 as discussed above.
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
24
payphones throughout the midwestern and eastern United States produce their
highest call volumes during the second and third quarters.
In the nine months ended September 30, 2003, operating activities provided
approximately $6.9 million of net cash, primarily due to $4.7 million of
receipts relating to refunds of telephone charges under the FCC's New Services
Test and $4.9 million of receipts in March 2003 relating to the sale of a
portion of the Company's bankruptcy claim due from WorldCom, as discussed below.
Approximately $2.8 million of these amounts were used to reduce the Company's
current liabilities for accounts payable, commissions, and accrued expenses,
$5.8 million was used for payments on the Company's Senior Credit Facility, and
$1.0 million was deposited in escrow with its lenders. In the first nine months
of 2002, operating activities used $1.1 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.
Capital expenditures for the nine months ended September 30, 2003 and 2002
were $0.5 million and $0.2 million, respectively. 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
nine months ended September 30, 2003 were $ 0.2 compared to $0.3 million for the
similar period ended September 30, 2002.
The Company made payments under capital lease obligations totaling
approximately $0.2 million in the first nine months of 2003 compared to $0.4
million in 2002. Cash balances decreased approximately $0.2 million during the
nine months ended September 30, 2003.
The Company's principal source of liquidity in the nine months ended
September 30, 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 7. 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), $1.0 million was
deposited in escrow, and $0.9 million was used to pay certain accounts payable.
The Company has used $0.2 million of the amount deposited in escrow and, to the
extent permitted by the Company's lenders, plans to use the remaining $0.8
million to fund new business initiatives and certain obligations of the Company.
Any amounts not used for such purposes would be applied to the balance due under
the Company's Junior Credit Facility.
During the nine months ended September 30, 2003, the Company received $4.7
million of refunds of prior period telephone charges relating to the recently
adopted new services test ("New Services Test" or "NST") in certain
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states. Of this amount, $3.8 million, $0.8 million and $0.1 million were
recognized as reductions in telephone charges in the fourth quarter of 2002,
first quarter of 2003, and third quarter of 2003, respectively. Approximately
$2.8 million of these refunds were used to pay a portion of the balance due on
the Company's Senior Credit Facility and the balance was used for working
capital purposes. Under the Telecom Act and related FCC Rules, LECs are required
to ensure that the cost to PSPs for obtaining local lines and service meet the
FCC's NST guidelines. The FCC's NST 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 $3.3 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 nine months ended September 30,
2002.
In the first nine months of 2002 the Company's principal source of
liquidity was from the Company's Senior Credit Facility. See Note 9 to the
consolidated financial statements for a description of this indebtedness. The
Company's primary uses of liquidity are to provide working capital and to meet
debt service requirements.
See also "Liquidity and Management's' Plans" included elsewhere herein and
in Note 2 to the consolidated financial statements.
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, which was repaid in the
second quarter of 2003, 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
An evaluation was performed under the supervision and with the
participation of our management, including the chief executive officer, or CEO,
and chief financial officer, or CFO, of the effectiveness of the design and
operation of our disclosure procedures. Based on that evaluation, our
management, including the CEO and CFO, concluded that our disclosure controls
and procedures were effective as of September 30, 2003. There have been no
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significant changes in our internal control over financial reporting in the
third quarter of 2003 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index.
(b) The Company filed a Current Report on Form 8-K, dated August 15,
2003, reporting that the Company issued a press release announcing
the results of operations for the quarter ended June 30, 2003 under
Item 9, Regulation FD Disclosure.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Form 10-Q to be signed on its behalf by the
undersigned thereunto duly authorized.
DAVEL COMMUNICATIONS, INC.
Date: November 14, 2003 /s/ Donald L. Paliwoda
---------------------------
Donald L. Paliwoda
Chief Financial Officer
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EXHIBIT INDEX
Exhibit No. Description
10.1 Forbearance Agreement, dated as of November 11, 2003, related to
Amended, Restated and Consolidated Credit Agreement, dated as of
July 24, 2003, by and among Davel Financing Company, L.L.C.,
PhoneTel Technologies, Inc., Cherokee Communications, Inc., Davel
Communications, Inc., the domestic subsidiaries of each of the
foregoing and Foothill Capital Corporation, as Agent, and the
lenders named therein.
10.2 Employment Agreement dated August 29, 2003 between Davel
Communications, Inc. and Woody McGee
31.1 Certification by Chief Executive Officer pursuant to Sarbanes -
Oxley Section 302.
31.2 Certification by Chief Financial Officer pursuant to Sarbanes -
Oxley Section 302.
32.1 Certification by Chief Executive Officer pursuant to Sarbanes -
Oxley Section 906.
32.2 Certification by Chief Financial Officer pursuant to Sarbanes -
Oxley Section 906.
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