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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 000-25207
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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) Identification No.)
200 PUBLIC SQUARE, SUITE 700, CLEVELAND, OH 44114
(address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(216) 241-2555
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No __
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. __
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 June 30, 2003 the aggregate market value of the voting and
nonvoting common equity held by non-affiliates of the registrant was
approximately $1,308,310 based upon the closing price on June 30, 2003 of $0.01.
As of March 19, 2004, there were 615,018,963 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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DAVEL COMMUNICATIONS, INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1 Business........................................................................................ 1
Item 2 Properties...................................................................................... 14
Item 3 Legal Proceedings............................................................................... 15
Item 4 Submission of Matters to a Vote of Security Holders............................................. 16
PART II
Item 5 Market for the Registrant's Common Stock and Related Stockholder Matters........................ 16
Item 6 Selected Consolidated Financial Data............................................................ 17
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations........... 17
Item 7A Quantitative and Qualitative Disclosures About Market Risk...................................... 28
Item 8 Financial Statements............................................................................ 29
Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure............ 59
Item 9A Disclosure Controls and Procedures.............................................................. 59
PART III
Item 10 Directors and Executive Officers of the Registrant.............................................. 59
Item 11 Executive Compensation.......................................................................... 61
Item 12 Security Ownership of Certain Beneficial Owners and Management.................................. 65
Item 13 Certain Relationships and Related Transactions.................................................. 66
Item 14 Principal Accountant Fees and Services.......................................................... 67
PART IV
Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K................................. 68
PART I
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934:
Certain of the statements contained in the body of this Report are
forward-looking statements (rather than historical facts) that are subject to
risks and uncertainties that could cause actual results to differ materially
from those described in the forward-looking statements. In the preparation of
this Report, where such forward-looking statements appear, the Company has
sought to accompany such statements with meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those described in the forward-looking statements. A description
of the principal risks and uncertainties inherent in the Company's business is
included herein under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Readers of this Report are
encouraged to read these cautionary statements carefully.
ITEM 1. BUSINESS
GENERAL OVERVIEW
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 payphones throughout the
United States. The Company's headquarters is located in Cleveland, Ohio (having
been relocated from Tampa, Florida after completion of the merger of its wholly
owned subsidiary with PhoneTel Technologies, Inc. ("PhoneTel" and the "PhoneTel
Merger" -- see Note 5 to the consolidated financial statements for acquisition
activities and for exit and disposal activities), with field service offices in
17 geographically dispersed locations.
As of December 31, 2003, the Company owned and operated a network of
approximately 47,000 payphones in 46 states and the District of Columbia,
providing it with one of the broadest geographic ranges of coverage of any
payphone service provider ("PSP") in the country. The Company's installed
payphone base generates revenue through both coin calls (local and
long-distance), non-coin calls (calling card, credit card, collect, and
third-party billed calls using the Company's preselected operator services
providers such as Opticom) and dial-around calls (utilizing a 1-800, 1010XXX or
similar "toll free" dialing method to select a carrier other than the Company's
pre-selected carrier). A significant portion of the Company's payphones are
located in high-traffic areas such as convenience stores, shopping centers,
truck stops, service stations, and grocery stores.
As part of the Telecommunications Act of 1996 ("1996 Telecom Act"),
Congress directed the Federal Communications Commission ("FCC") to ensure
widespread access to payphones for use by the general public. The most recent
estimates of payphone deployment released by the FCC suggest that there are
approximately 1.5 million payphones currently operating in the United States, of
which approximately 0.8 million are operated by the Regional Bell Operating
Companies ("RBOCs") and approximately 0.1 million are operated by the smaller
independent local exchange carriers ("LECs"). The remaining approximately 0.6
million payphones are owned or managed by the major long distance carriers such
as Sprint and AT&T and more than 1,000 independent payphone providers ("IPPs")
currently operating in the United States.
Effective as of February 19, 2002, certain 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 4 to the consolidated financial statements --
Debt Restructuring). The Senior Credit Facility provided for a combined $10
million line of credit which the Company and PhoneTel shared $5 million each.
The Company and PhoneTel each borrowed the amounts available under their
respective lines of credit on February 20, 2002, which amounts were used to pay
merger related expenses and accounts payable.
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
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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 has reduced operating costs by leveraging the combined
infrastructure of the companies.
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 acquisition. 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. -- See Note 5 to the consolidated financial statements for
acquisition activities.
In connection with the merger, the Company and PhoneTel effectuated the
debt exchanges, and amended, restated, and consolidated their respective junior
credit facilities into a combined restructured junior credit facility with a
face value of $101.0 million due December 31, 2005 (the "Debt Restructuring" and
the "Junior Credit Facility"). See Note 4 to the consolidated financial
statements -- Debt Restructuring and Note 10 -- Long-term Debt and Obligations
under Capital Leases.
The Company had net loss of $46.2 million, net income of $151.8
million, and net loss of $43.4 million, for the years ended December 31, 2003,
2002, and 2001, respectively. The net income in 2002 was the result of a $181.0
million gain on debt restructuring associated with the PhoneTel Merger on July
24, 2002, partially offset by operating losses of $29.2 million which, along
with the losses in 2003 and 2001, were primarily attributable to increased
competition from providers of wireless communication services and the impact on
the Company's revenue of certain changes in customer calling patterns in favor
of 1-800 type calls. In addition, 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 granted forbearance with respect to
certain financial covenant defaults and cash payments due under the terms of the
Junior Credit Facility through January 30, 2004. Thereafter, on February 24,
2004, the Company executed an amendment to the Junior Credit Facility (the
"Second Amendment") that waives all defaults existing through the date of the
Second Amendment, reduces the minimum amount of earnings (as defined in the
agreement) that the Company is required to maintain, and reduces the minimum
payments due under the Junior Credit Agreement to $130,000 per month through
December 31 2005, including the monthly agent fee, plus 100% of any regulatory
receipts, as defined in the agreement, received by the Company. Further, the
Company has also engaged in discussions with its Junior Lenders regarding the
possibility of restructuring its outstanding debt. Any such restructuring could
potentially include a debt-for-equity exchange that may substantially dilute the
interests of the Company's existing shareholders. There can be no assurance that
the Company will be successful in negotiating a reduction in the outstanding
balance of its Junior Credit Facility. See Note 10 to the consolidated financial
statements - Long-term Debt and Obligations under Capital Leases.
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 improve the operating results of
the Company. Significant elements of the plan executed or planned for 2003 and
2004 include (i) continuing cost savings and efficiencies resulting from the
merger with PhoneTel discussed in Note 5, (ii) the continued removal of
unprofitable payphones, (iii) reductions in telephone charges by changing to
competitive local exchange carriers ("CLECs") or alternative carriers, (iv) the
evaluation, sale or closure of unprofitable district operations, (v) outsourcing
payphone collection, service and maintenance activities to reduce such costs,
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, as a result, might be required to
dispose of assets to fund its operations or curtail its capital and other
expenditures to meet its debt service and other obligations. There can be no
assurances as to the Company's ability to execute such
2
dispositions, or the timing thereof, or the amount of proceeds that the Company
could realize from such sales. As a result, doubt exists about the Company's
ability to continue as a going concern.
INDUSTRY OVERVIEW
Today's telecommunications marketplace was principally shaped by the
1984 court-approved divestiture by AT&T of its local telephone operations (the
"AT&T Divestiture") and the many regulatory changes adopted by the FCC and state
regulatory authorities in response to and subsequent to the AT&T Divestiture,
including the authorization of the connection of competitive or independently
owned payphones to the public switched network. The "public switched network" is
the traditional domestic landline public telecommunications network used to
carry, switch and connect telephone calls. The connection of independently owned
payphones to the public switched network has resulted in the creation of
additional business segments in the telecommunications industry. Prior to these
developments, only the consolidated Bell system or independent LECs were
permitted to own and operate payphones. Following the AT&T Divestiture and
subsequent FCC and state regulatory rulings, the independent payphone sector
developed as a competitive alternative to the consolidated Bell system and other
LECs by providing more responsive customer service, lower cost of operations and
higher commissions to the owners or operators of the premises at which a
payphone is located ("Location Owners").
Prior to the AT&T Divestiture, the LECs could refuse to provide
payphone service to a business operator or, if service was installed, would
typically pay no or relatively small commissions for the right to place a
payphone on the business premises. Following the AT&T Divestiture and the FCC's
authorization of payphone competition, IPPs began to offer Location Owners
higher commissions on coin calls made from the payphones in order to obtain the
contractual right to install the equipment on the Location Owners' premises.
Initially, coin revenue was the only source of revenue for the payphone
operators because they were unable to participate in revenues from non-coin
calls. However, the operator service provider ("OSP") industry emerged and
enabled the competitive payphone operators to compete more effectively with the
regulated telephone companies by paying commissions to payphone owners for
non-coin calls. For the first time, IPPs were able to receive non-coin call
revenue from their payphones. With this incremental source of revenue from
non-coin calls, IPPs were able to compete more vigorously on a financial basis
with RBOCs and other LECs for site location agreements, as a complement to the
improved customer service and more efficient operations provided by the IPPs. As
part of the AT&T Divestiture, the United States was divided into Local Access
Transport Areas ("LATAs"). RBOCs were authorized to provide telephone service
that both originates and terminates within the same LATA ("intraLATA") pursuant
to tariffs filed with and approved by state regulatory authorities. RBOCs
typically provide payphone service primarily in their own respective
territories, and are now authorized to share in the payphone revenues generated
from telecommunications services between LATAs ("interLATA"). Long-distance
companies, such as Sprint, AT&T and WorldCom, provide interLATA services, and in
some circumstances, also provide local or long-distance service within LATAs. An
interLATA long-distance telephone call generally begins with an originating LEC
transmitting the call from the originating payphone to a point of connection
with a long-distance carrier. The long-distance carrier, through its owned or
leased switching and transmission facilities, transmits the call across its
long-distance network to the LEC servicing the local area in which the recipient
of the call is located. The terminating LEC then delivers the call to the
recipient.
BUSINESS STRATEGY
Rationalization Of Low-Revenue Phones. In recent years, the Company has
experienced revenue declines as a result of increased competition from cellular
and other telecommunications products. As a result of declining revenues, the
Company's strategy is to remove low revenue payphones that do not meet the
Company's minimum criteria of profitability and to promote improved density of
the Company's payphone routes. During the most recent two years ending December
31, 2003 and 2002, the Company removed approximately 24,800 and 14,900 payphones
respectively. Although a portion of these removals resulted from competitive
conditions or decisions not to renew contracts with Location Owners under
unfavorable terms, a large portion of these removals were to eliminate
unprofitable payphones. The Company has an ongoing program to identify
additional payphones to be removed in 2004 based upon low revenue performance
and route density considerations.
Outsourcing Service, Maintenance and Collection Activities.
Notwithstanding improvements in payphone route densities and other efficiencies
achieved following the PhoneTel Merger, the Company continues to examine its
cost structure to identify additional ways to improve the profitability of the
business. During 2003, the Company
3
outsourced the assembly and repair of its payphone equipment and closed its
warehouse and repair facility in Tampa, Florida to reduce the cost to repair,
maintain and store its replacement payphone equipment. The Company incurred a
loss from exit and disposal activities relating to this facility of
approximately $0.3 million. In the fourth quarter of 2003, the Company
outsourced the collection, service and maintenance of its payphones in the
western region of the United States to reduce the cost of servicing its
geographically disbursed payphones in this area. The Company closed eleven
district offices and incurred a loss from exit and disposal activities of
approximately $0.5 million relating to these facilities. Subsequent to December
31, 2003, the Company outsourced the servicing of additional payphones and
closed three additional district offices in Texas to further reduce its
operating costs. Although there were costs associated with the outsourcing of
these activities, the Company believes future savings will more than offset
these costs and have a favorable impact on the operating results of the Company.
The Company plans to continue to identify additional outsourcing opportunities
and to implement those strategies that can further reduce its operating costs.
Utilize Advanced Payphone Technology. The Company's payphones utilize
"smart" technology which provides voice synthesized calling instructions,
detects and counts coins deposited during each call, informs the caller at
certain intervals of the time remaining on each call, identifies the need for
and the amount of an additional deposit in order to continue the call, and
provides other functions associated with the completion of calls. Through the
use of a non-volatile, electronically erasable, programmable memory chip, the
payphones can also be programmed and reprogrammed from the Company's central
computer facilities to update rate information or to direct different types of
calls to particular carriers. The Company's payphones can also distinguish coins
by size and weight, report to its central host computer the total amount of coin
in the coin box, perform self-diagnosis and automatically report problems to a
pre-programmed service number.
Apply Sophisticated Monitoring and Management Information Systems. The
Company utilizes a blend of enterprise-class proprietary and non-proprietary
software that continuously tracks coin and non-coin revenues from each payphone,
as well as expenses relating to each payphone, including commissions payable to
the Location Owners. The Company's technology also allows it to efficiently
track and facilitate the activities of its field technicians via interactions
from the pay telephone with the Company's computer systems and technical support
personnel at the Company's headquarters.
Provide Outstanding Customer Service. The technology used by the
Company enables it to (i) respond quickly to equipment malfunctions and (ii)
maintain accurate records of payphone activity which can be verified by
customers. The Company strives to minimize "downtime" on its payphones by
identifying service problems as quickly as possible. The Company employs both
advanced telecommunications technology and trained field technicians as part of
its commitment to provide superior customer service. The records generated
through the Company's technology also allow for the more timely and accurate
payment of commissions to Location Owners.
Consolidation of Carrier Services. As part of its strategy to reduce
costs and improve service quality, the Company has consolidated its coin and
non-coin services with a limited number of major carriers. This enables the
Company to maximize the value of its traffic volumes and has translated into
more favorable economic and service terms and conditions in these key aspects of
its business.
Pursue Regulatory Improvements. The Company continues to actively
pursue regulatory changes that will enhance its near and long-term performance
and viability. Notably, the Company is pressing, through regulatory channels,
the reduction in line and related charges and improvements to the dial around
compensation collection system that are critical to the economic viability of
the payphone industry generally and the Company's operations specifically.
4
OPERATIONS
As of December 31, 2003 and December 31, 2002, the Company owned and
operated approximately 47,000 and 69,000 payphones, respectively.
Coin Calls
The Company's payphones generate coin revenues primarily from local
calls. Historically, the maximum rate that LECs and IPPs could charge for local
calls was generally set by state regulatory authorities and in most cases was
$0.25 through October 6, 1997. In ensuring "fair compensation" for all calls,
the FCC 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 demonstration by an individual
state that there are market failures within the state that would not allow
market-based rates to develop. On July 1, 1997, a federal court issued an order
which upheld the FCC's authority to deregulate local coin call rates. In
accordance with the FCC's ruling and the court order, certain LECs and IPPs,
including the Company, began to increase rates for local coin calls from $0.25
to $0.35 after October 7, 1997 and, beginning in November 2001, to $0.50. See
"Regulation -- Effect of Federal Regulation of Local and Dial-Around Calls."
Long distance coin calls are typically carried by long distance
carriers that have contracted to provide transmission services to the Company's
payphones. The Company pays a charge to the long-distance carrier each time the
carrier transports a long-distance call for which the Company receives coin
revenue from an end user.
Non-Coin Calls
The Company also receives revenues from non-coin calls made from its
payphones. Traditional non-coin calls include credit card, calling card, prepaid
calling card, collect and third-party billed calls where the caller dials "0"
plus the number or simply dials "0" for an operator.
The services needed to complete a non-coin call include providing an
automated or live operator to answer the call, verifying billing information,
validating calling cards and credit cards, routing and transmitting the call to
its destination, monitoring the call's duration and determining the charge for
the call, and billing and collecting the applicable charge. The Company has
contracted with operator service providers to handle these calls and perform all
associated functions, while paying the Company a commission on the revenues
generated thereby.
The Company realizes additional non-coin revenue from various carriers
pursuant to the 1996 Telecom Act and FCC regulations thereunder as compensation
for "dial-around" non-coin calls made from its payphones. A dial-around call is
made by dialing an access code for the purpose of reaching a long distance
carrier company other than the one designated by the payphone operator or using
a traditional "toll free" number, generally by dialing a 1-800/888/877/866
number, a 950-XXXX number or a seven-digit "1010XXXX" code.
Payphone Base
The Company selects locations for its payphones where there is
typically high demand for payphone service, such as convenience stores, truck
stops, service stations, grocery stores and shopping centers. For many
locations, historical information regarding an installed payphone is available
because payphone operators are often obligated pursuant to agreements to provide
this information to Location Owners for their payphones. In locations where
historical revenue information is not available, the Company relies on its site
survey to examine geographic factors, population density, traffic patterns and
other factors in determining whether to install a payphone. The Company's
marketing staff attempts to obtain agreements to install the Company's payphones
("Location Agreements") at locations with favorable historical data regarding
payphone revenues. The Company recognizes, however, that recent changes in
payphone traffic volumes and usage patterns being experienced on an
industry-wide basis warrant a continued assessment of the locational deployment
of its payphones.
The following table sets forth, for the last three fiscal years, the
number of Company payphones acquired, installed and removed during the year as
well as the net decrease in Company payphones in operation.
5
2003 2002 2001
-------- -------- --------
Acquired................................................... -- 28,000 --
Installed.................................................. 2,830 880 1,507
Removed.................................................... (24,830) (14,880) (13,507)
------- ------- -------
Net Increase/(Decrease).................................... (22,000) 14,000 (12,000)
======= ======= =======
Total payphones in service (approximately)................. 47,000 69,000 55,000
======= ======= =======
The Company had approximately 47,000 payphones in operation in
forty-six states and the District of Columbia as of December 31, 2003, compared
with approximately 69,000 in operation as of December 31, 2002. The five states
possessing the greatest numbers of installed telephones as of December 31, 2003
were: Florida (6,460), Texas (4,047), New York (3,371), Virginia (2,936), and
Georgia (2,812).
In 2003, the Company continued its aggressive monitoring of the
payphone base, which began in 1999, and removed under-performing payphones,
which are available for relocation at sites with greater potential for
profitability.
Location Agreements generally provide for revenue sharing with the
applicable Location Owner. The Company's Location Agreements generally provide
commissions based on fixed percentages of revenues and have three-to-five year
terms. The Company can generally terminate a Location Agreement on 30 days'
notice to the Location Owner if the payphone does not generate sufficient
revenue.
Service and Maintenance
The Company employs a system of field service technicians and
independent contractors, each of whom collects coin boxes and cleans and
maintains a route of payphones. The technicians and contractors also respond to
trouble calls made by Location Owners, by users of payphones or by the telephone
itself as part of its internal diagnostic procedures. Some technicians are also
responsible for the installation of new payphones. Due to the Company's polling
and electronic tracking and trouble reporting systems and the ability of the
field service technicians to perform on-site service and maintenance functions,
the Company is able to limit the frequency of trips to the payphones as well as
the number of employees needed to service the payphones.
Customers, Sales and Marketing
The Location Owners with whom the Company contracts are a diverse group
of small, medium and large businesses which are frequented by individuals
needing payphone access. The majority of the Company's payphones are located at
convenience stores, truck stops, service stations, grocery stores and shopping
centers. As of December 31, 2003, corporate payphone accounts of 50 or more
payphones represented more than 30 percent of the Company's installed payphone
base.
Service and Equipment Suppliers
The Company's primary suppliers provide payphone components, local line
access, and long-distance transmission and operator services. In order to
promote acceptance by end users accustomed to using LEC-owned payphone
equipment, the Company utilizes payphones designed to be similar in appearance
and operation to payphones owned by LECs.
The Company purchases some parts and equipment from various
manufacturers and otherwise utilizes parts from payphones removed from field
service for repair and installation of payphones. The Company has historically
obtained local line access from various LECs, including Verizon, SBC
Communications, Qwest and various other incumbent and competitive suppliers of
local line access. New sources of local line access have emerged as competition
continues to develop in local service markets. The Company currently utilizes a
number of CLECs to provide local line access at rates that are lower than the
rates that could be obtained from incumbent LECs. As part of the Company's
strategy to further reduce line costs, during the fourth quarter of 2003, the
Company entered into an agreement with a CLEC that will provide line access for
a minimum of 10,500 of its payphones. The Company is also searching for
additional opportunities to further reduce line costs and is evaluating the
rates of other competitive
6
local access carriers. The Company believes it will be able to substantially
reduce its telephone charges through these efforts. Long-distance services are
provided to the Company by various long-distance and operator service providers,
including Opticom, AT&T, and others.
The Company expects the basic availability of such products and
services to continue in the future; however, the continuing availability of
alternative sources at existing or lower rates cannot be assured. Although the
Company is not aware of any current circumstances that would require the Company
to seek alternative suppliers for any material portion of the products or
services used in the operation of its business, transition from the Company's
existing suppliers, if necessary, could have a disruptive effect on the
Company's operations and could give rise to unforeseen delays, additional
expenses or loss of revenue.
Assembly and Repair Of Payphones
Historically, the Company assembled and repaired payphone equipment for
its own use. The assembly of payphone equipment provided the Company with
technical expertise used in the operation, service, maintenance and repair of
its payphones. The Company assembled, refurbished or replaced payphones from
standard payphone components either obtained from the Company's sizable
inventory or purchased from component manufacturers. These components include a
metal case, an integrated circuit board incorporating a microprocessor, a
handset and cord, and a coin box and lock. On the occasion when components are
not available from inventory, the components can be purchased by the Company
from several suppliers. The Company does not believe that the loss of any single
supplier would have a material adverse effect on its assembly operations.
In March 2003 the Company closed its refurbishing facility located in
Tampa, Florida and has outsourced the assembly and repair of payphone equipment
to a third party provider. The Company believes that given its sizable inventory
of refurbished payphone equipment and other component parts, it can more
effectively deploy the cash resources to other portions of the Company's
business, which had previously been utilized in connection with the Tampa
refurbishing facility. See Note 5 to the consolidated financial statements for
exit and disposal activities.
The Company's payphones comply with all material regulatory
requirements regarding the performance and quality of payphone equipment and
have all of the operating characteristics required by the applicable regulatory
authorities, including free access to local emergency ("911") telephone numbers,
dial-around access to all available carriers, and automatic coin return
capability for incomplete calls.
Technology
The payphone equipment installed by the Company makes use of
microprocessors to provide voice synthesized calling instructions, detect and
count coin deposits during each call, inform the caller at certain intervals of
the time remaining on each call, identify the need for and the amount of an
additional deposit and other functions associated with completion of calls.
Through the use of non-volatile, electronically erasable, programmable read-only
memory chips, the payphones can also be programmed and reprogrammed from the
Company's central computer facilities to update rate information or to direct
different kinds of calls to particular carriers.
The Company's payphones can distinguish coins by size and weight,
report to a remote location the total coin in the coin box, perform
self-diagnosis and automatically report problems to a pre-programmed service
number, and immediately report attempts at vandalism or theft. Many of the
payphones operate on power available from the telephone lines, thereby avoiding
the need for and reliance upon an additional power source at the installation
location.
The Company utilizes proprietary and non-proprietary software that
tracks the coin and non-coin revenues from each payphone as well as expenses
relating to that payphone, including commissions payable to the Location Owners.
The Company provides all technical support required to operate the
payphones, such as computers and software and hardware specialists, at its
headquarters in Cleveland, Ohio. The Company's assembly and repair support
operations located in Tampa, Florida previously provided materials, equipment,
spare parts and accessories to the field. In 2003, this function was outsourced
to one of the Company's suppliers and the Tampa facility was closed.
7
(See Note 5 to the consolidated financial statements for exit and disposal
activities.) Each of the Company's division offices and/or each of the
technician's vans maintain inventories for immediate deployment in the field.
REGULATION
The FCC and state regulatory authorities have traditionally regulated
payphone and long-distance services, with regulatory jurisdiction being
determined by the interstate or intrastate character of the service and the
degree of regulatory oversight varying among jurisdictions. On September 20 and
November 8, 1996, the FCC adopted initial rules and policies to implement
Section 276 of the 1996 Telecom Act. The 1996 Telecom Act substantially
restructured the telecommunications industry, included specific provisions
related to the payphone industry and required the FCC to develop rules necessary
to implement and administer the provisions of the 1996 Telecom Act on both an
interstate and intrastate basis. Among other provisions, the 1996 Telecom Act
granted the FCC the power to preempt state payphone regulations to the extent
that any state requirements are inconsistent with the FCC's implementation of
Section 276.
Federal Regulation Of Local Coin and Dial-Around Calls
The Telephone Operator Consumer Services Improvement Act of 1990
("TOCSIA") established various requirements for companies that provide operator
services and for call aggregators, including PSPs, who send calls to those OSPs.
The requirements of TOCSIA as implemented by the FCC included call branding,
information posting, rate quotations, the filing of informational tariffs and
the right of payphone users to access any OSP to make non-coin calls. TOCSIA
also required the FCC to take action to limit the exposure of payphone companies
to undue risk of fraud upon providing this "open access" to carriers.
TOCSIA further directed the FCC to consider the need to provide
compensation for IPPs for dial-around calls. Accordingly, the FCC ruled in May
1992 that IPPs were entitled to dial-around compensation. Because of the
complexity of establishing an accounting system for determining per call
compensation for these calls, and for other reasons, the FCC temporarily set
this compensation at $6.00 per payphone per month based on an assumed average of
15 interstate carrier access code dial-around calls per month and a rate of
$0.40 per call. The failure by the FCC to provide compensation for 800 "toll
free" dial-around calls was challenged by the IPPs, and a federal court
subsequently ruled that the FCC should have provided compensation for these toll
free calls.
In 1996, recognizing that IPPs had been at a severe competitive
disadvantage under the existing system of regulation and had experienced
substantial increases in dial-around calls without a corresponding adjustment in
compensation, Congress enacted Section 276 to promote both competition among
payphone service providers and the widespread deployment of payphones throughout
the nation. Section 276 directed the FCC to implement rules by November 1996
that would:
- create a standard regulatory scheme for all public payphone
service providers;
- establish a per call compensation plan to ensure that all
payphone service providers are fairly compensated for each and
every completed intrastate and interstate call, except for 911
emergency and telecommunications relay service calls;
- terminate subsidies for LEC payphones from LEC regulated
rate-base operations;
- prescribe, at a minimum, nonstructural safeguards to eliminate
discrimination between LECs and IPPs and remove the LEC
payphones from the LEC's regulated asset base;
- provide for the RBOCs to have the same rights that IPPs have
to negotiate with Location Owners over the selection of
interLATA carrier services, subject to the FCC's determination
that the selection right is in the public interest and subject
to existing contracts between the Location Owners and
interLATA carriers;
- provide for the right of all PSPs to choose the local,
intraLATA and interLATA carriers subject to the requirements
of, and contractual rights negotiated with, Location Owners
and other valid state regulatory requirements;
8
- evaluate the requirement for payphones which would not
normally be installed under competitive conditions but which
might be desirable as a matter of public policy, and establish
how to provide for and maintain such payphones if it is
determined they are required; and
- preempt any state requirements which are inconsistent with the
FCC's regulations implementing Section 276.
In September and November 1996, the FCC issued its rulings implementing
Section 276 (the "1996 Payphone Order"). In the 1996 Payphone Order, the FCC
determined that the best way to ensure fair compensation to independent and LEC
PSPs for each and every call was to deregulate, to the maximum extent possible,
the price of all calls originating from payphones. For local coin calls, the FCC
mandated that deregulation of the local coin rate would not occur until October
1997 in order to provide a period of orderly transition from the previous system
of state regulation.
To achieve fair compensation for dial-around calls through deregulation
and competition, the FCC in the 1996 Payphone Order directed a two-phase
transition from a regulated market. In the first phase, November 1996 to October
1997, the FCC prescribed flat-rate compensation payable to the PSPs by the
interexchange carriers ("IXCs") in the amount of $45.85 per month per payphone.
This rate was arrived at by determining that the deregulated local coin rate was
a valid market-based surrogate for dial-around calls. The FCC applied a
market-based, deregulated coin rate of $0.35 per call to a finding from the
record that there was a monthly average of 131 compensable dial-around calls per
payphone. This total included both carrier access code calls dialed for the
purpose of reaching a long distance company other than the one designated by the
PSP as well as 800 "toll free" calls. The monthly, per phone flat-rate
compensation of $45.85 was to be assessed only against IXCs with annual
toll-call revenues in excess of $100 million and allocated among such IXCs in
proportion to their gross long-distance revenues. During the second phase of the
transition to deregulation and market-based compensation (initially from October
1997 to October 1998, but subsequently extended in a later order by one year to
October 1999), the FCC directed the IXCs to pay the PSPs on a per-call basis for
dial-around calls at the assumed deregulated coin rate of $0.35 per call. At the
conclusion of the second phase, the FCC set the market-based local coin rate,
determined on a payphone-by-payphone basis, as the default per-call compensation
rate in the absence of a negotiated agreement between the PSP and the IXC. To
facilitate per-call compensation, the FCC required the PSPs to transmit
payphone-specific coding digits which would identify each call as originating
from a payphone and required the LECs to make such coding available to the PSPs
as a tariffed item included in the local access line service.
In July 1997, a federal court (the "Court") responded to an appeal of
the 1996 Payphone Order, finding that the FCC erred in (1) setting the default
per-call rate at $0.35 without considering the differences in underlying costs
between dial-around calls and local coin calls, (2) assessing the flat-rate
compensation against only the carriers with annual toll-call revenues in excess
of $100 million, and (3) allocating the assessment of the flat-rate compensation
based on gross revenues rather than on a factor more directly related to the
number of dial-around calls processed by the carrier. The Court also assigned
error to other aspects of the 1996 Payphone Order concerning inmate payphones
and the accounting treatment of payphones transferred by an RBOC to a separate
affiliate.
In response to the Court's remand, the FCC issued its modified ruling
implementing Section 276 (the "1997 Payphone Order") in October of 1997. The FCC
determined that distinct and severable costs of $0.066 were attributable to coin
calls that did not apply to the costs incurred by the PSPs in providing access
for dial-around calls. Accordingly, the FCC adjusted the per call rate during
the second phase of interim compensation to $0.284 (which is $0.35 less $0.066).
While the FCC tentatively concluded that the $0.284 default rate should be
utilized in determining compensation during the first phase and reiterated that
PSPs were entitled to compensation for each and every call during the first
phase, it deferred a decision on the precise method of allocating the initial
interim period (November 1996 through October 1997) flat-rate payment obligation
among the IXCs and the number of calls to be used in determining the total
amount of the payment obligation.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC
98-481, which extended and waived certain requirements concerning the provision
by the LECs of payphone-specific coding digits which identify a call as
originating from a payphone. Without the transmission of payphone-specific
coding digits, some of the IXCs have claimed they are unable to identify a call
as a payphone call eligible for dial-around compensation. With the stated
purpose of ensuring the continued payment of dial-around compensation, the FCC's
Memorandum
9
and Order issued on April 3, 1998 left in place the requirement for payment of
per-call compensation for payphones on lines that do not transmit the requisite
payphone-specific coding digits but gave the IXCs a choice for computing the
amount of compensation for payphones on LEC lines not transmitting the
payphone-specific coding digits of either accurately computing per-call
compensation from their databases or paying per-phone, flat-rate compensation
computed by multiplying the $0.284 per call rate by the nationwide average
number of 800 subscriber and access code calls placed from RBOC payphones for
corresponding payment periods. Accurate payments made at the flat rate are not
subject to subsequent adjustment for actual call counts from the applicable
payphone.
On May 15, 1998, the Court again remanded the per-call compensation
rate to the FCC for further explanation without vacating the $0.284 per call
rate. The Court opined that the FCC had failed to explain adequately its
derivation of the $0.284 default rate. The Court stated that any resulting
overpayment may be subject to refund and directed the FCC to conclude its
proceedings within a six-month period from the effective date of the Court's
decision.
In response to the Court's second remand, the FCC conducted further
proceedings and sought additional comment from interested parties to address the
relevant issues posed by the Court. On February 4, 1999, the FCC released the
Third Report and Order and Order on Reconsideration of the Second Report and
Order (the "1999 Payphone Order"), in which the FCC abandoned its efforts to
derive a "market-based" default dial-around compensation rate and instead
adopted a "cost-based" rate of $0.24 per dial-around call, which will be
adjusted to $0.238 effective April 21, 2002. Both PSPs and IXCs petitioned the
Court for review of the 1999 Payphone Order's determination of the dial-around
compensation rate. On June 16, 2000, the Court affirmed the 1999 Payphone Order
setting a 24-cent dial-around compensation rate. On all the issues, including
those raised by the IXCs and the payphone providers, the Court applied the
"arbitrary and capricious" standard of review and found that the FCC's rulings
were lawful and sustainable under that standard. The new 24-cent rate became
effective April 21, 1999. The 24-cent rate will also be applied retroactively to
the period beginning on October 7, 1997 and ending on April 20, 1999 (the
"intermediate period"), less a $0.002 amount to account for FLEX ANI payphone
tracking costs, for a net compensation of $0.238.
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 interim period only, to reflect a different method of
calculating the delay in IXC payments to PSPs for the interim period, and
determined that the total interim period compensation rate should be $33.89 per
payphone per month ($.229 times an average of 148 calls per payphone per month).
The 2002 Payphone Order deferred to a later order its determination of the
allocation of this total compensation rate among the various carriers required
to pay compensation for the interim period. In addition to addressing the rate
level for dial-around compensation, the FCC has also addressed the issue of
carrier responsibility with respect to dial-around compensation payments.
On October 23, 2002 the FCC released its Fifth Order on
Reconsideration and Order on Remand (the "Interim Order"), which resolved all
the remaining issues surrounding the interim/intermediate period true-up and
specifically 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
without (1) prior notification and an opportunity to contest the claimed amount
in good faith (only uncontested amounts may be withheld); and (2) providing PSPs
an opportunity to "schedule" payments over a reasonable period of time.
10
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 representing the estimated amount due by the Company to certain dial-around
carriers under the Interim Order. Of this amount, $3.6 million and $3.8 million
is included in accounts payable and other accrued expenses in the accompanying
consolidated balance sheets at December 31, 2003 and 2002, respectively. In
January 2004, certain carriers deducted approximately $0.7 million from their
current dial-around compensation payments, thus reducing this liability. The
remaining amount outstanding is expected to be deducted from future quarterly
payments of dial-around compensation to be received from the applicable
dial-around carriers during 2004.
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 16 to the
consolidated financial statements). 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 and $0.4 million of net receipts from
other carriers under the Interim Order that was recognized as revenue in the
third and fourth quarters of 2003, respectively. Such revenues totaling $8.3
million have been reported as dial-around compensation adjustments in the
accompanying consolidated statements of operations for the year ended December
31, 2003. The Company also estimates that it is entitled to receive in excess of
$10.0 million of additional dial-around compensation from certain carriers, of
which $1.2 million was received and will be recognized as revenue subsequent to
December 31, 2003 under the Company's accounting policy. 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.
Effect of Federal Regulation of Local Coin and Dial-Around Calls
Dial-Around Calls. Based on the FCC's tentative conclusion in the 1997
Payphone Order, the Company during 1997 adjusted the amounts of dial-around
compensation previously recorded for the period November 7, 1996 to June 30,
1997 from the initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131
calls). As a result of this adjustment, the provision recorded for the year
ended December 31, 1997, related to reduced dial-around
11
compensation, is approximately $3.3 million. Based on the reduction in the
per-call compensation rate in the 1999 Payphone Order, the Company further
reduced non-coin revenues by $9.0 million during 1998. The adjustment included
approximately $6.0 million to adjust revenue recorded during the period November
7, 1996 to October 6, 1997 from $37.20 per-phone per-month to $31.18 per phone
per month ($0.238 per call multiplied by 131 calls). The remaining $3.0 million
of the adjustment was to adjust revenues recorded during the period October 7,
1997 through December 31, 1998 to actual dial-around call volumes for the period
multiplied by $0.238 per call. Based upon the Company's estimate of the
liability to certain carriers under the Interim Order, the Company recorded an
adjustment to reduce revenues from dial-around compensation by $3.8 million for
the year ended December 31, 2002. In 2003, the Company recognized additional
revenues of $8.3 million for adjustments to dial-around compensation relating to
the Interim Order.
The Company recorded dial-around compensation revenue, including
adjustments under the Interim Order, of approximately $21.5 million for the year
ended December 31, 2003; $11.5 million for the year ended December 31, 2002; and
$19.1 million for the year ended December 31, 2001.
The Company believes that it is legally entitled to fair compensation
under the 1996 Telcom Act for dial-around calls the Company delivered to any
carrier during the period November 7, 1996 to October 6, 1997. While the amount
of $0.24 per call ($0.238 before April 21, 2002) constitutes the current level
of "fair" compensation, as determined by the FCC, certain carriers have asserted
in the past, are asserting and are expected to assert in the future that the
appropriate level of fair compensation should be lower than $0.24 per call. If
the level of fair compensation is ultimately determined to be an amount less
than $0.24 per call, such determination could have a material adverse effect on
the Company's results of operations and financial position.
Local Coin Call Rates. To ensure "fair compensation" for local coin
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 that upheld the FCC's authority to deregulate local coin call rates. In
accordance with the FCC's ruling and the court order, certain LECs and IPPs,
including the Company, have increased rates for local coin calls. Initially,
when the Company increased the local coin rate to $0.35, the Company experienced
a large drop in call volume, which coincides with the Cellular "one-rate" plan
introduction. When the Company subsequently raised its local coin rates to
$0.50, it did not experience call volume declines at the same levels. The
Company has experienced, and continues to experience, lower coin call volumes on
its payphones resulting not only from increased local coin calling rates, but
from the growth in wireless communication services, changes in call traffic and
the geographic mix of the Company's payphones, as well.
Other Provisions of The 1996 Telecom Act and FCC Rules
As a whole, the 1996 Telecom Act and FCC Rules significantly altered
the competitive framework of the payphone industry. The Company believes that
implementation of the 1996 Telecom Act has addressed certain historical
inequities in the payphone marketplace and has, in part, led to a more equitable
and competitive environment for all payphone providers. However, there remain
several key areas of implementation of the 1996 Telecom Act yet to be fully and
properly implemented such that the 1996 congressional mandate for widespread
deployment of payphones is not being realized. This circumstance creates an
uncertain environment in which the Company and the industry must operate. The
Company has identified the following such uncertainties:
- Various matters pending in several federal courts and raised
before the Congress which, while not directly challenging
Section 276, relate to the validity and constitutionality of
the 1996 Telecom Act, as well as other uncertainties related
to the impact, timing and implementation of the 1996 Telecom
Act.
- The 1996 Payphone Order required that LEC payphone operations
be removed from the regulated rate base on April 15, 1997. The
LECs were also required to make the access lines that are
provided for their own payphones equally available to IPPs and
to ensure that the cost to payphone providers for obtaining
local lines and services met the FCC's new services test
guidelines, which require that LECs price payphone access
lines at the direct cost to the LEC plus a reasonable
allocation of overhead. Proceedings are still pending
12
in various stages and formats before the FCC and numerous
state regulatory bodies across the nation to implement these
provisions.
- In the past, RBOCs were allegedly impaired in their ability to
compete with the IPPs because they were not permitted to
select the interLATA carrier to serve their payphones. Recent
changes to the FCC Rules remove this restriction. Under the
existing rules, the RBOCs are now permitted to participate
with the Location Owner in selecting the carrier of interLATA
services to their payphones, effective upon FCC approval of
each RBOC's Comparably Efficient Interconnection plans.
Existing contracts between Location Owners and payphone or
long-distance providers that were in effect as of February 8,
1996 were grandfathered and will remain in effect pursuant to
their terms.
- The 1996 Payphone Order preempts state regulations that may
require IPPs to route intraLATA calls to the LEC by containing
provisions that allow all payphone providers to select the
intraLATA carrier of their choice. Outstanding questions still
exist with respect to 0+ local and 0 - call routing, whose
classification will await the outcome of various state
regulatory proceedings or initiatives and potential FCC
action.
- The 1996 Payphone Order determined that the administration of
programs for maintaining public interest payphones should be
left to the states within certain guidelines. Various state
proceedings have been undertaken in reviewing this issue, but
no widespread or effective actions have been taken to stem the
tide of payphone removal around the nation. The FCC has
pending various "universal service" proposals under
consideration which may impact the Company, both positively
and negatively.
Billed Party Preference and Rate Disclosure
On January 29, 1998, the FCC released its Second Report and Order on
Reconsideration entitled In the Matter of Billed Party Preference for InterLATA
0+ Calls, Docket No. 92-77. Effective July 1, 1998, all carriers providing
operator services were required to give consumers using payphones the option of
receiving a rate quote before a call is connected when making a 0+ interstate
call. The system appears to be functioning adequately to meet its designated
goals.
State and Local Regulation
State regulatory authorities have been primarily responsible for
regulating the rates, terms and conditions for intrastate payphone services.
Regulatory approval to operate payphones in a state typically involves
submission of a certification application and an agreement by the Company to
comply with applicable rules, regulations and reporting requirements. The states
and the District of Columbia have adopted a variety of state-specific
regulations that govern rates charged for coin and non-coin calls, as well as a
broad range of technical and operational requirements. The 1996 Telecom Act
contains provisions that require all states to allow payphone competition on
fair terms for both LECs and IPPs. State authorities also in most cases regulate
LEC tariffs for interconnection of independent payphones, as well as the LECs'
own payphone operations and practices.
The Company is also affected by state regulation of operator services.
Most states have capped the rates that consumers can be charged for coin toll
calls and non-coin local and intrastate toll calls made from payphones. In
addition, the Company must comply with regulations designed to afford consumers
notice at the payphone location of the long-distance company or companies
servicing the payphone and the ability to access alternate carriers. The Company
believes that it is currently in material compliance with all such regulatory
requirements.
In accordance with requirements under the 1996 Telecom Act, state
regulatory authorities are currently reviewing the rates that LECs charge IPPs
for local line access and associated services. Local line access charges have
been reduced in certain states, and the Company believes that selected states'
continuing review of local line access charges, coupled with competition for
local line access service resulting from implementation of the 1996 Telecom Act,
may lead to more options available to the Company for local line access at
competitive rates. The Company cannot provide assurance, however, that such
options or local line access rates will become available in all states.
13
The Company believes that an increasing number of municipalities and
other units of local government have begun to impose taxes, license fees and
operating rules on the operations and revenues of payphones. The Company
believes that some of these fees and restrictions may be in violation of
provisions of the 1996 Telecom Act prohibiting barriers to entry into the
business of operating payphones and the policy of the Act to encourage wide
deployment of payphones. However, in at least one instance, involving a
challenge to a payphone ordinance adopted by the Village of Huntington Park,
California, the FCC declined to overturn a total ban on payphones in a downtown
area. The proliferation of local government licensing, restriction, taxation and
regulation of payphone services could have an adverse affect on the Company and
other PSPs unless the industry is successful in resisting or moderating this
trend.
MAJOR CUSTOMERS
No individual customer accounted for more than 10% of the Company's
consolidated revenues in 2003, 2002 or 2001.
COMPETITION
The Company competes for payphone locations directly with LECs and
other IPPs. The Company also competes, indirectly, with long-distance companies,
which can offer Location Owners commissions on long-distance calls made from
LEC-owned payphones. Most LECs and long-distance companies against which the
Company competes and some IPPs may have substantially greater financial,
marketing and other resources than the Company. In addition, many LECs, faced
with competition from the Company and other IPPs, have increased their
compensation arrangements with Location Owners to offer more favorable
commission schedules.
The Company believes that the competitive factors among payphone
providers are (1) the commission payments to a Location Owner, (2) the ability
to serve accounts with locations in several LATAs or states, (3) the quality of
service and the availability of specialized services provided to a Location
Owner and payphone users, and (4) responsiveness to customer service needs. The
Company believes it is currently competitive in each of these areas.
The Company competes with long-distance carriers that provide
dial-around services which can be accessed through the Company's payphones.
Certain national long-distance operator service providers and prepaid calling
card providers have implemented extensive advertising promotions and
distribution schemes which have increased dial-around activity on payphones
owned by LECs and IPPs, including the Company, thereby reducing traffic to the
Company's primary providers of long-distance service.
Notwithstanding the foregoing, the Company believes that its principal
competition is from providers of wireless communications services for both local
and long distance traffic. Certain providers of wireless communication services
have introduced rate plans that are competitively priced with certain of the
products offered by the Company and have negatively impacted the usage of
payphones throughout the nation.
EMPLOYEES
As of December 31, 2003, the Company had 293 full-time employees, none
of whom are the subject of a collective bargaining agreement. The Company
believes that its relationship with its employees is good.
ITEM 2. PROPERTIES
The Company leases approximately 16,668 square feet of space in
Cleveland, Ohio for executive office space. The Company also leases space for
its 17 district offices for payphone operations in various geographic locations
across the country. In the fourth quarter of 2003 and the first quarter of 2004,
the Company has closed 14 field offices and the payphones previously managed by
those offices are now being serviced by sub-contractors (see Note 5 to the
consolidated financial statements for exit and disposal activities).
14
ITEM 3. LEGAL PROCEEDINGS
In March 2000, the Company and its affiliate Telaleasing Enterprises,
Inc. were sued in Maricopa County, Arizona Superior Court by CSK Auto, Inc.
("CSK"). The suit alleges that the Company breached a location agreement between
the parties. CSK's complaint 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 December 31, 2003, the Company has fully satisfied the obligation.
In February 2001, Picus Communications, LLC ("Picus"), a debtor in
Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern
District of Virginia, brought suit against Davel and its wholly owned
subsidiary, Telaleasing Enterprises, Inc., in the United States District Court
for the Eastern District of Virginia, claiming unpaid invoices of over $600,000
for local telephone services in Virginia, Maryland, and the District of
Columbia. The various pleadings and claims in this matter were consolidated in
an adversary proceeding and set for trial to begin on October 21, 2002. Prior to
the commencement of the trial, on October 9, 2002 Picus filed a motion in the
bankruptcy court to seek court approval of a settlement of all outstanding
claims between the parties. The settlement provides that (i) Picus will
cooperate with the Company to recover certain dial-around compensation
potentially owed to the Company for the calendar year of 2000 and the first
calendar quarter of 2001, (ii) within ten days after entry of an order approving
the settlement and December 15, 2002, the Company was required to and has paid
Picus $79,500, (iii) the Company paid Picus an additional $150,000 that was due
no later than May 15, 2003; and (iv) the Company will pay Picus forty percent
(40%) of the dial-around compensation for the calendar year of 2000 attributable
to the Picus lines, if any. If any of the aforementioned payments are not timely
paid by the Company, Picus will be entitled to obtain a judgment against Davel
for the full amount of its claim against the Company, plus interest, less any
amounts actually paid to Picus under the settlement agreement. As of December
31, 2003, the Company has fully satisfied the obligation
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 has been forwarded to
Davel's insurance carrier for action. The parties are currently engaged in the
discovery process and the trial is scheduled for June 2004. While Davel believes
that it has meritorious defenses to the allegations contained in the second
amended complaint and intends to vigorously defend itself, Davel cannot at this
time predict its likelihood of success on the merits.
The Company is also a party to a contract with Sprint Communications
Company, L.P. ("Sprint") that provides for the servicing of operator-assisted
calls. Under this arrangement, Sprint has assumed responsibility for tracking,
rating, billing and collection of these calls and remits a percentage of the
gross proceeds to the Company in the form of a monthly 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,
15
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.
The Company is involved in other litigation arising in the normal
course of its business which it believes will not materially affect its
financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December
31, 2003, no matters were submitted to a vote of the Company's shareholders.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Information. Davel Common Stock trades on the NASDAQ
over-the-counter bulletin board under the symbol `DAVL.OB'. The following table
sets forth, for the periods indicated, the high and low closing prices of Davel
Common Stock on the NASDAQ National Market System, or bulletin board system,
from January 1, 2002 through December 31, 2003.
HIGH LOW
---- ---
2002
First Quarter............................................................................ $ 0.05 $ 0.02
Second Quarter........................................................................... 0.04 0.02
Third Quarter............................................................................ 0.05 0.03
Fourth Quarter........................................................................... 0.04 0.01
2003
First Quarter............................................................................ $ 0.01 $ 0.01
Second Quarter........................................................................... 0.02 0.01
Third Quarter............................................................................ 0.03 0.01
Fourth Quarter........................................................................... 0.05 0.02
As of March 25, 2004, there were approximately 1,623 holders of record
of the Common Stock, not including stockholders whose shares were held in
"nominee" or "street" name. The closing sale price of the Company's Common Stock
on March 25, 2004 was $0.015 per share.
16
Dividends. The Company did not pay any dividends on its Common Stock
during 2002 and 2003 and does not intend to pay any Common Stock dividends in
the foreseeable future. It is the current policy of the Company's Board of
Directors to retain cash to repay indebtedness and to finance the growth and
development of the Company's business. The payment of dividends is effectively
prohibited by the Company's Junior Credit Facility. Payment of cash dividends,
if made in the future, will be determined by the Company's Board of Directors
based on the conditions then existing, including the Company's financial
condition, capital requirements, cash flow, profitability, business outlook and
other factors.
Recent Sales of Unregistered Securities. In the year ended December 31,
2003, the Company did not sell any securities that were not registered under the
Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of the Company. The data should be read in conjunction with
the consolidated financial statements, related notes thereto and other financial
information included herein.
YEAR ENDED DECEMBER 31
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
-------------------------------------------------------------
2003 2002 (2) 2001 2000 1999
--------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Revenue .......................................... $ 81,773 $ 76,952 $ 90,618 $ 126,271 $ 175,846
Expenses ......................................... 94,166 93,385 106,620 168,581 184,011
Asset Impairment Charges (1) ..................... 27,141 -- -- 42,032 48,924
--------- --------- --------- --------- ---------
Operating loss ................................... (39,534) (16,433) (16,002) (84,342) (57,089)
Interest and other expense, net .................. (6,657) (12,793) (27,412) (27,138) (23,412)
Income taxes ..................................... -- -- -- -- 1,755
Gain from extinguishment of debt ................. -- 180,977 -- -- --
--------- --------- --------- --------- ---------
Net income (loss) ................................ $ (46,191) $ 151,751 $ (43,414) $(111,480) $ (78,746)
========= ========= ========= ========= =========
Basic and diluted income (loss) per share:
Net income (loss) ................................ $ (0.08) $ 0.56 $ (3.89) $ (10.02) $ (7.40)
========= ========= ========= ========= =========
Weighted average common shares
outstanding, basic and diluted ................. 615,019 272,598 11,169 11,126 10,660
BALANCE SHEET DATA:
Total assets ..................................... $ 50,322 $ 106,616 $ 68,325 $ 93,187 $ 180,761
Current maturities of long-term debt and
obligations under capital leases ............... 1,994 11,449 237,726 239,083 21,535
Long-term debt and obligations under capital
leases, less current maturities ................ 125,962 118,229 308 839 206,509
Shareholders' deficit ............................ (102,501) (56,310) (229,813) (186,392) (75,079)
- ---------------
(1) The years ended December 31, 2003, 2000, and 1999 include asset
impairment charges associated with goodwill and fixed assets of
$27,141, $42,032, and $48,924, respectively.
(2) The year ended December 31, 2002 includes the results of PhoneTel
Technologies, Inc. from the date of the PhoneTel acquisition, July 24,
2002.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
Certain of the statements contained below are forward-looking
statements (rather than historical facts) that are subject to risks and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements.
17
GENERAL
During 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 payphone. 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, 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 one pre-programmed into the telephone or to make a traditional "toll free"
call (dial-around calls). Revenues from dial-around calls are recognized based
on estimates of calls made using most recent actual historical data and the
Federal Communications Commission mandated dial-around compensation rate in
effect. This is commonly referred to as "dial-around" access. See "Business --
Regulation."
The principal costs related to the ongoing operation of the Company's
payphones include telephone charges, commissions, service, maintenance and
network costs. Telephone charges consist of payments made by the Company to LECs
and long distance carriers for line charges and use of their networks.
Commission expense represents payments to Location Owners. Service, maintenance
and network costs represent the cost of servicing and maintaining the payphones
on an ongoing basis.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
information from the Company's Consolidated Statements of Operations, included
elsewhere in this Annual Report on Form 10-K, expressed as a percentage of total
revenues.
YEARS ENDED DECEMBER 31
-------------------------
2003 2002 2001
----- ------ ------
REVENUES:
Coin calls.......................................................... 61.3% 74.0% 68.1%
Non-coin calls...................................................... 28.5 31.0 31.9
Dial-around compensation adjustments................................ 10.2 (5.0) --
----- ----- -----
Total revenues...................................................... 100.0 100.0 100.0
----- ----- -----
COSTS AND EXPENSES:
Telephone charges................................................... 28.2 25.2 32.6
Commissions......................................................... 16.6 20.5 24.5
Service, maintenance and network costs.............................. 29.4 29.9 26.0
Depreciation and amortization....................................... 26.3 26.5 21.2
Selling, general and administrative................................. 13.7 15.5 13.4
Asset impairment charges............................................ 33.2 -- --
Exit and disposal activities........................................ 1.0 3.8 --
----- ----- -----
Total operating costs and expenses 148.4 121.4 117.7
----- ----- -----
Operating loss...................................................... (48.4)% (21.4)% (17.7)%
===== ===== =====
Critical Accounting Policies and Estimates
The Company's reported results of operations can be affected by the use
of estimates and the Company's critical accounting policies. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates, among others,
include amounts relating to the carrying values of the Company's accounts
receivable, payphone assets and location contracts and the related revenues and
expenses applicable to dial-around compensation and asset impairment. Actual
results could differ from those estimates.
18
Revenues from coin calls, reselling operator assisted and long distance
services, and compensation for dial-around calls are recognized in the period in
which the customer places the related call. The recognition of dial-around
revenues require complex and often subjective estimation processes that are
largely predicated on the Company's historical operating experience. In addition
certain costs and expenses, such as commissions, require the use of revenue
estimates in the accounting process. Significant differences in our actual
dial-around experience could affect these estimates. The FCC has the authority
pursuant to the Telecommunications Act of 1996 to affect rates related to
revenue from dial-around compensation, including retroactive rate adjustments
and refunds. (See "Business - Regulation"). Rate adjustments arising from FCC
rate actions that require refunds to interexchange or other carriers are
recorded in the first period that they become both probable of payment and
estimable in amount. Rate adjustments that result in payments to the Company by
interexchange or other carriers are recorded when received.
Under the Company's accounting policy relating to asset impairment, the
Company periodically reviews long-lived assets to be held and used and goodwill
for impairment whenever events or changes in circumstances indicate the asset
may be impaired and, as to goodwill, at least annually. The Company evaluates
potential impairment of long-lived assets, other than goodwill, based upon the
cash flows derived from each of the Company's operating districts, the lowest
level for which operating cash flows for such asset groupings are identifiable.
A loss relating to an impairment of assets occurs when the aggregate of the
estimated undiscounted future cash inflows expected to be generated by the
Company's asset groups (including any salvage values) are less than the related
assets' carrying value. Impairment is measured based on the difference between
the higher of the fair value of the assets or present value of the discounted
expected future cash flows and the assets' carrying value. The Company considers
impairment of goodwill whenever the carrying value of the Company's net assets,
after taking into account any impairment charges described above, exceeded the
fair value of the Company, which amount is based upon the present value of
expected future cash flows of the Company. In the event that the fair value of
the Company including goodwill exceeds the carrying value, the Company
calculates the implied value of the goodwill following the methodology provided
in Statements on Financial Accounting Standards No. 142, "Intangible Assets".
The excess carrying value of goodwill over its implied value, if any, results in
an impairment charge. No impairment was incurred in 2002 and 2001. The Company
incurred asset impairment losses relating to its payphones, location contracts
and goodwill of $27.1 million in 2003 (see Note 3 to the consolidated financial
statements).
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
On July 24, 2002, the Company acquired approximately 28,000 payphones
in connection with the PhoneTel Merger. Operating results for 2002 include the
revenues and expenses associated with these payphones for the period following
July 24, 2002. Operating results for 2003 include the revenues and expenses
relating to these payphones for the full twelve months of 2003. Offsetting the
additional revenue and expense amounts in the later part of 2002 and in 2003
arising from the acquisition of PhoneTel is the reduction in revenues and
expenses resulting from the decline in the Company's phone count and cost
containment efforts. The Company's had approximately 47,000 phones in service on
December 31, 2003 and approximately 69,000 phones in service on December 31,
2002. However, the average number of payphones in service for the years ended
December 31, 2003 and 2002 was approximately 59,800 and 62,000, respectively.
This decrease in the average number of payphones in 2003 is partly due to the
Company's increasingly aggressive program to remove low revenue phones and
partly due to a loss in customer locations.
Total revenues increased approximately $4.8 million, or 6.2%, from
approximately $77.0 million in the year ended December 31, 2002 to approximately
$81.8 million in the year ended December 31, 2003. This increase was primarily
attributable to the dial-around compensation adjustments offset by lower coin
and non-coin call revenues as discussed below.
Coin call revenues decreased approximately $6.9 million, or 12.1%, from
approximately $57.0 million in the year ended December 31, 2002 to approximately
$50.1 million in the year ended December 31, 2003. The decrease in coin call
revenues was due to the reduction in the average number of payphones in service
in 2003 and lower call volumes. Notwithstanding the PhoneTel Merger, the average
number of payphones declined due to the removal of unprofitable phone locations
and lower call volumes resulted from the increased competition from wireless and
other public communication services.
19
Non-coin call revenues, which is comprised primarily of dial-around
revenue and operator service revenue, decreased approximately $0.5 million, or
2.1%, from approximately $23.8 million in the year ended December 31, 2002 to
approximately $23.3 million in the year ended December 31, 2003. This decrease
was primarily attributable to a decrease in dial-around revenues offset by an
increase in operator service and other revenues. Dial-around revenue decreased
approximately $2.1 million, from approximately $15.3 million in the year ended
December 31, 2002 to approximately $13.2 million in the year ended December 31,
2003. The dial-around decrease is primarily attributable to reductions the
average number of payphones and the average number of dial-around calls due to
competition from wireless communication services and the continuing
underpayments of dial-around revenues by IXCs caused by deficiencies in the
established payment and tracking process. Long-distance revenues increased
approximately $0.5 million, from approximately $7.3 million in the year ended
December 31, 2002 to approximately $7.8 million in the year ended December 31,
2003. This increase is primarily due to a change in operator service providers
for a portion of the Company's payphone base that pays commission on gross
billings at a higher rate than the Company's former operator service provider.
Non-coin call revenues also includes other revenue, which increased
approximately $1.1 million from approximately $1.2 million in the year ended
December 31, 2002 to approximately $2.3 million in the year ended December 31,
2003. This increase relates primarily to telephone installation and repair
services provided to a former related party, which services were discontinued in
October 2003.
During the year ended December 31, 2003, the Company recorded $8.3
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 15 to the
consolidated financial statements). This adjustment included the sale of a
portion of the Company's accounts receivable bankruptcy claim due from WorldCom.
Of the proceeds received in 2003, $3.9 million related to the amount due from
WorldCom under the Interim Order applicable to dial-around compensation (see
Note 16 to the consolidated financial statements). In 2002, the Company recorded
a $3.8 million charge as a dial-around compensation adjustment for estimated
overpayments made by certain dial-around carriers under the FCC's Interim Order.
Although the Company estimates that it is entitled to receive additional amounts
in excess of $10.0 million relating to underpayments made by other carriers,
there can be no assurance that the Company will be able to collect these amounts
from those carriers. Any such refunds will be recognized as revenue in the
period such revenues are received.
Telephone charges increased approximately $3.6 million, or 18.6%, from
approximately $19.4 million in the year ended December 31, 2002 to approximately
$23.0 million in the year ended December 31, 2003. This increase is primarily
due to a reduction in regulatory refunds from LECs relating to the "New Services
Test" and end user common line charges ("EUCL charges") that are classified as
reductions in telephone charges in the Company's consolidated statements of
operations (see Note 16). The Company recorded $2.2 million of such refunds in
2003 compared to $7.7 of regulatory refunds in 2002. Without these refunds
telephone charges would have declined by $1.9 million, or 7.0%, primarily due to
a reduction in the average number payphones in service and lower line charges
resulting from the use of competitive local exchange carriers ("CLECs"). The
Company has executed additional contracts with LECs and CLECs and is 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 $2.2 million, or 13.9%, from
approximately $15.8 million in the year ended December 31, 2002 to approximately
$13.6 million in the year ended December 31, 2003. The decrease was primarily
attributable to lower commissionable revenues (as a result, in part, to a
decline in the average number of payphones) in 2003 and management actions to
re-negotiate contracts with lower rates upon renewal. The Company continues to
actively review its strategies related to contract renewals in order to maintain
its competitive position while retaining its customer base.
Service, maintenance and network costs increased approximately $1.0
million, or 4.3%, from approximately $23.0 million in the year ended December
31, 2002 to approximately $24.0 million in the year ended December 31, 2003.
This increase was primarily attributable to the additional cost associated with
the combined field organizations following the PhoneTel Merger. Field operating
costs of PhoneTel were included in service, maintenance and network costs for
twelve months in 2003 compared to five months in 2002. In 2003, the Company
implemented several cost reduction measures, including a substantial reduction
in the Company's workforce. In the fourth quarter of 2003 and the first quarter
of 2004, the Company also began to outsource the service, collection and
maintenance
20
of its payphones in certain higher cost districts. While the Company believes
these changes will have a favorable impact on operating results in 2004, no
assurances can be given regarding such effect.
Depreciation and amortization expenses increased $1.1 million, or 5.4%,
from $20.4 million in the year ended December 31, 2002 to $21.5 million in the
year ended December 31, 2003. This increase in expense is primarily a result of
depreciation and amortization of the assets acquired in the PhoneTel Merger
offset in part by lower depreciation and amortization due to the removal of
unprofitable payphones and the write-down in asset value relating to the
impairment charges described below.
Selling, general and administrative expenses decreased approximately
$0.8 million, or 6.7%, from approximately $12.0 million in the year ended
December 31, 2002 to approximately $11.2 million in the year ended December 31,
2003. The decrease was primarily attributable to a reduction in expenses
relating to the relocation of the Company's Corporate headquarters from Tampa,
Florida to Cleveland, Ohio following the PhoneTel Merger offset by an increase
in professional fees of approximately $1.0 million. An increase in professional
fees was due in part to legal and financial advisory fees incurred in 2003 in
connection with the evaluation of financial and strategic alternatives available
to the Company.
The cost relating to exit and disposal activities decreased by $2.1
million, or 72.4%, from $2.9 million in the year ended December 31, 2002 to
approximately $0.8 million in the year ended December 31, 2003. In connection
with the Company's plans to outsource certain payphone service, repair and
warehousing functions, the Company closed its warehouse and repair facility in
Tampa, Florida and eleven district office facilities during 2003. The Company
incurred lease termination, severance and other closing costs relating to these
facilities. In connection with the PhoneTel Merger in 2002, the Company
relocated it corporate headquarters from Tampa, Florida to Cleveland, Ohio. In
September 2002, the Company terminated its former headquarters facility lease,
abandoned or disposed of certain furniture, fixtures and leasehold improvements,
and incurred severance costs related to the termination of certain employees.
All exit activities relating to the Company's former headquarters were completed
prior to December 31, 2002.
Asset impairment losses totaling $27.1 million were incurred in the
year ended December 31, 2003. The loss consisted of a $9.6 million write-down in
the carrying value of the Company's payphone assets and location contracts and a
$17.5 million write-off of goodwill in accordance with SFAS No. 144 and SFAS No.
142, respectively (see Note 3 to the consolidated financial statements). These
impairment charges were recorded in the second quarter of 2003. Management
reevaluated the Company's projected performance and reached the conclusion that
financial results would not be sufficient to support the full carrying amount of
the assets. No comparable loss was incurred in the year ended December 31, 2002.
Interest expense in the year ended December 31, 2003 decreased
approximately $6.4 million, or 49.2%, from approximately $13.0 million in the
year ended December 31, 2002 to approximately $6.6 million in the year ended
December 31, 2003. This decrease is primarily due to the reduction in
indebtedness resulting from the debt restructuring described below (see Note 4
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 and recording all future payments at the time of the
restructuring. In connection with this debt restructuring, the Company also
recognized a gain of approximately $181.0 million in 2002 resulting from the
extinguishment of the Company's former credit facility (the "Old Credit
Facility").
Other income (expense) decreased approximately $342,000 to $98,000 in
expense in the year ended December 31, 2003 from $244,000 of income in the year
ended December 31, 2002. The decrease is primarily due to losses attributable to
the sale of assets in 2003, including a $192,000 loss on the sale of payphone
assets relating to three unprofitable districts in the northern Midwest states.
For the year ended December 31, 2003, the Company had a net loss of
$46.2 million compared to net income of $151.8 million for the year ended
December 31, 2002. The 2003 net loss included asset impairment charges of $27.1
million relating to the write-down in the carrying value of the Company's
payphone assets and goodwill. Net income in 2002 included a gain on debt
extinguishment totaling $181.0 million relating to the debt restructuring
described above. Without these items, the Company would have had a net loss of
$19.1 million in 2003 compared to $29.2 million in 2002.
21
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
On July 24, 2002, the Company acquired approximately 28,000 phones in
the PhoneTel Merger. The revenues and expenses associated with these phones for
the period of July 24 to December 31, 2002 are included in the results of
operations for the year ended December 31, 2002. Offsetting these revenue and
expense increases in the latter part of 2002 is the reduction in revenues and
expenses resulting from the impact of the Company's ongoing program to remove
unprofitable phones and the effects of implementing the PhoneTel Merger
servicing agreement. The servicing agreement, which was implemented in the third
quarter of 2001 in anticipation of the PhoneTel Merger, was designed to commence
cost savings prior to the merger by combining field service operations on a
geographic basis to gain efficiencies resulting from the increased concentration
of payphone service routes.
The Company operated approximately 14,000 more phones on December 31,
2002 than on December 31, 2001, net of the phones acquired in the PhoneTel
Merger and the program to remove unprofitable phones. The Company's had
approximately 69,000 phones in service on December 31, 2002 and approximately
55,000 phones in service on December 31, 2001. However, the average number of
phones in service for the years ended December 31, 2002 and 2001 was
approximately 62,000 for both the years due to the 2001 reduction in phones
resulting from the Company's ongoing program to remove low revenue phones.
Total revenues decreased approximately $13.6 million, or 15.1%, from
approximately $90.6 million in the year ended December 31, 2001 to approximately
$77.0 million in the year ended December 31, 2002. This decrease was primarily
attributable to the removal of unprofitable phone locations, lower call volumes
on the Company's payphones resulting from the growth in wireless and other
public communication services, and changes in call traffic. This decrease was
also due to the dial-around compensation adjustment described below.
Coin call revenues decreased approximately $4.7 million, or 7.7%, from
approximately $61.7 million in the year ended December 31, 2001 to approximately
$57.0 million in the year ended December 31, 2002. The decrease in coin call
revenues was primarily attributable to lower call volumes on the Company's
payphones due to increased competition from wireless and other public
communication services and the impact of increasing the coin call rate from
$0.35 to $0.50 beginning November 2001. The decrease in call volume was
partially offset by the increase in the coin call rate.
Non-coin call revenues, which is comprised primarily of dial-around
revenue and operator service revenue, decreased approximately $5.2 million, or
17.8%, from approximately $29.0 million in the year ended December 31, 2001 to
approximately $23.8 million in the year ended December 31, 2002. This decrease
was primarily attributable to lower call volumes on the Company's payphones
resulting from the growth in wireless communication services and changes in call
traffic. Dial-around revenue decreased approximately $3.8 million, from
approximately $19.1 million in the year ended December 31, 2001 to approximately
$15.3 million in the year ended December 31, 2002. The dial-around decrease is
primarily attributable to reductions in the number of dial-around calls due to
competition from wireless communication services and the continuing
underpayments of dial-around revenues caused by deficiencies in the established
payment and tracking process. The decrease in dial-around revenue is also due to
a $0.9 million reduction relating to the WorldCom bankruptcy filing in July
2002. Long-distance revenues decreased approximately $2.5 million, from
approximately $9.8 million in the year ended December 31, 2001 to approximately
$7.3 million in the year ended December 31, 2002 due to lower call volumes for
the reasons stated above. Operator services are provided by third parties that
pay Davel a commission on their gross billings. Non-coin call revenues also
includes other revenue, which increased approximately $1.1 million from
approximately $0.1 million in the year ended December 31, 2001 to approximately
$1.2 million in the year ended December 31, 2002. This increase relates
primarily to telephone installation and repair services provided to a former
related party.
In 2002, the Company recorded a $3.8 million dial-around compensation
adjustment for estimated overpayments by certain IXCs that were received by the
Company in prior years. There was no comparable charge in 2001 relating to the
industry-wide true-up among payphone providers and long-distance carriers
pursuant to the FCC's Interim Order. See note 15 to the consolidated financial
statements.
Telephone charges decreased approximately $6.4 million, or 22.7%, from
approximately $29.6 million in the year ended December 31, 2001 to approximately
$23.2 million in the year ended December 31, 2002. The decrease
22
is due lower line charges resulting from the use of competitive local exchange
carriers ("CLECs"), regulatory changes resulting in lower rates charged by LECs,
and other management actions to attain lower rates. Telephone charges in 2002
were also impacted by refunds totaling $3.1 million received from BellSouth for
prior period charges pursuant to a recently adopted "New Service Test" in
Tennessee, $3.8 million of "New Services Test" refunds in North Carolina and
Maryland, other LEC refunds from prior periods resulting from regulatory rulings
of $0.8 million, and a favorable adjustment related to a litigation settlement
of $0.8 million. LEC refunds received as a result of regulatory rulings in 2001
totaled $2.4 million. A $1.3 million charge in 2002 and a $0.7 million charge in
2001 associated with the settlement of a dispute with MCI partially offset these
savings.
Commissions decreased approximately $6.4 million, or 28.9%, from
approximately $22.2 million in the year ended December 31, 2001 to approximately
$15.8 million in the year ended December 31, 2002. The decrease was primarily
attributable to lower commissionable revenues and management actions to
re-negotiate contracts with lower rates upon renewal. Commissions for the year
ended December 31, 2002 were also favorably impacted by lower commission rates
relating to PhoneTel location contracts and favorable adjustments of $0.6
million resulting from contract terminations. The Company continues to actively
review its strategies related to contract renewals in order to maintain its
competitive position while retaining its customer base.
Service, maintenance and network costs decreased approximately $0.5
million, or 2.2%, from approximately $23.5 million in the year ended December
31, 2001 to approximately $23.0 million in the year ended December 31, 2002. The
decrease was primarily attributable to the additional payphones and related
expenses resulting from the PhoneTel Merger offset by the effects of savings
generated from rationalization of field offices, increased geographic and route
density of the payphones, and the Company's ability to improve efficiency on
servicing the Company's payphones. Decreases in network billing costs (primarily
payphone polling costs) of $0.9 million and district office expenses of $0.4
million were offset by an increase in vehicle insurance expense of $1.1 million.
Net decreases of $0.3 million in a variety of other expense items comprised the
remaining changes.
Depreciation and amortization expenses increased $1.2 million, or 6.2%,
from $19.2 million in the year ended December 31, 2001 to $20.4 million in the
year ended December 31, 2002. The increase in expense is primarily a result of
depreciation and amortization of the assets acquired in the PhoneTel Merger
offset by lower depreciation and amortization due to the program to remove
unprofitable payphones and, to a lesser extent, the write-off of assets upon
relocation of the Company's former headquarters from Tampa, Florida to
Cleveland, Ohio following the PhoneTel Merger.
Selling, general and administrative expenses decreased approximately
$0.1 million, or 1.3%, from approximately $12.1 million in the year ended
December 31, 2001 to approximately $12.0 million in the year ended December 31,
2002. The decrease in expense was primarily attributable to a reduction in
salaries and salary-related expenses of approximately $1.0 million, which
occurred as a result of continued reductions in headcount in light of the lower
number of payphones in service, and a decrease in professional fees of
approximately $1.2 million. These decreases were offset by an increase in
insurance (primarily directors and officers and general liability insurance) of
$1.0 million and a $0.5 million charge relating to the settlement of a lawsuit.
A variety of other expense items provided a net increase in selling, general and
administrative expenses of $0.6 million compared to 2001.
In connection with the PhoneTel Merger, the Company relocated it
corporate headquarters from Tampa, Florida to Cleveland, Ohio and incurred a
loss of approximately $2.9 million relating to exit and disposal activities. In
September 2002, the Company terminated its headquarters facility lease,
abandoned or disposed of certain furniture, fixtures and leasehold improvements,
and incurred severance costs related to the termination of certain employees.
All exit activities relating to the Company's former headquarters were completed
prior to December 31, 2002. No comparable expense was incurred in the year ended
December 31, 2001.
Interest expense in the year ended December 31, 2002 decreased
approximately $14.6 million, or 52.9%, from approximately $27.7 million in the
year ended December 31, 2001 to approximately $13.0 million in the year ended
December 31, 2002. This decrease is primarily due to the reduction in
indebtedness resulting from the debt restructuring described above (see
"Business---General Overview" and "Liquidity, Capital Resources and Management's
Plans"). In addition, no interest is recognized on the Davel portion of the
Company's Junior Credit Facility as a result of accounting for the
debt-for-equity exchange as a troubled debt restructuring. In connection
23
with this debt restructuring, the Company also recognized a gain of
approximately $181.0 million in 2002 resulting from the extinguishment of the
Company's Old Credit Facility.
Other income decreased approximately $16,000 to $244,000 in the year
ended December 31, 2002 from $260,000 in the year ended December 31, 2001.
For the year ended December 31, 2002, net income of $151.8 million was
$195.2 greater than the net loss of $43.4 million for the year ended December
31, 2001, primarily due to the $181.0 million gain on debt extinguishment
discussed above. Excluding the gain on debt extinguishment and $2.9 million of
exit and disposal activity costs, the Company's net loss would have been $26.3
million in the year ended December 31, 2002, a reduction of $17.1 million from
the net loss of $43.4 million in the prior year. This decrease in net loss
occurred because efforts to reduce operating expenses, as noted above, exceeded
the decline in revenues.
LIQUIDITY, CAPITAL RESOURCES AND MANAGEMENT'S PLANS
Cash Flows
Historically, the Company's primary sources of liquidity have been cash
from operations and borrowings under various credit facilities. The Company's
revenues and cash flows from its payphone operating regions are affected by
seasonal variations, geographic distribution of payphones, removal of
unprofitable payphones, 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. The Company's payphones throughout the midwestern and eastern United
States produce their highest call volumes, and therefore generate the highest
level of cash flow, during the second and third quarters.
Although the Company had a net loss of approximately $46.2 million
during the year ended December 31, 2003, the Company generated approximately
$8.8 million of net cash from operating activities. The net cash generated by
operating activities in 2003 was principally due to approximately $13.4 million
of regulatory receipts received in 2003 (dial-around compensation adjustments,
New Services Test refunds and EUCL refunds), of which $3.8 million was included
in accounts receivable at December 31, 2002. Approximately $1.1 million of the
net cash from operating activities was used for capital expenditures and other
investing activities, $5.8 million was used to pay the remaining balance due
under the Company's Senior Credit Facility, and $0.9 million was used for other
debt and capital lease payments.
During the year ended December 31, 2002, the Company had net income of
approximately $151.8 million which included a non-cash gain from debt
extinguishment of approximately $181.0 million. Net of other non-cash items and
changes in working capital, operating activities used approximately $0.5 million
of net cash in 2002. In February 2002, the Company received $4.8 million from
borrowings under its Senior Credit Facility, net of the $0.2 million cost of
issuing that debt, that was used for working capital purposes and to fund
acquisition costs related to the PhoneTel Merger. The Company also made
principal payments of $3.8 million and $0.5 million on its long-term debt and
capital lease obligations, respectively, during 2002.
During the year ended December 31, 2002, the Company had net cash from
operating activities of approximately $2.3 million, including approximately $5.6
million of New Services Test refunds. Approximately $3.2 million of this amount
was deferred and recognized as a reduction of telephone expense in 2002, pending
appeal by the LEC. Operating cash and cash provided by operating activities was
used for the payment of approximately $1.9 million of debt and capital lease
obligations, as well as $0.5 million of capital expenditures and $0.6 million of
location contracts.
Subsequent to December 31, 2003, the Company received $1.2 million of
dial-around compensation from Qwest resulting from the FCC's Interim Order. The
amount received after December 31, 2003 was used to pay the Company's
outstanding debt, as required under the terms of Company's Junior Credit
Facility, as amended. The Company expects to receive additional regulatory
receipts, the proceeds of which are required to be paid to the
24
Junior Lenders. The timing and amount of such receipts, which could be
substantial, cannot be determined due to the uncertainty regarding the
willingness and ability of the carriers to pay such amounts.
Capital expenditures for 2003 were $1.1 million compared to $0.4
million for 2002 and $0.5 million for 2001. These capital expenditures were
primarily for the purchase of payphone components and equipment, computers and
software equipment. The on-going strategy of removing underperforming phones,
combined with the existence of an extensive inventory of phone components,
allows for minimal capital equipment expenditures. The Company has no material
commitments for equipment purchases.
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 is 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 years ended
December 31, 2003 and 2002, approximately $11.3 million and $4.6 million of
interest, respectively, 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, at the option of the holders, accrues at the rate of
14% per annum.
At December 31, 2003, the Company was not in compliance with the
minimum Adjusted EBITDA covenant under the Junior Credit Agreement. On February
24, 2004, the Company executed an amendment (the "Second Amendment") that waives
all defaults through the date of the amendment, reduces the minimum amount of
EBITDA and Adjusted EBITDA that the Company is required to maintain through
December 31, 2004, and provides for the negotiation of revised quarterly
covenant levels for EBITDA and Adjusted EBITDA in 2005. Beginning December 1,
2003, the Second Amendment reduces the minimum payments due under the Junior
Credit Facility to $100,000 per month plus the monthly Agent fee through the
maturity date on December 31, 2005. The Company is also required to make
additional payments equal to 100% of any "Regulatory Receipts" received by the
Company (prior year EUCL charge and New Services Test refunds from LECs and net
dial-around true-up refunds from long-distance carriers, as defined in the
agreement).
The Company has been engaged in discussions with its Junior Lenders
regarding the possibility of restructuring the debt outstanding under the Junior
Credit Facility. Any such restructuring could potentially include a
debt-for-equity exchange that may substantially dilute the interests of the
Company's existing shareholders. There can be no assurance that the Company will
be successful in negotiating a reduction in the outstanding balance of its
Junior Credit Facility.
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 4). The Senior Credit Facility provided for a combined $10 million line of
credit which the Company and PhoneTel shared $5 million each. The Company and
PhoneTel each borrowed the amounts available under their respective lines of
credit on February 20, 2002, which amounts were used to pay merger related
expenses and accounts payable. Davel and PhoneTel agreed to remain jointly and
severally liable for all amounts due under the Senior Credit Facility.
25
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. On May 2, 2003, the Company paid the remaining
balance, including interest, due under the Senior Credit Facility.
Financial Condition 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. Excluding the gain
on debt extinguishment of $181.0 million in 2002, the Company has incurred
losses of approximately $46.2 million, $29.2 million and $43.4 million for the
years ended December 31, 2003, 2002 and 2001, respectively. These losses were
primarily attributable to increased competition from providers of wireless
communication services and the impact on the Company's revenue of certain
regulatory changes. In addition, as of December 31, 2003, the Company had a
working capital deficit of $8.2 million and its liabilities exceeded it assets
by $102.5 million. Although the Company's lenders have waived all defaults, the
Company was not in compliance with certain financial covenants and did not make
certain debt payments that were originally due under its Junior Credit Facility
(see Note 10 to the consolidated financial statements). These 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 to improve the operating results of the Company. Significant
elements of the plan executed or planned for 2003 and 2004 include (i)
continuing cost savings and efficiencies resulting from the merger with PhoneTel
discussed in Note 5 to the consolidated financial statements, (ii) the continued
removal of unprofitable payphones, (iii) reductions in telephone charges by
changing to competitive local exchange carriers ("CLECs") and other alternative
carriers, (iv) the evaluation, sale or closure of unprofitable district
operations, (v) outsourcing payphone collection, service and maintenance
activities to reduce such costs, 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, as a result, might be required to dispose of
assets to fund its operations or curtail its capital and other expenditures to
meet its debt service and other obligations. There can be no assurances as to
the Company's ability to execute such dispositions, or the timing thereof, or
the amount of proceeds that the Company could realize from such sales. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Contractual Obligations
The Company's principal contractual obligations at December 31, 2003
are (in thousands):
Contractual Obligations:
Less than More than 5
Total 1 year 1-3 years 3-5 years years
--------- --------- ---------- --------- -----------
Long Term Debt (1) $ 143,058 $ 2,843 $ 140,215 $ - $ -
Capital Lease Obligation 98 95 3 - -
Operating Leases 2,022 832 1,057 133 -
Purchase Obligation (2) 6,475 4,975 1,500 - -
--------- --------- ---------- ------- -------
Total $ 151,653 $ 8,745 $ 142,775 $ 133 $ -
========= ========= ========== ======= =======
(1) Long-Term Debt includes amounts payable for principal and
interest.
(2) Purchase obligation includes minimum amounts expected to be
paid in connection with contracts to purchase local line
access and payphone service contracts.
26
IMPACT OF INFLATION
Inflation is not a material factor affecting the Company's business.
General operating expenses such as salaries, employee benefits and occupancy
costs are, however, subject to normal inflationary pressures.
SEASONALITY
The Company's revenues from its payphone operating regions are affected
by seasonal variations, geographic distribution of payphones and type of
location. Because many of the Company's payphones are located outdoors, weather
patterns have differing effects on the Company's results depending on the region
of the country where the payphones are located. Most of the Company's payphones
in Florida produce substantially higher call volume in the first and second
quarters than at other times during the year, while the Company's payphones
throughout the Midwestern and eastern United States produce their highest call
volumes during the second and third quarters. While the aggregate effect of the
variations in different geographical regions tend to counteract the effect of
one another, the Company has historically experienced higher revenue and income
in the second and third quarters than in the first and fourth quarters. Changes
in the geographical distribution of its payphones may in the future result in
different seasonal variations in the Company's results.
NEW ACCOUNTING PRONOUNCEMENTS
During December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure". Statement No. 148
establishes standards for two alternative methods of transition to the fair
value method of accounting for stock-based employee compensation of SFAS No.
123, "Accounting for Stock-Based Compensation". SFAS No. 148 also amends and
augments the disclosure provisions of SFAS No. 123 and APB No. 28, "Interim
Financial Reporting", to require disclosure in the summary of significant
accounting policies for all companies of the effects of an entity's accounting
policy with respect to stock based employee compensation on reported net income
and earnings per share in annual and interim financial statements. The
transitions standards and disclosure requirements of SFAS No. 148 are effective
for fiscal years and interim periods ending after December 15, 2002.
SFAS No. 148 does not require the Company to transition from the
intrinsic value approach provided in APB Opinion No. 25, "Accounting for
Employee Stock Based Compensation". In addition, the Company does not currently
plan to transition to the fair value approach in SFAS No. 123. However, the
Company has adopted the additional disclosure requirements of SFAS No. 148 in
this annual report.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("Interpretation No. 45"). Under
Interpretation No. 45, guarantees, contracts and indemnification agreements are
required to be initially recorded at fair value. Current practice provides for
the recognition of a liability only when a loss is probable and reasonably
estimable, as those terms are defined under SFAS No. 5, "Accounting for
Contingencies". In addition, Interpretation No. 45 requires significant new
disclosures for all guarantees even if the likelihood of the guarantor's having
to make payments under the guarantee is remote. The disclosure requirements are
effective for financial statements of interim and annual periods ending after
December 15, 2002. The initial recognition and measurement provisions of
Interpretation No. 45 are applicable on a prospective basis to guarantees,
contracts or indemnification agreements issued or modified after December 31,
2002.
The Company currently has no guarantees, contracts or indemnification
agreements that would require fair value treatment under the new standard. The
Company's current policy is to disclose all material guarantees and contingent
arrangements, similar to the disclosure requirements of Interpretation No. 45,
which provide for disclosure of the approximate term, nature of guarantee,
maximum potential amount of exposure, and the nature of recourse provisions and
collateral.
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
27
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks inherent in the
Company's financial instruments that arise from transactions entered into in the
normal course of business. The Company's long-term obligations consist primarily
of the amounts due under the Junior Credit Facility which bears interest at a
fixed rate. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
The Company does not presently enter into any transactions involving
derivative financial instruments for risk management or other purposes due to
the fixed rate structure of its existing debt, the stability of interest rates
in recent times, and because Management does not consider the potential impact
of changes in interest rates to be material. As a matter of policy, the Company
does not hold derivatives for trading purposes.
The Company's available cash balances are invested on a short-term
basis (generally overnight) and, accordingly are not subject to significant
risks associated with changes in interest rates. Substantially all of the
Company's cash flows are derived from its operations within the United States
and the Company is not subject to market risk associated with changes in foreign
exchange rates.
28
ITEM 8. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of the Independent Public Accountants................................................................. 30
Consolidated Balance Sheets as of December 31, 2003 and 2002................................................. 31
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001................... 32
Consolidated Statements of Changes in Shareholders' Equity (Deficit) and Other Comprehensive Loss for the
years ended December 31, 2003, 2002, and 2001.............................................................. 33
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001................... 34
Notes to Consolidated Financial Statements................................................................... 35
29
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Davel Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Davel
Communications, Inc. (the "Company") and Subsidiaries as of December 31, 2003
and 2002, and the related consolidated statements of operations, changes in
shareholders' equity (deficit) and other comprehensive loss and cash flows for
the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Davel
Communications, Inc. and Subsidiaries at December 31, 2003 and 2002, and the
consolidated results of their operations and their cash flows for the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 2 to the financial statements, the Company has
incurred recurring operating losses, has a substantial working capital
deficiency and has been unable to comply with the terms of its debt agreements.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters are also
discussed in Note 2. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
AIDMAN PISER & COMPANY, P. A.
Tampa, Florida
March 19, 2004
30
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31
------------------------
2003 2002
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 7,775 $ 6,854
Accounts receivable, net of allowance for doubtful accounts
of $1,870 at December 31, 2002 7,975 16,807
Other current assets 2,922 3,286
--------- ---------
Total current assets 18,672 26,947
Property and equipment, net 22,878 41,855
Location contracts, net 6,746 18,043
Goodwill - 17,455
Other assets, net 2,026 2,316
--------- ---------
Total assets $ 50,322 $ 106,616
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and obligations under capital leases $ 1,994 $ 11,449
Accrued commissions payable 9,020 11,986
Accounts payable and other accrued expenses 15,847 21,262
--------- ---------
Total current liabilities 26,861 44,697
Long-term debt and obligations under capital leases 125,962 118,229
--------- ---------
Total liabilities 152,823 162,926
--------- ---------
Commitments and contingencies (Note 19) - -
Shareholders' deficit:
Preferred stock - $0.01 par value, 1,000,000 share authorized,
no shares outstanding - -
Common Stock - $0.01 par value, 1,000,000,000 shares authorized, 615,018,963 shares
issued and outstanding 6,150 6,150
Additional paid-in capital 144,210 144,210
Accumulated deficit (252,861) (206,670)
--------- ---------
Total shareholders' deficit (102,501) (56,310)
--------- ---------
Total liabilities and shareholders' deficit $ 50,322 $ 106,616
========= =========
The accompanying notes are an integral part of these financial statements.
31
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31
---------------------------------------------------
2003 2002 2001
------------- ------------- -------------
REVENUES:
Coin calls $ 50,132 $ 56,952 $ 61,668
Non-coin calls 23,335 23,807 28,950
Dial-around compensation adjustments 8,306 (3,807) -
------------- ------------- -------------
Total revenues 81,773 76,952 90,618
------------- ------------- -------------
OPERATING EXPENSES:
Telephone charges 23,029 19,350 29,577
Commissions 13,584 15,767 22,168
Service, maintenance and network costs 24,028 22,998 23,519
Depreciation and amortization 21,523 20,392 19,241
Selling, general and administrative 11,216 11,959 12,115
Asset impairment charges 27,141 - -
Exit and disposal activities 786 2,919 -
------------- ------------- -------------
Total costs and expenses 121,307 93,385 106,620
------------- ------------- -------------
Operating loss (39,534) (16,433) (16,002)
OTHER INCOME (EXPENSE):
Interest expense (net) (6,559) (13,037) (27,672)
Gain on debt extinguishment - 180,977 -
Other (98) 244 260
------------- ------------- -------------
Total other income (expense) (6,657) 168,184 (27,412)
------------- ------------- -------------
NET INCOME (LOSS) $ (46,191) $ 151,751 $ (43,414)
============= ============= =============
EARNINGS (LOSS) PER SHARE:
Net income (loss) per common share, basic and diluted $ (0.08) $ 0.56 $ (3.89)
============= ============= =============
Weighted average number of shares, basic and diluted 615,018,963 272,598,189 11,169,485
============= ============= =============
The accompanying notes are an integral part of these financial statements.
32
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) AND OTHER
COMPREHENSIVE 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) LOSS
----------- ---------- ---------- ----------- ------------- ------------- -------------
Balances December 31, 2000 11,169,540 $ 112 $ 128,503 $ (315,007) $ - $ (186,392) $ -
Rescission of common stock (100) - - - - - -
Market change on interest collar - - - - (7) (7) (7)
Net loss - - - (43,414) - (43,414) (43,414)
----------- ---------- ---------- ---------- ---------- ---------- ----------
Balances December 31, 2001 11,169,440 112 128,503 (358,421) (7) (229,813) $ (43,421)
==========
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 - - - (46,191) - (46,191) $ (46,191)
----------- ---------- ---------- ---------- ---------- ---------- ----------
Balances December 31, 2003 615,018,963 $ 6,150 $ 144,210 $ (252,861) $ - $ (102,501) $ (46,191)
=========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
33
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31
---------------------------------
2003 2002 2001
-------- --------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(46,191) $ 151,751 $(43,414)
Adjustments to reconcile net income (loss) to net cash flow from operating activities:
Depreciation and amortization 21,523 20,392 19,241
Amortization of deferred financing costs and non-cash interest 5,207 11,711 3,681
Gain from debt extinguishment - (180,977) -
Non-cash exit and disposal activities - 1,309 -
Loss (gain) on disposal of assets 295 (71) 272
Increase in allowance for doubtful accounts 156 1,241 -
Deferred revenue (150) (188) (188)
Asset impairment charges 9,686 - -
Goodwill impairment 17,455 - -
Changes in assets and liabilities, net of assets acquired:
Accounts receivable 8,676 (1,679) 2,378
Other current assets 364 (1,105) (351)
Accrued commissions payable (2,966) (2,879) 1,286
Accounts payable and accrued expenses (5,161) (177) (3,931)
Accrued interest (104) 138 23,281
-------- --------- --------
Net cash from operating activities 8,790 (534) 2,255
-------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received in PhoneTel merger, net of acquisition costs - 2,784 -
Proceeds from sale of assets 334 116 -
Capital expenditures (1,130) (371) (521)
Payment of acquisition costs - (611) -
Payments for location contracts (276) (321) (618)
Increase in other assets (43) (332) -
-------- --------- --------
Net cash from investing activities (1,115) 1,265 (1,139)
-------- --------- --------
Cash flows from financing activities:
Proceeds from Senior Credit Facility - 5,000 -
Payments on long-term debt (6,544) (3,750) (941)
Payments on revolving line of credit - - (159)
Principal payments under capital leases (210) (460) (787)
-------- --------- --------
Net cash from financing activities (6,754) 790 (1,887)
-------- --------- --------
Net increase (decrease) in cash and cash equivalents 921 1,521 (771)
Cash and cash equivalents, beginning of period 6,854 5,333 6,104
-------- --------- --------
Cash and cash equivalents, end of period $ 7,775 $ 6,854 $ 5,333
======== ========= ========
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST PAID $ 885 $ 1,441 $ -
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 -
Property and equipment acquired under capital leases - - 29
The accompanying notes are an integral part of these financial statements.
34
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Davel Communications, Inc. and subsidiaries, (the "Company" or "Davel")
was incorporated on June 9, 1998 under the laws of the State of Delaware. The
Company is the largest domestic independent payphone service provider in the
United States of America. The Company operates in a single business segment
within the telecommunications industry, operating, servicing, and maintaining a
system of approximately 47,000 payphones in 46 states and the District of
Columbia. The Company's headquarters is located in Cleveland, Ohio with field
service offices in 17 geographically dispersed locations.
On July 24, 2002, the Company restructured its long-term debt by
completing the debt-for-equity exchange described in Note 4. Immediately
thereafter, on that same date, the Company and PhoneTel Technologies, Inc.
("PhoneTel") completed the merger described in Note 5 (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 date of acquisition.
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. Excluding the gain
on debt extinguishment of $181.0 million in 2002, the Company has incurred
losses of approximately $46.2 million, $29.2 million and $43.4 million for the
years ended December 31, 2003, 2002 and 2001, respectively. These losses were
primarily attributable to increased competition from providers of wireless
communication services and the impact on the Company's revenue of certain
regulatory changes. In addition, as of December 31, 2003, the Company had a
working capital deficit of $8.2 million and its liabilities exceeded it assets
by $102.5 million. Although the Company's lenders have waived all defaults, the
Company was not in compliance with certain financial covenants and did not make
certain debt payments that were originally due under its Junior Credit Facility
(see Note 10). These 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 to improve the operating results of the Company. Significant elements
of the plan executed or planned for 2003 and 2004 include (i) continuing cost
savings and efficiencies resulting from the merger with PhoneTel discussed in
Note 5, (ii) the continued removal of unprofitable payphones, (iii) reductions
in telephone charges by changing to competitive local exchange carriers
("CLECs") or other alternative carriers, (iv) the evaluation, sale or closure of
unprofitable district operations, (v) outsourcing payphone collection, service
and maintenance activities to reduce such costs, 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.
As discussed in Note 10, the Company has been engaged in discussions with
its Junior Lenders regarding the possibility of restructuring its outstanding
debt. Any such restructuring could potentially include a debt-for-equity
exchange that may substantially dilute the interests of the Company's existing
shareholders. There can be no assurance that the Company will b successful in
negotiating a reduction in the outstanding balance of its Junior Credit
Facility.
Notwithstanding these activities and plans, the Company may continue to
face liquidity shortfalls and, as a result, might be required to dispose of
assets to fund its operations or curtail its capital and other expenditures to
meet its debt service and other obligations. There can be no assurances as to
the Company's ability to execute such dispositions, or the timing thereof, or
the amount of proceeds that the Company could realize from such sales. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
35
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions are eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. While the Company
places its cash and cash equivalents with quality financial institutions,
balances may exceed amounts covered by FDIC insurance, with management's
approval. Cash and cash equivalents includes $1.0 million on deposit under an
informal arrangement at a bank, which is collateral for letters of credit issued
to suppliers.
Concentrations of Credit Risk
Trade accounts receivable are concentrated with companies in the
telecommunications industry. Accordingly, the credit risk associated with the
trade accounts receivable will fluctuate with the overall condition of the
telecommunications industry. Other than the MCI/ WorldCom bankruptcy filing,
discussed in Note 16, during all periods presented, credit losses were within
management's overall expectations.
Fair Value of Financial Instruments
Financial instruments consist of cash, accounts receivable, accounts
payable and accrued liabilities and long-term debt. The fair value of the
financial instruments, other than long-term debt, approximates their respective
carrying amounts. Fair value for all financial instruments other than long-term
debt, for which no quoted market prices exist, were based on appropriate
estimates. The fair value of the Company's long-term debt is estimated based on
market prices for similar issues or on the current interest rates offered to the
Company for debt of the same remaining maturities. Based upon prevailing
interest rates available to the Company for similar instruments, the fair value
of long-term debt at December 31, 2003 is approximately $117.1 million, compared
to its carrying value of $128.0 million on the same date.
Derivative Financial Instruments and Hedging Activities
The Company does not hold derivatives for trading purposes. In 2001,
the Company held a derivative financial instrument, principally an interest rate
collar contract, to hedge exposure to changes in interest rates on debt
obligations. For the interest rate collar, the interest rate collar settlement
differential is reflected as an adjustment to interest expense. Adoption of
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities", on January 1, 2001, resulted in
a cumulative after-tax increase in other comprehensive loss of $7,000 in 2001
and a decrease in other comprehensive loss of $7,000 in 2002. This interest rate
collar agreement terminated in February 2002. 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.
Property and Equipment
Property and equipment held and used in the Company's operations is stated
at cost and depreciation is provided over the estimated useful lives using the
straight-line method. Installed payphones and related equipment includes
installation costs, which are capitalized and amortized over the estimated
useful lives of the equipment. The costs associated with normal maintenance,
repair, and refurbishment of telephone equipment are charged to expense as
incurred. The capitalized cost of equipment and vehicles under capital leases is
amortized over the lesser of the lease
36
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
term or the asset's estimated useful life, and is included in depreciation and
amortization expense in the consolidated statements of operations.
Uninstalled payphone equipment consists of replacement payphones and
related equipment and is carried at the lower of cost or fair value.
Location Contracts
Location contracts include acquisition costs allocated to location owner
contracts and other costs associated with obtaining written and signed location
contracts. These assets are amortized on a straight-line basis over their
estimated useful lives based on contract terms (3 to 5 years). Amortization
expense related to location contracts was $4.5 million, $4.1 million, and $1.2
million for the years ended December 31, 2003, 2002 and 2001 respectively.
Accumulated amortization as of December 31, 2003 and 2002 was approximately
$17.4 million and $7.7 million, respectively.
Goodwill
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No.
142). Under SFAS No. 142, goodwill and certain other intangible assets with an
indefinite life must be tested at least annually for impairment and can no
longer be amortized. During 2002, the Company completed its initial evaluation
of goodwill for impairment and recognized no impairment losses based upon a
comparison of the carrying value of the Company's net assets and the estimated
enterprise value of the Company. In 2003, the Company completed its annual
evaluation of goodwill for impairment and the balance was written-off. See
"Impairments of Long-lived Assets and Goodwill," below. Prior to 2002, goodwill
was amortized on a straight-line basis over periods estimated to be benefited,
generally 15 years. There was no amortization expense related to goodwill during
the year ended December 31, 2001.
Impairments of Long-Lived Assets and Goodwill
The Company reviews long-lived assets to be held and used and goodwill for
impairment whenever events or changes in circumstances indicate the asset may be
impaired. 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, 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 was based upon the present value of expected
future cash flows. 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.
37
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Asset impairment charges were as follows for the year ended December 31,
2003 (in thousands):
Payphone Assets................................................... $ 9,686
Goodwill.......................................................... 17,455
-----------
Total impairment charges....................................... $ 27,141
===========
Management exercised considerable judgment to estimate undiscounted and
discounted future cash flows. The amount of future cash flows the Company will
ultimately realize remains under continuous review, but could differ materially
from the amounts assumed in arriving at the impairment loss.
Revenue Recognition
The Company derives its revenues from two principal sources: coin calls
and non-coin calls. Coin calls represent calls paid for by callers with coins
deposited into the payphone. Coin call revenues are recorded in the amount of
coins deposited in the payphones and in the period deposited. Revenue from
non-coin calls, which includes dial-around compensation, as discussed in Note
15, and operator service revenue is recognized in the period in which the
customer places the call.
Operator Service Revenue: Non-coin operator service calls are serviced by
independent operator service providers. These carriers assume billing and
collection responsibilities for operator-assisted calls originating on the
Company's payphone network and pay "commissions" to the Company based upon gross
revenues. The Company recognizes operator service revenues in amounts equal to
the commission that it is entitled to receive during the period the service is
rendered.
Dial-around Revenue: The Company also recognizes non-coin dial-around
revenues from calls that are dialed from its payphones to gain access to a long
distance company or to make a traditional "toll free" call (dial-around calls).
Revenues from dial-around calls are recognized based on estimates using the
Company's historical collection experience because a) the interexchange carriers
("IXCs") have historically paid for fewer dial-around calls than are actually
made (due to the reasons discussed in Note 15 to the financial statements) and
b) the collection period for dial-around revenue may be as long as a year.
Davel's estimate of revenue is based on historical analyses of calls placed
versus amounts collected. These studies are updated on a continuous basis.
Recorded amounts are adjusted to actual amounts received and estimates are
updated once the applicable dial-around compensation has been collected.
Regulated Rate Actions
The Federal Communications Commission ("FCC") possesses the authority
pursuant to the Telecommunications Act of 1996 (the "Telecom Act") to effect
rate actions related to dial-around compensation, including retroactive rate
adjustments and refunds (See Note 15), and other telecommunication revenues and
expenses. Rate adjustments arising from FCC rate actions that require refunds to
dial-around carriers are recorded in the first period that they become both
probable of payment and estimable in amount. Rate adjustments that result in
payments to the Company by dial-around or other carriers are recorded when
received.
Telephone Charges
Telephone charges consist of payments made to local exchange carriers
("LECs") and IXCs for local and long-distance line and transmission services. In
2003, 2002 and 2001, the Company recognized $0.8 million, $7.1 million and $1.9
million of refunds of prior period telephone charges, respectively, relating to
the recently adopted "New Services Test" in certain states. Under the Telecom
Act and related FCC Rules, LECs are required to make access lines that are
provided for their own payphones equally available to independent payphone
providers to ensure that the cost to payphone providers for obtaining local
lines and service met the FCCs new services test guidelines. Such guidelines
require LECs to price payphone access lines at the direct cost to the LEC plus a
reasonable allocation of
38
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
overhead. Refunds pursuant to the "New Services Test" are recorded as reductions
in telephone charges in the Company's consolidated statements of operations.
Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Deferred tax assets and
liabilities are measured using enacted tax rates for the periods such taxes are
expected to be recovered or settled. The effect of a change in tax rates on
deferred tax assets and liabilities is recognized in the period in which the
change is enacted. Deferred tax assets are reduced by a valuation allowance when
it is deemed more likely than not that the asset will not be utilized.
Stock-based compensation
The Company accounts for compensation costs associated with stock options
issued to employees under the provisions of Accounting Principles Board Opinion
No. 25 ("APB No. 25") whereby compensation is recognized to the extent the
market price of the underlying stock at the date of grant exceeds the exercise
price of the option granted. The Company has adopted the disclosure provisions
of Financial Accounting Standard No. 123 -- Accounting for Stock-Based
Compensation ("SFAS No. 123"), which requires disclosure of compensation expense
that would have been recognized if the fair-value based method of determining
compensation had been used for all arrangements under which employees receive
shares of stock or equity instruments. Stock-based compensation to non-employees
is accounted for using the fair-value based method prescribed by SFAS No. 123.
The following table reflects supplemental financial information related to
stock-based employee compensation, as required by SFAS No. 148 (See "Recent
Accounting Pronouncements", below; in thousands, except per share amounts):
2003 2002 2001
---------- --------- ---------
Net income (loss), as reported............................................. $ (46,191) $ 151,751 $(43,414)
Net income (loss) per share, as reported................................... (0.08) 0.56 (3.89)
Stock-based employee compensation 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.................................................... -- (767) (1,659)
Unaudited pro forma net income (loss), as if the fair value method had been
applied to all awards.................................................... (46,191) 150,984 (45,073)
Unaudited pro forma net income (loss) per share, as if the fair value
method had been applied to all awards.................................... (0.08) 0.55 (4.04)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Such estimates, among others, include amounts relating to the
carrying value of the Company's accounts receivable and payphone location
contracts and the related revenues and expenses applicable to dial-around
compensation and asset impairment. Actual results could differ from those
estimates.
39
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Recent Accounting Pronouncements
During December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure". Statement No. 148
establishes standards for two alternative methods of transition to the fair
value method of accounting for stock-based employee compensation of SFAS No.
123, "Accounting for Stock-Based Compensation". SFAS No. 148 also amends and
augments the disclosure provisions of SFAS No. 123 and APB No. 28, "Interim
Financial Reporting", to require disclosure in the summary of significant
accounting policies for all companies of the effects of an entity's accounting
policy with respect to stock based employee compensation on reported net income
and earnings per share in annual and interim financial statements. The
transitions standards and disclosure requirements of SFAS No. 148 are effective
for fiscal years and interim periods ending after December 15, 2002.
SFAS No. 148 does not require the Company to transition from the intrinsic
value approach provided in APB Opinion No. 25, "Accounting for Employee Stock
Based Compensation". In addition, the Company does not currently plan to
transition to the fair value approach in SFAS No. 123. However, the Company has
adopted the additional disclosure requirements of SFAS No. 148 in this annual
report.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("Interpretation No. 45"). Under
Interpretation No. 45, guarantees, contracts and indemnification agreements are
required to be initially recorded at fair value. Current practice provides for
the recognition of a liability only when a loss is probable and reasonably
estimable, as those terms are defined under SFAS No. 5, "Accounting for
Contingencies". In addition, Interpretation No. 45 requires significant new
disclosures for all guarantees even if the likelihood of the guarantor's having
to make payments under the guarantee is remote. The disclosure requirements are
effective for financial statements of interim and annual periods ending after
December 15, 2002. The initial recognition and measurement provisions of
Interpretation No. 45 are applicable on a prospective basis to guarantees,
contracts or indemnification agreements issued or modified after December 31,
2002.
The Company currently has no guarantees, contracts or indemnification
agreements that would require fair value treatment under the new standard. The
Company's current policy is to disclose all material guarantees and contingent
arrangements, similar to the disclosure requirements of Interpretation No. 45,
which provide for disclosure of the approximate term, nature of guarantee,
maximum potential amount of exposure, and the nature of recourse provisions and
collateral.
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
40
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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.
Reclassification
Certain reclassifications have been made to prior year balances to conform
to the current year presentation.
4. DEBT RESTRUCTURING
On July 24, 2002 (the "closing date"), immediately prior to the merger
discussed in Note 5, the existing PhoneTel junior lenders exchanged an amount of
indebtedness that reduced the junior indebtedness of PhoneTel to $36.5 million
for 112,246,511 shares of PhoneTel common stock, which was subsequently
exchanged for 204,659,064 shares of the Company in the PhoneTel Merger. Also, on
this date, the existing Davel junior lenders exchanged $237.2 million of
outstanding indebtedness and $45.7 million of related accrued interest for
380,612,730 shares of common stock (with a value of $13.7 million, based upon
market prices around the closing date), which reduced Davel's junior
indebtedness to $63.5 million. Upon completion of the debt exchanges, Davel and
PhoneTel amended, restated and consolidated their respective junior credit
facilities into a combined restructured junior credit facility with a principal
balance, excluding fees, of $100.0 million (the "Junior Credit Facility") due
December 31, 2005 (the "maturity date").
Davel has accounted for its debt-for-equity exchange as a troubled debt
restructuring. Accordingly, the Company has recognized a gain on extinguishment
of the old debt based upon the difference between the carrying value of its old
credit facility (including accrued interest) and the amount of the equity
interest and new debt, including interest, issued by Davel to its lenders. The
gain on debt extinguishment, included in other income (expense) in the
accompanying consolidated statements of operations, is as follows (in
thousands):
Old Credit Facility:
Principal balance.......................................................... $ 237,255
Accrued interest........................................................... 45,704
-------------
Carrying value............................................................. 282,959
Common stock issued (380,612,730 shares at $0.036)............................ (13,702)
Principal balance of new debt................................................. (63,500)
Interest, costs and fees on new debt (payable through maturity)............... (24,780)
-------------
Gain on debt extinguishment................................................... $ 180,977
=============
Following the PhoneTel Merger and the debt exchanges, the combined junior
indebtedness of the Company has a face value of $101.0 million, 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 has 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 exchange and the merger, the creditors of the Company in the
aggregate own 95.2% of the outstanding common stock of the Company.
41
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
5. ACQUISITION
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 has and will continue to
result in the expansion of its market presence and further reduce its operating
costs by leveraging the combined infrastructure. In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", the
results of operations of PhoneTel are included in the accompanying financial
statements since the date of acquisition.
In connection with the PhoneTel Merger, 100% of the voting shares in
PhoneTel were acquired and each share of common stock of PhoneTel was converted
into 1.8233 shares of common stock of the Company, or an aggregate of
223,236,793 shares with a fair value of approximately $8.0 million. The fair
value of the Davel common stock was derived using an average market price per
share of Davel common stock of $0.036, which was based on an average of the
closing prices for a range of trading days (July 19, 2002 through July 29, 2002)
around the closing date of the acquisition. 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 has not been amortized but was 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 3). Purchased intangibles
are amortized on a straight-line basis over their respective useful lives.
The PhoneTel Merger has been accounted for as a purchase business
combination and the purchase price has been allocated as follows (in thousands):
Cash and cash equivalents....................................................... $ 3,884
Accounts receivable............................................................. 4,612
Other current assets............................................................ 1,552
Property and equipment.......................................................... 11,347
Intangible assets (location contracts).......................................... 19,821
Goodwill........................................................................ 17,455
Other assets.................................................................... 765
-------------
Assets acquired.............................................................. 59,436
-------------
Accounts payable and other accrued expenses..................................... (9,238)
Accrued commissions payable..................................................... (3,367)
Senior credit facility (See Note 10)............................................ (4,583)
Junior credit facility (See Note 10)............................................ (32,206)
Other long-term debt (See Note 10)............................................. (928)
-------------
Liabilities assumed.......................................................... (50,322)
-------------
Net assets acquired............................................................. $ 9,114
=============
42
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 3 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 4 and above as if they had occurred at the
beginning of the periods presented. Pro forma financial information is not
intended to be indicative of the results of operations that the Company would
have reported had the transactions been consummated as of the beginning of the
respective periods.
UNAUDITED PRO FORMA
INFORMATION
FOR THE YEARS ENDED
DECEMBER 31
-----------------------------
2002 2001
-------------- -------------
Revenue............................................................... $ 100,382 $ 135,589
------------- -------------
Loss from operations before gain on debt extinguishment............... (31,490) (35,866)
Gain on debt extinguishment........................................... 171,480 169,244
------------- -------------
Net income............................................................ $ 139,990 $ 133,378
============= =============
Net income per common share, basic and diluted:....................... $ 0.23 $ 0.22
============= =============
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's Tampa
headquarters were expensed as incurred or as otherwise provided in SFAS No. 146,
"Accounting Costs Associated with Exit or Disposal Activities". Substantially
all exit activities relating to the former Tampa headquarters were completed
prior to December 31, 2002. The following table reflects the components of exit
and disposal activities shown as a separate line item in the Company's
consolidated statements of operations (in thousands):
Abandonment or disposals of property and equipment.................... $ 1,308
Lease termination..................................................... 600
Employee severance.................................................... 667
Other merger related expenses......................................... 344
----------
$ 2,919
==========
The Company also began to outsource the assembly and repair of its
payphone equipment and closed its warehouse and repair facility in Tampa,
Florida that was previously utilized for such purpose. 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. In the fourth quarter
of 2003, the Company outsourced the collection, service and maintenance of its
payphones in the western region of the United States to reduce the cost
servicing its geographically disbursed payphones in this area. The Company
closed eleven district offices and incurred a loss from exit and disposal
activities of approximately $0.5 million relating to these facilities.
Subsequent to December 31, 2003, the Company outsourced the servicing of
additional payphones and closed three additional district offices in Texas to
further reduce its operating costs.
43
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Activity in the allowance for doubtful accounts is summarized as follows
for the years ended December 31 (in thousands):
2003 2002 2001
---------- ---------- ---------
Balance, at beginning of period........................................ $ 1,870 $ -- $ 1,515
Charged to revenue or expense.......................................... 156 1,241 --
PhoneTel acquisition................................................... -- 629 --
Uncollected balances written off, net of recoveries.................... (2,026) -- (1,515)
---------- ---------- ---------
Balance, at end of period.............................................. $ -- $ 1,870 $ --
========== ========== =========
On July 21, 2002, WorldCom, Inc. and its subsidiary MCI, both of whom are
major payors of dial-around revenue to the Company, filed for protection under
Chapter 11 of the United States Bankruptcy Code. As a result of this filing, the
Company increased its allowance for doubtful accounts and reduced its accrual of
dial-around revenues for the second quarter of 2002 by $0.9 million from the
amount it would have normally accrued, as the bankruptcy impaired the Company's
ability to receive pre-petition dial-around payments for the quarter from
WorldCom. In addition, approximately $0.6 million of the addition to the
allowance for doubtful accounts relating to the PhoneTel acquisition relates to
PhoneTel's dial-around receivable from WorldCom at the date of acquisition. The
Company does not believe that the WorldCom bankruptcy filing has materially
impaired or will materially impair the Company's ability to continue to collect
dial-around payments from WorldCom post-petition. For post-petition periods, the
Company has resumed its normal accrual of dial-around revenue attributable to
WorldCom. On March 10, 2003, the Company sold a portion of its WorldCom
bankruptcy claim and recovered a portion of the pre-petition revenues from
dial-around compensation (see Note 16).
During 2003 and 2001, the Company evaluated the allowance for doubtful
accounts and determined that certain amounts related to dial-around revenue were
uncollectible, and accordingly these amounts were written off against the
allowance for doubtful accounts.
7. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows at December 31, 2003 and
2002 (in thousands):
ESTIMATED
USEFUL LIFE
IN YEARS 2003 2002
----------- ------------- -------------
Installed payphones and related equipment........................ 5-10 $ 99,373 $ 113,125
Furniture, fixtures and office equipment......................... 5-7 1,703 1,566
Vehicles, equipment under capital leases and other equipment..... 4-10 2,001 2,014
Leasehold improvements........................................... 3-5 490 334
------------- -------------
103,567 117,039
Less -- Accumulated depreciation................................. (86,588) (82,738)
------------- -------------
16,979 34,301
Uninstalled payphone equipment................................... 5,899 7,554
------------- -------------
Net property and equipment....................................... $ 22,878 $ 41,855
============= =============
Depreciation expense was $16.8 million, $16.0 million and $17.7 million
for the years ended December 31, 2003, 2002 and 2001, respectively.
44
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
8. OTHER ASSETS
Other assets, net of accumulated amortization, consist of the following at
December 31, 2003 and 2002 (in thousands):
2003 2002
---------- ----------
Non-compete agreements................................. $ 211 $ 356
Deposits............................................... 1,742 1,786
Other.................................................. 73 174
---------- ----------
$ 2,026 $ 2,316
========== ==========
9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following at December
31, 2003 and 2002 (in thousands):
2003 2002
------------ -----------
Accounts payable.................................... $ 1,617 $ 2,216
Taxes payable....................................... 4,614 4,757
Deferred revenue.................................... 38 188
Accrued telephone bills............................. 3,165 7,387
Accrued compensation................................ 1,004 1,282
Other............................................... 5,409 5,432
------------ -----------
$ 15,847 $ 21,262
============ ===========
10. LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES
Following is a summary of long-term debt and obligations under capital
leases as of December 31, 2003 and 2002 (in thousands):
2003 2002
--------- ---------
JUNIOR CREDIT FACILITY, due December 31, 2005:
TERM NOTE A, ($50,000 face value) plus unamortized
premium, discount and capitalized interest of
$11,644 at December 31, 2003........................ $ 61,644 $ 59,869
TERM NOTE B, ($51,000 face value) plus unamortized
premium, discount and capitalized interest of
$14,077 at December 31, 2003........................ 65,077 62,681
SENIOR CREDIT FACILITY, originally due in monthly
installments of $833.3 plus interest at 15% through
June 30, 2003......................................... -- 5,833
NOTE PAYABLE, ($1,233 face value) due November
16, 2004.............................................. 1,137 987
CAPITAL LEASE obligations with various interest rates
and maturity dates through 2005....................... 98 308
--------- ---------
127,956 129,678
Less -- Current maturities.............................. (1,994) (11,449)
--------- ---------
$ 125,962 $ 118,229
========= =========
Maturities of long-term debt during each of the next two years consist of
(amounts in thousands): $1,994 in 2004 and $125,962 in 2005.
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
45
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 is 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 years ended December 31, 2003 and 2002, approximately $11.3
million and $4.6 million of interest, respectively, 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, at the option of the
holders, accrues at the rate of 14% per annum.
As discussed in Note 4, 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 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, 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 in 2002........................ 24,122 -- 24,122
Discount: present value of acquired debt in 2002................ -- (4,658) (4,658)
------------ ---------------- -------------
Subtotal..................................................... 88,257 32,207 120,464
Payment-in-kind interest in 2002................................ 2,928 1,693 4,621
Amortization of premiums and discounts in 2002.................. (2,982) 447 (2,535)
------------ ---------------- -------------
Carrying value on December 31, 2002 88,203 34,347 122,550
Payment-in-kind interest in 2003................................ 7,165 4,118 11,283
Principal and interest payments in 2003 (709) (408) (1,117)
Amortization of premiums and discounts in 2003.................. (7,247) 1,252 (5,995)
------------ ---------------- -------------
Carrying value on December 31, 2003 $ 87,412 $ 39,309 $ 126,721
============ ================ =============
The Junior Credit Agreement is secured by substantially all assets of the
Company and was subordinate in right of payment to the Senior Credit Facility.
The Junior Credit Facility also provides for the payment of a 1% loan fee,
payment of a $30,000 monthly administrative fee to Wells Fargo Foothill, Inc.,
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.
The Company was not in compliance with certain financial covenants under
its Senior Credit Facility and, as a result, was in default under its Junior
Credit Facility from August 31, 2002 through January 31, 2003. In addition, the
Company was not in compliance with the minimum EBITDA and Adjusted EBITDA
financial covenants under the Junior Credit Agreement at December 31, 2002. On
March 31, 2003, the Company executed an amendment to its Junior Credit Facility
(the "First Amendment") that reduced the minimum amount of EBITDA and Adjusted
EBITDA that the Company was 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
46
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
amount) due under Junior Credit Facility during 2003 to coincide with the
anticipated early retirement of the Senior Credit Facility resulting from the
prepayment described below. Under the First Amendment, the Company was required
to make monthly payments of $1,041,667 from July 1 through December 1, 2003.
Payments due after December 31, 2003 were not affected by the First Amendment.
Notwithstanding the March 31, 2003 Amendment and waiver, the Company was
not in compliance with the new minimum Adjusted EBITDA covenant under the Junior
Credit Agreement, as amended, 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 granted 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 was 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, which payments were made by the Company.
At December 31, 2003, the Company was not in compliance with the minimum
Adjusted EBITDA covenant under the Junior Credit Agreement and was in default
under this agreement. On February 24, 2004, the Company executed an amendment
(the "Second Amendment") that waived all defaults through the date of the
amendment, reduces the minimum amount of EBITDA and Adjusted EBITDA that the
Company is required to maintain through December 31, 2004, and provides for the
negotiation of revised quarterly covenant levels for EBITDA and Adjusted EBITDA
in 2005. Beginning December 1, 2003, the Second Amendment reduces the minimum
payments due under the Junior Credit Facility to $100,000 per month plus the
monthly Agent fee through the maturity date on December 31, 2005. The Company is
also required to make additional payments equal to 100% of any "Regulatory
Receipts" received by the Company (prior year end user common line charge and
new services test refunds from LECs and net dial-around true-up refunds from
long-distance carriers, as defined in the agreement).
The Company has been engaged in discussions with its Junior Lenders
regarding the possibility of restructuring the debt outstanding under the Junior
Credit Facility. Any such restructuring could potentially include a
debt-for-equity exchange that may substantially dilute the interests of the
Company's existing shareholders. There can be no assurance that the Company will
be successful in negotiating a reduction in the outstanding balance of its
Junior Credit Facility.
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 4). The Senior Credit Facility provided for a combined $10 million line of
credit which the Company and PhoneTel shared $5 million each. The Company and
PhoneTel each borrowed the amounts available under their respective lines of
credit on February 20, 2002, which amounts were used to pay merger related
expenses and accounts payable. Davel and PhoneTel agreed to remain jointly and
severally liable for all amounts due under the Senior Credit Facility.
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. On May 2, 2003, the Company paid the remaining
balance, including interest, due under the Senior Credit Facility.
47
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 16, 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.
OLD CREDIT FACILITY
In connection with the merger with Peoples Telephone Company in 1998, the
Company entered into a secured credit facility ("Old Credit Facility") with Bank
of America, formerly known as NationsBank, N.A. (the original "Administrative
Agent"), and the other lenders named therein. Effective March 23, 2001, PNC
Bank, National Association became the Administrative Agent. The Old Credit
Facility originally provided for borrowings by the Company's wholly owned
subsidiary, Davel Financing Company, L.L.C., from time to time of up to $245.0
million, including a $45 million revolving facility, for working capital and
other corporate purposes.
The Company's borrowings under the original Old Credit Facility bore
interest at a floating rate and could be maintained as Base Rate Loans (as
defined in the Old Credit Facility, as amended) or, at the Company's option, as
Eurodollar Loans (as defined in the Old Credit Facility, as amended). Base Rate
Loans bore interest at the Base Rate (defined as the higher of (i) the
applicable prime lending rate of Bank of America or (ii) the Federal Reserve
reported certificate of deposit rate plus 1%). Eurodollar Loans bore interest at
the Eurodollar Rate (as defined in the Old Credit Facility, as amended). On July
24, 2002, the Old Credit Facility was restructured in connection with the
debt-for-equity exchange and Junior Credit Facility described above.
11. LEASE COMMITMENTS
The Company conducts a portion of its operations in leased facilities
under noncancellable operating leases expiring at various dates through 2008.
Some of the operating leases provide that the Company pay taxes, maintenance,
insurance and other occupancy expenses applicable to leased premises. The
Company also maintains certain equipment under noncancellable capital leases
expiring at various dates through 2005.
The annual minimum rental commitments under operating and capital leases
are as follows (in thousands):
YEAR ENDED DECEMBER 31: OPERATING CAPITAL TOTAL
----------------------- --------- ---------- ----------
2004....................................................... $ 832 $ 95 $ 927
2005....................................................... 517 3 520
2006....................................................... 327 -- 327
2007....................................................... 213 -- 213
2008....................................................... 133 -- 133
--------- --------- ----------
$ 2,022 98 $ 2,120
========= ==========
Less current capital lease obligations....................... (95)
---------
Long-term capital lease obligations.......................... $ 3
=========
Rent expense for operating leases for the years ended December 31, 2003,
2002, and 2001 was $1,856,000, $2,062,000, and $2,640,000, respectively.
48
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
12. INCOME TAXES
No provision for income taxes was required and no income taxes were paid
for the years ended December 31, 2003, 2002 and 2001 because of operating losses
generated by the Company. In 2002, the Company had a taxable loss of
approximately $17.9 million as a result of the Federal tax exclusion relating to
the gain on debt extinguishment recognized in connection with the
debt-for-equity exchange described in Note 4. Under Section 108 of the Internal
Revenue Code ("IRC"), special tax rules apply to cancellation of indebtedness
income ("COD Income") for companies that are insolvent (as defined in the IRC)
immediately prior to the discharge of indebtedness. COD Income of $181.0 million
is excluded from taxable income but must be applied to reduce the 2002 taxable
loss, tax net operating loss carryforwards, and other tax attributes.
A reconciliation of federal statutory income taxes to the Company's
effective tax provision is as follows (in thousands):
2003 2002 2001
-------------- ------------ ------------
Provision for federal income tax at the statutory
rate (35%)............................................... $ (16,167) $ 51,595 $ (14,761)
State income taxes net of federal benefit.................. (1,022) 5,509 (1,560)
Change in deferred tax asset valuation allowance,
net of amounts relating to the PhoneTel acquisition
in 2002.................................................. 6,696 (57,577) 15,107
Write-off of Goodwill...................................... 6,109 -- --
Other, net................................................. 4,384 473 1,214
------------- ------------ ------------
Income tax provision (benefit)............................. $ -- $ -- $ --
============= ============ ============
The tax effects of significant temporary differences representing deferred
tax assets and liabilities are as follows (in thousands):
2003 2002
------------- --------------
DEFERRED TAX ASSETS:
Net operating loss carryforward................................ $ 38,592 $ 29,549
Capital loss carryforward...................................... 550 550
Amortization of location contracts and goodwill................ 11,236 16,925
Alternative minimum tax credit carryforward.................... 192 192
Impairment charge.............................................. 21,497 17,852
Investment write-off........................................... 9,033 9,033
Allowance for doubtful accounts................................ -- 704
Unamortized debt premium, net.................................. 4,073 6,295
Other.......................................................... 1,672 1,756
------------- --------------
Total deferred tax assets...................................... 86,845 82,856
Valuation allowance............................................ (75,219) (68,523)
------------- --------------
Net deferred tax assets........................................ 11,626 14,333
------------- --------------
DEFERRED TAX LIABILITIES:
Depreciation................................................... (11,626) (14,333)
------------- --------------
Total deferred tax liabilities................................. (11,626) (14,333)
------------- --------------
Net deferred tax liability..................................... $ -- $ --
============= ==============
Realization of deferred tax assets is dependent upon sufficient future
taxable income during the periods that temporary differences and carryforwards
are expected to be available to reduce taxable income. The Company has recorded
a valuation allowance to reflect the estimated amount of deferred tax assets
which may not be realized due to the expiration of its operating loss and
capital loss carryforwards.
At December 31, 2003, the Company had tax net operating loss carryforwards
of approximately $180.2 million, including $22.2 million of loss carryforwards
relating to PhoneTel, that expire in various amounts in the years 2004 to 2021.
Following the debt-for-equity exchange described in Note 4, utilization of net
operating loss carryforwards incurred prior to 2002 are subject to an annual
limitation of approximately $2.9 million for Davel and $1.7 million
49
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
for PhoneTel under the rules of IRC Section 382. Under IRC Section 382, the
maximum amount of pre-2002 net operating losses that can be utilized by the
Company during the loss carryforward period is limited to approximately $77.2
million. The Company's deferred tax asset of $38.6 million is based upon this
limitation. The tax net operating loss carryforwards of PhoneTel can only be
utilized against future taxable income of PhoneTel, if any, determined as if
this acquired company continued to file a separate income tax return.
The Company's aggregate net operating loss carryforward includes a $25.4 million
tax loss in 2003 which is not subject to the limitations described above.
Together with the prior losses, the maximum amount of net operating loss
carryforwards that can be utilized in the future is limited to $102.6 million.
13. CAPITAL STOCK TRANSACTIONS
Preferred Stock
The Company's certificate of incorporation authorizes 1,000,000 shares of
preferred stock, par value $.01 per share. The Company does not have any
immediate plans to issue any shares of preferred stock.
Common Stock
On July 11, 2002, the Company received shareholder approval to increase
the number of authorized shares of common stock, $0.01 par value, from
50,000,000 to 1,000,000,000 shares to effect the debt-for-equity exchange and
the PhoneTel Merger described in Notes 4 and 5.
Stock Options and Warrants
On October 4, 2000, the board of directors approved the Davel
Communications, Inc. 2000 Long-Term Equity Incentive Plan (the "Plan"). The Plan
was approved by the Company's stockholders at its 2000 Annual Meeting on
November 2, 2000. The Plan provides for the grants of stock options, stock
appreciation rights, restricted stock, performance awards and any combination of
the foregoing to employees, officers and directors of, and certain other
individuals who perform significant services for the Company and its
subsidiaries. On February 11, 2002, the Plan was amended to increase the number
of shares of common stock available for issuance pursuant to the Plan from
1,000,000 to 26,780,208 shares to allow the Company to grant equity based
compensation to employees of the Company after the PhoneTel Merger. The maximum
number of stock options granted to any individual in any fiscal year cannot
exceed 10% of the authorized shares.
On January 10, 2002, the Company granted options to purchase 72,000 shares
of Common Stock, valued at $2,000, to its Directors. In addition, the
outstanding options and warrants of PhoneTel were converted into 618,107 stock
options and 1,963,738 warrants of the Company with an aggregate value of $6,000.
All of the warrants expired unexercised on November 19, 2002. No shares or
options were issued under the Plan during the years ended December 31, 2001 or
2003.
At December 31, 2003, approximately 26,708,208 shares of Common Stock were
reserved for issuance pursuant to the Plan. If all shares reserved under the
Plan were issued pursuant to stock options, such shares would constitute 4% of
the outstanding common stock of the Company. No awards have been granted under
the Plan since January 10, 2002. The Company also had 64,624 warrants to
purchase Common Stock outstanding at December 31, 2003, all of which were
exercisable.
The Company has several pre-existing stock option plans under which
options to acquire up to 2,948,615 shares were available to be granted to
directors, officers and certain employees of the Company, including the stock
option plans acquired in the PhoneTel and Peoples Telephone Mergers. Vesting
periods for options issued under these plans range from immediate vesting up to
10 years and generally expire after 5 to 10 years. The plans also provide for
the issuance of restricted common stock. In 2003, 2002, and 2001, no shares of
restricted stock were issued. The Company's policy is to record compensation
based on the fair market value of the Company's Common Stock on the day the
restricted shares are granted. This compensation expense is recorded ratably
over the vesting period of the restricted stock.
50
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The exercise price of options generally equals the market price of the
Company's stock on the date of grant. Accordingly, no compensation cost has been
recognized for options granted to employees under the plans. See Note 3 for the
effect on net income (loss) and related per share amounts had compensation cost
for the plans been determined based on the fair value of the options at the
grant dates consistent with the method of SFAS No. 123, "Accounting for
Stock-Based Compensation".
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options-pricing method with the following
weighted-average assumptions used for grants in 2002: dividend yield of 0%;
expected volatility of 275.0%, risk-free interest rates of 2.0%, and expected
life of approximately five years.
A summary of the status of the Company's stock option plans as of December
31 and changes during the years ending on those dates is presented below (shares
in thousands):
2003 2002 2001
------------------- -------------------- ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- --------- ------- ---------- ------ --------
Outstanding at beginning of year......................... 1,174 $ 4.45 835 $ 12.55 1,405 $ 11.55
Granted.................................................. -- -- 690 0.54 -- --
Expired.................................................. (211) 7.89 (351) 16.03 (219) 14.88
Cancelled................................................ (195) 0.75 -- -- (351) 7.07
------ ------ -----
Outstanding at end of year............................... 768 4.44 1,174 4.45 835 12.55
------ ------ -----
Options exercisable at end of year....................... 768 4.44 1,174 4.45 829 12.60
====== ====== =====
Weighted-average fair value of options granted during
the year............................................... $ -- $ 0.03 $ --
The following information applies to options outstanding at December 31,
2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------- ------------------------------------------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER
RANGE OF OUTSTANDING AT REMAINING CONTRACTUAL AVERAGE EXERCISABLE AT WEIGHTED AVERAGE
EXERCISE PRICE DECEMBER 31, 2003 LIFE (YEARS) EXERCISE PRICE DECEMBER 31, 2003 EXERCISE PRICE
- ------------------ ------------------ --------------------- -------------- ----------------- ----------------
$0.03 to $0.078 132,000 2.5 $ 0.052 132,000 $ 0.052
0.85 to 0.86 176,867 1.2 0.86 176,867 0.86
3.88 to 6.50 409,300 0.7 5.88 409,300 5.88
10.38 to 30.85 49,355 3.4 16.99 49,355 16.99
------- -------
767,522 4.44 767,522 4.44
======= =======
14. EARNINGS PER SHARE
In accordance with SFAS No. 128 "Earnings Per Share", basic earnings per
share amounts are computed by dividing income or loss applicable to common
shareholders by the weighted average number of shares outstanding during the
period. Diluted earnings per share amounts are determined in the same manner as
basic earnings per share except the number of shares is increased assuming
exercise of stock options and warrants using the treasury stock method. In
addition, income or loss applicable to common shareholders is not adjusted for
dividends and other transactions relating to preferred shares for which
conversion is assumed. For the year ended December 31, 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. For the years ended December 31, 2001
and 2003, diluted earnings per share amounts are the same as basic earnings per
share because the Company has a net loss and the impact of the assumed exercise
of the stock options and warrants is not
51
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
dilutive. The number of shares of Common Stock relating to stock options and
warrants that could potentially dilute basic earnings per share in the future
that were not included in the computation of diluted earnings per share were
832,146, 1,310,524, and 1,134,513 shares for the years ended December 31, 2003,
2002 and 2001, respectively.
15. DIAL-AROUND COMPENSATION
On September 20, 1996, the Federal Communications Commission (FCC)
adopted rules in a docket entitled In the Matter of Implementation of the
Payphone Reclassification and Compensation Provisions of the Telecommunications
Act of 1996, FCC 96-388 (the "1996 Payphone Order"), implementing the payphone
provisions of Section 276 of the Telecom Act. The 1996 Payphone Order, which
became effective November 7, 1996, mandated dial-around compensation for both
access code calls and 800 subscriber calls. Several parties filed petitions for
judicial review of certain of the FCC regulations including the dial-around
compensation rate. On July 1, 1997, the U.S. Court of Appeals for the District
of Columbia Circuit (the "Court") responded to appeals related to the 1996
Payphone Order by remanding certain issues to the FCC for reconsideration. The
Court remanded the issue to the FCC for further consideration, and clarified on
September 16, 1997, that it had vacated certain portions of the FCC's 1996
Payphone Order, including the dial-around compensation rate.
On October 9, 1997, the FCC adopted and released its Second Report and
Order in the same docket, FCC 97-371 (the "1997 Payphone Order"). This order
addressed the per-call compensation rate for 800 subscriber and access code
calls that originate from payphones in light of the decision of the Court which
vacated and remanded certain portions of the FCC's 1996 Payphone Order. The FCC
concluded that the rate for per-call compensation for 800 subscriber and access
code calls from payphones 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
52
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
review of the 1999 Payphone Order's determination of the dial-around
compensation rate. On June 16, 2000, the Court affirmed the 1999 Payphone Order
setting a 24-cent dial-around compensation rate. The new 24-cent rate became
effective April 21, 1999. The 24-cent rate was also applied retroactively to the
period beginning on October 7, 1997 and ending on April 20, 1999 (the
"intermediate period"), less a $0.002 amount to account for FLEX ANI payphone
tracking costs, for a net compensation of $0.238.
In a decision released January 31, 2002 (the "2002 Payphone Order") the
FCC partially addressed the remaining issues concerning the "true-up" required
for the earlier dial-around compensation periods. The FCC adjusted the per-call
rate to $.229, for the period commencing November 7, 1996 and ending on October
6, 1997 ("the interim period"), to reflect a different method of calculating the
delay in IXC payments to PSPs for the interim period, and determined that the
total interim period compensation rate should be $33.89 per payphone per month
($.229 times an average of 148 calls per payphone per month). The 2002 Payphone
Order deferred to a later order its determination of the allocation of this
total compensation rate among the various carriers required to pay compensation
for the interim period. In addition to addressing the rate level for dial-around
compensation, the FCC has also addressed the issue of carrier responsibility
with respect to dial-around compensation payments.
On October 23, 2002 the FCC released its Fifth Order on Reconsideration
and Order on Remand (the "Interim Order"), which resolved all the remaining
issues surrounding the interim/intermediate period true-up and specifically
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
without (1) prior notification and an opportunity to contest the claimed amount
in good faith (only uncontested amounts may be withheld); and (2) providing PSPs
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 representing the estimated amount due by the Company to certain dial-around
carriers under the Interim Order. Of this amount, $3.6 million and $3.8 million
is included in accounts payable and other accrued expenses in the accompanying
consolidated balance sheets at December 31, 2003 and 2002, respectively. In
January 2004, certain carriers deducted approximately $0.7 million from their
current dial-around compensation payments, thus reducing this liability. The
remaining amount outstanding is expected to be deducted from future quarterly
payments of dial-around compensation to be received from the applicable
dial-around carriers during 2004.
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 16). 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 and $0.4
million of net receipts from other carriers under the Interim Order that was
53
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
recognized as revenue in the third and fourth quarters of 2003, respectively.
Such revenues totaling $8.3 million have been reported as dial-around
compensation adjustments in the accompanying consolidated statements of
operations for the year ended December 31, 2003. The Company also estimates that
it is entitled to receive in excess of $10.0 million of additional dial-around
compensation from certain carriers, of which $1.2 million was received and will
be recognized as revenue subsequent to December 31, 2003 under the Company's
accounting policy. 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.
16. 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
54
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
approximately $3.9 million related to the Interim Order described in Note 15. 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
(see Note 10 - "Senior Credit Facility"), and $0.9 million was used to pay
certain accounts payable.
During the years ended December 31, 2003, 2002, and 2001, the Company
recognized $0.8 million, $7.1 million, and 1.9 million of refunds, respectively,
of prior period telephone charges relating to the recently adopted new services
test ("New Services Test" or "NST") in certain states. Approximately $2.8
million of these refunds were used to pay a portion of the balance due on the
Company's Senior Credit Facility in 2003 and the balance was used for working
capital purposes. Under the Telecom Act and related FCC Rules, LECs are required
to provide local lines and service to PSPs in accordance with 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, through its memberships in various state payphone associations,
continues to pursue refunds from LECs relating to the New Services Test. These
efforts involve petitioning the public service commissions in the states in
which the LECs operate. Although the Company expects to obtain additional NST
refunds in the future, the Company is unable to determine the timing and amount
of such refunds, which could be substantial, due to the uncertainty regarding
the outcome of the regulatory proceedings in which the Company is represented or
involved.
During the years ending December 31, 2003 and 2002, the Company
received $1.4 million and $0.6 million of telephone charge refunds from certain
LECs relating to end user common line charges ("EUCL Charges"). Under a decision
by the Court of Appeals for the District of Columbia Circuit, prior to April
1997, the Court determined that LECs were discriminating against IPPs because
they did not assess their own payphone divisions with EUCL Charges. The Court
ruled that these charges should be assessed equally to IPPs and their own
payphone divisions to eliminate this subsidy to LEC payphone divisions. The
Company and other IPPs have been successful in negotiating and recovering EUCL
Charges relating to periods prior to April 1997 and expects to continue to
obtain additional refunds in the future. The Company is unable to determine the
timing or amount of such refund, if any, due to the uncertainty regarding the
ability of the Company to successfully challenge and collect such amounts from
the applicable the LECs. EUCL and NST refunds have been included in the
accompanying consolidated statements of operations as a reduction of telephone
charges.
17. 401(k) PROFIT SHARING PLAN
Certain subsidiaries created 401(k) plans that were merged into the Davel
Communications Inc. Profit Sharing Plan in 1999 (the "Old Davel Plan"). The Old
Davel Plan provided for matching contributions from the Company that were
limited to certain percentages of employee contributions. Additional
discretionary amounts could be contributed by the Company. The Company
contributed approximately $117,000 and $159,000 for the years ended December 31,
2002 and 2001, respectively.
PhoneTel also has a 401(k) plan that provides for but does not require
Company contributions to the plan. There were no Company contributions to the
PhoneTel plan during 2002 or 2003. Effective January 1, 2003, the plan name was
changed to the Davel Communications, Inc Employee Saving Plan (the "New Davel
Plan") and substantially all employees of the Company are eligible to
participate upon completion of the minimum term of service. Beginning January 1,
2003, employees can elect to make contributions to the New Davel Plan but are no
longer be permitted to make contributions to the Old Davel Plan.
55
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
18. 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"). The
Company earned revenue of $1,917,000 in 2003 and $962,000 in 2002 from various
telecommunication contractor services provided to Urban, principally residence
and small business facility provisioning and inside wiring. Additionally, in
2003, Urban was paid $125,000 for providing the Company with pay telephone
management and other services for the Company's payphone installations located
in and around New York, New York. In October 2003, the Company and Urban
terminated its service relationship. The net amount of accounts receivable due
from Urban, including the remaining outstanding amount acquired in the PhoneTel
Merger, was $123,000 and $799,000 at December 31, 2003 and 2002, respectively.
In connection with the PhoneTel Merger discussed in Note 5, a former
major shareholder agreed to forego payment on certain accrued management fees
amounting to $436,000, which was accounted for in the second quarter of 2002.
Such amount is reflected in the accompanying consolidated financial statements
as a reduction of selling, general and administrative expenses.
Mr. Renard, a former Director and Executive Officer of the Company entered
into a six-month consulting agreement following the termination of his
employment with the Company. In connection with the consulting agreement, Mr.
Renard provided regulatory consulting services in the consideration of the sum
$12,500 per month, plus reimbursement for the costs incident to the maintenance
of family medical insurance.
The Company engaged in the following transactions with Mr. David Hill, a
shareholder and former Director and Chairman of the Board, during the year ended
December 31, 2001 (in thousands):
Payments made for rent of commercial real estate.................. $ 270
=========
Payments made for consulting services............................. $ 275
=========
Payments received for providing administrative services........... $ 203
=========
19. COMMITMENTS AND CONTINGENCIES
In March 2000, the Company and its affiliate Telaleasing Enterprises, Inc.
were sued in Maricopa County, Arizona Superior Court by CSK Auto, Inc. ("CSK").
The suit alleges that the Company breached a location agreement between the
parties. CSK's complaint alleges damages in excess of $5 million. The Company
removed the case to the U.S. District Court for Arizona and moved to have the
matter transferred to facilitate consolidation with the related case in
California brought by TCG and UST. On October 16, 2000, the U.S. District Court
for Arizona denied the Company's transfer motion and ordered the case remanded
back to Arizona state court. On February 27, 2003 the parties agreed to a
settlement of this case, pursuant to which the case will be dismissed with
prejudice in exchange for four quarterly payments to the plaintiff in the amount
of $131,250, the total of which was recorded in the fourth quarter of 2002. As
of December 31, 2003, the Company has fully satisfied this obligation.
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
56
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Picus lines, if any. If any of the aforementioned payments are not timely paid
by the Company, Picus will be entitled to obtain a judgment against Davel for
the full amount of its claim against the Company, plus interest, less any
amounts actually paid to Picus under the settlement agreement. As of December
31, 2003, the Company has fully satisfied the obligation.
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 has been forwarded to
Davel's insurance carrier for action. The parties are currently engaged in the
discovery process and the trial is scheduled for June 2004. While Davel believes
that it has meritorious defenses to the allegations contained in the second
amended complaint and intends to vigorously defend itself, Davel cannot at this
time predict its likelihood of success on the merits.
The Company is also a party to a contract with Sprint Communications
Company, L.P. ("Sprint") that provides for the servicing of operator-assisted
calls. Under this arrangement, Sprint has assumed responsibility for tracking,
rating, billing and collection of these calls and remits a percentage of the
gross proceeds to the Company in the form of a monthly 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 provided directly by Sprint. If the
data, as presented by Sprint, is utilized in the calculation, a shortfall could
result. The Company has provided Sprint with 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
57
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
that some liability or receivable for this matter may ultimately be determined
as a result of the dispute, the amount of which, if any, is not presently
determinable.
The Company is involved in other litigation arising in the normal course
of its business which it believes will not materially affect its financial
position or results of operations.
20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
Certain unaudited quarterly financial information for the year ended
December 31, 2003 and 2002, is as follows (in thousands except per share data):
MARCH JUNE SEPTEMBER DECEMBER FULL YEAR
------- -------- --------- -------- ---------
2003
Total revenues...................................... $22,918 $ 19,722 $ 23,520 $15,613 $ 81,773
Operating income (loss)............................. (3,202) (32,119) 930 (5,143) (39,534)
Net loss............................................ (4,742) (33,716) (681) (7,052) (46,191)
Net loss per share, basic and diluted .............. $ (0.01) $ (0.05) $ (0.01) $ (0.01) $ (0.08)
2002
Total revenues...................................... $17,262 $ 17,400 $ 22,891 $23,206 $ 80,759
Operating loss...................................... (3,292) (1,815) (5,314) (6,012) (16,433)
Net income (loss)................................... (7,841) (6,484) 173,694 (7,618) 151,751
Net income (loss) per share, basic and
diluted.......................................... $ (0.70) $ (0.58) $ 0.38 $ (0.01) $ 0.56
Net income (loss) per share amounts for each quarter are required to be
computed independently. Therefore, the sum of such quarterly per share amounts
do not necessarily equal the amount computed on an annual basis. During the
first, third and fourth quarters of 2003, the Company recognized revenues
related to dial-around compensation adjustments, including amounts related to
the sale of a portion of the Company's accounts receivable bankruptcy claim due
from WorldCom, of $3.9 million, $4.0 million and 0.4 million, respectively (see
Note 15). The Company also recorded NST refunds of $0.8 million in the first
quarter and EUCL refunds of $1.4 million in the fourth quarter of 2003 (see Note
16). During second quarter of 2003, the Company recorded the $27.1 million asset
impairment loss described in Note 3.
For 2002, the Company recorded a gain on debt extinguishment of $181.0
million in the third quarter relating to the debt restructuring described in
Note 4. The Company also recorded a $2.8 million loss from exit and disposal
activities during the third quarter of 2002 related to the closing of the
Company's former headquarters in Tampa, FL (see Note 5). As described in Note 5,
the third and fourth quarters of 2002 include the results of operation of
PhoneTel after July 24, 2002, the date of acquisition.
58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in the Registrant's accountants during the two
most recent fiscal years. There have been no disagreements with the Registrant's
accountants on any matter of accounting principles or practice or financial
statement disclosure at any time during the two most recent fiscal years.
ITEM 9A. DISCLOSURE CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures as of December 31, 2003.
Based on that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of December 31, 2003. There were no material
changes in the Company's internal controls over financial reporting during the
fourth quarter of 2003.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
DIRECTORS
The Company has four directors as of December 31, 2003. As part of the
PhoneTel Merger, Messrs. Barrett, Chapman and Genda were elected to serve until
the next annual meeting of the Company's stockholders or until his successor has
been elected and qualified. Effective September 1, 2003, Mr. McGee was elected
by the Board to serve on the Company's Board of Directors, replacing former
director Mr. Chichester, to serve until the next annual meeting of the Company's
stockholders or until his successor has been elected and qualified.
The following table sets forth certain information for each director.
DIRECTOR
CONTINUOUSLY
NAME SINCE AGE
- ----------------- ----------------- ---
Andrew C. Barrett July 24, 2002 63
James N. Chapman July 24, 2002 41
Kevin P. Genda July 24, 2002 38
Woody M. McGee September 1, 2003 52
Andrew C. Barrett has been the managing director of The Barrett Group,
Inc., a company providing consulting services to the telephone, media, and cable
industries, since 1997. Prior to that time, Mr. Barrett was a commissioner of
the FCC from 1989 to 1996 and a commissioner for the Illinois Commerce
Commission from 1980 to 1989. During his regulatory career, Mr. Barrett was a
member of the National Association of Regulatory Utility Commissioners ("NARUC")
executive committee and the NARUC committee on communications and a chairman of
the NARUC Committee on Water. Mr. Barrett is currently a director of
Telecommunications Systems, Inc.
James N. Chapman is associated with Regiment Capital Advisors, LLC
("Regiment") which he joined in January 2003. Prior to Regiment, Mr. Chapman
acted as a capital markets and strategic planning consultant with private and
public companies, as well as hedge funds, across a range of industries. Prior to
establishing an independent consulting practice, Mr. Chapman worked for The
Renco Group, Inc. ("Renco") from December 1996 to December 2001. Prior to Renco,
Mr. Chapman was a founding principal of Fieldstone Private Capital Group
("Fieldstone") in August 1990. Prior to joining Fieldstone, Mr. Chapman worked
for Bankers Trust Company from July 1985 to August 1990, most recently in the BT
Securities capital markets area. In addition to the Company, Mr. Chapman
59
serves as a member of the board of directors of Coinmach Corporation, Anchor
Glass Container Corporation, Southwest Royalties, Inc. and several privately
held companies.
Kevin P Genda has served as Managing Director of Cerberus Capital
Management, L.P. since 1995 and the Senior Vice President -- Chief Credit
Officer of Ableco Finance LLC, an affiliate of Cerberus, since Ableco's founding
four years ago. Mr. Genda oversees Cerberus' asset based lending activities.
Prior to joining Cerberus and Ableco in 1995, Mr. Genda was Vice President for
new business organization and evaluation at Foothill Capital Corporation, where
he was active in loan origination and distressed investing. Mr. Genda previously
worked at Huntington Holdings, a $300 million leveraged buyout firm, and at The
CIT Group/Business Credit, Inc. as an analyst for new investments and credits.
Woody M. McGee became Chief Executive Officer and director of the Company
effective September 1, 2003. Prior to joining the Company Mr. McGee was
President and Chief Executive Officer of McGee and Associates, LLC from January
2001. McGee and Associates is an independent consulting company providing
financial, operational and crisis management services to companies in the
telecommunications, computer and software sectors. From June 1999 to December
2000 Mr. McGee served as the Vice President and Chief Financial Officer of
Telxon Corporation until such time as it was merged with Symbol Technologies,
Inc. Prior to joining Telxon, Mr. McGee was employed as the Senior Vice
President and General Manager of H K Systems (formerly known as Western Atlas,
Inc.) from 1997. During 1996 and 1997 Mr. McGee held the positions of Vice
President, Chief Financial Officer and Treasurer with Mosler, Inc. For a period
of five years prior to joining Mosler, Mr. McGee held various positions with the
material handlings systems division of Western Atlas, Inc. (formerly known as
Litton Industries), including Controller, Chief Financial Officer, Vice
President of Operations, Vice President of Sales, and President and Chief
Operating Officer of a divisional subsidiary.
EXECUTIVE OFFICERS
The following table sets forth the names and ages of the Company's
executive officers and their positions with the Company:
Name Age Position
---- --- --------
Woody M. McGee 52 Chief Executive Officer
Tammy L. Martin 39 General Counsel and Secretary
Donald L. Paliwoda 51 Chief Financial Officer and Treasurer
Andrew P. Tzamaras 40 Chief Operating Officer
Tammy L. Martin has served as General Counsel of the Company since
September 5, 2002 and Secretary since June 9, 2003. Prior to that time, Ms.
Martin served as General Counsel of AmericanGreetings.com, Inc. since December
2000. From March 2000 to June 2000 she was Chief Financial Officer and General
Counsel for Portalvision, Inc. For seven years prior thereto, Ms. Martin held
several senior management positions with PhoneTel, including Chief
Administrative Officer, General Counsel and Secretary.
Donald L. Paliwoda has served as Chief Financial Officer of the Company
since October 14, 2003 and Treasurer of the Company since June 9, 2003. Prior to
Mr. Paliwoda's appointment as Chief Financial Officer, he served the Company in
various positions since July 24, 2002 including Interim Chief Financial Officer
and Corporate Controller. Prior to the PhoneTel Merger, Mr. Paliwoda was the
Corporate Controller of PhoneTel since November 1997. For a period of two years
prior thereto, Mr. Paliwoda held various positions with Biskind Development,
Inc., a privately held property management and real estate development firm,
including Chief Financial Officer and Controller.
Andrew P. Tzamaras became Chief Operating Officer on March 23, 2004. Mr.
Tzamaras has served as a Regional Vice President of the Company since December
of 1998. Prior to that time, Mr. Tzamaras held various operations management
positions including Regional Operations Director for Peoples Telephone Company
from June 1994 to December 1998. For four years prior to joining Peoples
Telephone Company, Mr. Tzamaras served as Director of Operations for Atlantic
Telco, which, at the time, was the largest independent payphone provider in the
mid-atlantic states.
60
CODE OF ETHICS
In March 2004, the Company adopted and the Board of Directors approved the
Code of Ethics and Business Conduct for Officers, Directors, and Employees of
Davel Communications, Inc. (the "Code of Ethics"). The Code of Ethics was
adopted to promote honest and ethical conduct, including full, fair and accurate
financial reporting, by all Directors, Officers and employees of the Company.
The Code of Ethics is being filed with the Commission as Exhibit 14.1 to this
Form 10-K.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 and related
regulations require the Company's directors, certain officers, and any persons
holding more than 10% of the Company's common stock ("reporting persons") to
report their initial ownership of the Company's common stock and any subsequent
changes in that ownership to the Securities and Exchange Commission. Specific
due dates have been established, and the Company is required to disclose in this
Item 10 any failure to file by these dates during 2003. To its knowledge, all
reporting persons of the Company satisfied these filing requirements in 2003.
In making this disclosure, the Company has relied on written
representations of reporting persons and filings made with the Commission.
ITEM 11. EXECUTIVE COMPENSATION
The following tables and notes set forth the compensation of the Company's
Chief Executive Officer and the Company's other executive officers whose salary
and bonuses exceeded $100,000 in the fiscal year ended December 31, 2003.
SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Compensation
------------------- ----------------------
Restricted
Stock Securities
Awards; Underlying
Name and Other Annual LTIP Options/ All Other
Principal Position Year Salary Bonus Compensation Payouts SARs Compensation
------------------ ---- ------ ----- ------------ ---------- ---- ------------
WOODY M. MCGEE 2003 $ 77,885 $ -- -- -- -- $205,697 (1)
Chief Executive Officer 2002 -- -- -- -- -- 28,852 (1)
2001 -- -- -- -- -- --
JOHN D. CHICHESTER (2) 2003 276,640 150,000 -- -- -- 525,000 (3)
Former Chief Executive 2002 164,528 150,000 -- -- -- --
Officer 2001 -- -- -- -- -- --
TAMMY L. MARTIN (4) 2003 182,412 30,000 -- -- -- --
General Counsel 2002 52,500 -- -- -- -- --
2001 -- -- -- -- -- --
DONALD L. PALIWODA (5) 2003 103,330 7,500 -- -- -- --
Chief Financial Officer 2002 40,902 -- -- -- -- --
2001 -- -- -- -- -- --
(1) Mr. McGee became Chief Executive Officer on September 1, 2003. McGee
& Associates, L.L.C., an entity owned by Mr. McGee, also received
consulting fees for services rendered to the Company prior to Mr.
McGee becoming CEO.
(2) Mr. Chichester became Chief Executive Officer on July 24, 2002 and
served until August 29, 2003.
(3) Represents payments to Mr. Chichester in connection with the
termination of his employment with the Company.
(4) Ms. Martin became the General Counsel on September 5, 2002.
(5) Mr. Paliwoda joined the Company on July 24, 2002 as a result of the
PhoneTel Merger and became Chief Financial Officer on October 14,
2003.
61
OPTION GRANTS IN LAST FISCAL YEAR
No options were granted for the year ended December 31, 2003.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Value of
Unexercised
In-the-Money
Options at
Number of Shares Underlying December 31,
Number of Shares Unexercised Options at 2003
Acquired on Value December 31, 2003 Exercisable/
Name Exercise(1) Realized(1) Exercisable/Unexercisable Unexercisable(2)
---- ----------- ----------- ------------------------- ----------------
Woody M. McGee -- -- 0 / 0 $0 / $0
Tammy L. Martin -- -- 0 / 0 0 / 0
Donald L. Paliwoda -- -- 12,763 / 0 0 / 0
John D. Chichester (3) -- -- 0 / 0 0 / 0
(1) There were no option exercises in the last fiscal year.
(2) Equals the difference between the aggregate exercise price of such
options and the aggregate fair market value of the shares of Common
Stock that would be received upon exercise, assuming such exercise
occurred on December 31, 2003, at which date the closing price of
the Common Stock as quoted on the Nasdaq over-the-counter bulletin
board was $0.02 per share. The above valuations may not reflect the
actual value of unexercised options as the value of unexercised
options fluctuates with market activity.
(3) Options expire if not exercised within 90 days of termination.
COMPENSATION OF DIRECTORS
At its September 10, 2002 regular meeting, the Board approved a
compensation policy providing that the directors of the Company who are not
employees receive, as their sole and exclusive compensation for their service to
the Company an annual cash retainer in the amount of $25,000, plus reimbursement
for any reasonable travel expenses. Except for Mr. Renard, director fees in an
amount equal to $29,779 were paid to each non-employee director during 2003 for
services rendered to the Company during 2002 and 2003. Mr. Renard received
$22,969 for directors fees and expenses during 2003 for services rendered prior
to his resignation from the Board on August 31, 2003. The Company also paid
$75,000 to Mr. Renard during 2003 in connection with a consulting agreement (see
Item 13 - Certain Relationships and Related Transactions).
In accordance with the Company's by-laws, in July 2003 the Board of
Directors established and designated certain independent directors to serve on
the Special Committee of the Board to identify and evaluate the strategic and
financial alternatives available to the Company in order to maximize value to
the Corporation's stakeholders. In accordance with the foregoing, special
committee fees in an amount equal to $30,000 were paid to Mr. Barrett and Mr.
Renard, and Mr. Chapman received special committee fees in an amount equal to
$50,000 as Chairman of the Special Committee.
INCENTIVE COMPENSATION
During 2003, the Compensation Committee of the Board established a
mechanism by which executives of the Company were to be granted incentive
compensation. The Company established bonus objectives based upon the objectives
of the Company, primarily in connection with the implementation of cost-savings
initiatives and other strategic alternatives adopted by the Board of Directors.
The eligibility of the Executives to earn a bonus is based upon the
implementation of each cost-savings initiative, as well as the realization by
the Company of the cost-savings associated therewith. Fifty-percent of any bonus
amount is paid to the Executives upon implementation of the cost-savings
initiative and the balance is paid upon realization by the Company of the
cost-savings; provided,
62
however, that the cost-savings realization must occur within twelve months of
implementation in order to qualify for inclusion under the bonus plan.
The Company also maintains the Davel Communications, Inc. 2002 Long-Term
Equity Incentive Plan, the Company's principal stock option plan (the "Stock
Option Plan"), pursuant to which the executive officers may be granted options
to purchase common stock at the latest closing price that is available prior to
the date the options are awarded. Under the Stock Option Plan, other employees
may be granted restricted stock or options to purchase shares of Common Stock.
The Compensation Committee determines which individuals will be granted options,
the number of shares to be subject to option and other terms and conditions
applicable to the grants. No options were granted to executive officers during
2002 and 2003.
401(k) PLAN
The Company maintains a 401(k) Plan, which is available to all employees
of the Company, including its executive officers. During 2002 the Company
provided a matching contribution to the Plan up to a maximum of 1.5% of the
salary of the contributing employee. The Company's contribution to an employee's
account vests over a period of five years. In 1999, the 401(k) plan of the
Company was merged with the plans of Peoples Telephone and Communications
Central Inc., subsidiaries of the Company. PhoneTel also has a 401(k) plan that
provides for but does not require Company contributions to the plan. There were
no Company contributions to the PhoneTel plan during 2002. Effective January 1,
2003, the plan name was changed to the Davel Communications, Inc. Employee
Saving Plan (the "New Davel Plan") and substantially all employees of the
Company are eligible to participate upon completion of the minimum term of
service. Beginning January 1, 2003, employees can elect to make contributions to
the New Davel Plan but will no longer be permitted to make contributions to the
Old Davel Plan. No matching contributions were made during 2003 and none are
expected to be made under the New Davel Plan during 2004.
EMPLOYMENT AGREEMENTS
Effective August 29, 2003, Davel entered into an employment agreement with
Woody McGee to serve as its Chief Executive Officer. The employment agreement
has a term of one year commencing September 1, 2003 and may be extended for an
additional one-year period. The employment agreement provides for an annual base
salary of $250,000 during the term of the employment agreement as well as
customary fringe benefits. The employment agreement also provides Mr. McGee with
the opportunity to earn an annual cash bonus based upon the successful
implementation of certain cost savings initiatives and cost savings realized by
the Company as directed by the Board of Directors; provided, however, the
agreement provides that such bonus amount shall not be less than $150,000. In
the event the Company terminates Mr. McGee's employment, without cause, prior to
the expiration of the agreement, Mr. McGee shall be entitled to a cash severance
payment equal to the sum of three months base salary and the unpaid portion of
any bonus earned as of the date of termination.
Effective September 4, 2002, Davel entered into an employment agreement
with Tammy L. Martin to serve as its General Counsel. The employment agreement
has an initial term of one year commencing September 4, 2002 was extended for an
additional one-year period. The employment agreement provided for an annual base
salary of $175,000 during the term of the employment agreement, as well as
participation in those benefit and bonus programs provided to other similarly
situated executives of the Company. During February 2004 the Company entered
into a new, one-year employment agreement with Ms. Martin, at annual base salary
levels and other terms substantially similar to the previous agreement. In the
event Ms. Martin's position is eliminated due to a restructuring or acquisition
of the Company, or in connection with an acquisition pursuant to which she is
requested to relocate more that fifty miles from her primary residence and does
not accept the terms of such relocation, Ms. Martin will be paid as severance an
amount equal to the greater of (i) six months base salary or (ii) the base
salary due and owing under the un-expired term of the agreement.
On or about February 12, 2004, the Company entered into an employment
agreement with Donald L. Paliwoda to serve as its Chief Financial Officer. The
employment agreement has a term of one year and provides for an annual base
salary of $115,000 during the term of the agreement, as well as participation in
those benefit and bonus programs provided to other similarly situated executives
of the Company. In the event Mr. Paliwoda's position is eliminated due to a
restructuring or acquisition of the Company, or in connection with an
acquisition pursuant to which he is
63
requested to relocate more that fifty miles from his primary residence and does
not accept the terms of such relocation, Mr. Paliwoda will be paid as severance
an amount equal to the greater of (i) six months base salary or (ii) the base
salary due and owing under the un-expired term of the agreement.
On or about March 22, 2004, the Company entered into an employment
agreement with Andrew P. Tzamaras to serve as its Chief Operating Officer. The
employment agreement has a term of one year and provides for an annual base
salary of $120,000 during the term of the agreement, as well as participation in
those benefit and bonus programs provided to other similarly situated executives
of the Company. In the event Mr. Tzamaras' position is eliminated due to a
restructuring or acquisition of the Company, or in connection with an
acquisition pursuant to which he is requested to relocate more that fifty miles
from his primary residence and does not accept the terms of such relocation, Mr.
Tzamaras will be paid as severance an amount equal to the greater of (i) six
months base salary or (ii) the base salary due and owing under the un-expired
term of the agreement.
COMPENSATION COMMITTEE REPORT
The Compensation Committee of the Board of Directors is responsible for
determining the compensation of all executive officers of the Company.
Compensation Philosophy
The Committee's objectives in its compensation decisions are to establish
incentives for the Company's executive officers to achieve optimal short-term
and long-term operating performance for the Company and to link executive and
stakeholder interests. The Company determines the elements of each executive
officer's compensation package by evaluating the responsibilities of his
position, his performance and that of the Company, as well as his contribution
to the Company's overall performance.
2003 Compensation
There were four potential elements of compensation of the executive
officers for 2003: base salary, cash bonus, stock options granted under the
Stock Option Plan and annual stock grants.
The 2003 compensation of executive officers was generally established at
levels consistent with their prior employment and/or written agreement with the
Company. In each instance, the terms of employment were reviewed by the
Committee and found to be generally consistent with the Committee's policies
regarding executive compensation and appropriate in light of the financial
condition of the Company.
Base salaries of all officers were intended to be relatively moderate and
are believed to be at or below the median of the base salaries paid in 2003 by
public telecommunications companies of a size comparable to the Company. The
existing employment agreements did not provide for automatic increases in the
base salary of any of the executive officers.
The Chief Executive Officer and General Counsel were each entitled to a
bonus determined by reference to his or her employment agreement based on his or
her efforts to help the Company reach its goals and objectives.
In an effort to provide a long-term incentive for future performance that
aligns the executive officers' interests with the interests of stockholders,
executive officers are eligible for participation in the Company's Stock Option
Plan. Stock options are intended to provide an incentive for the creation of
stockholder value over the term of several years since the full benefit of
options will be realized only if the price of common stock appreciates over that
term. In 2003, no stock options were granted to the executive officers of the
Company with respect to the Company's performance in 2002. The Company also may
award stock grants under the Stock Option Plan. Stock awarded under the Stock
Option Plan would contain certain restrictions on transfer. Awarding stock with
restriction on its transfer provides further long-term incentives that align the
interests of the executive officers with the interests of stockholders.
This Report of the Compensation Committee on Executive Compensation shall
not be deemed incorporated by reference by any general statement incorporating
by reference this Annual Report or any portion hereof into any of
64
the Company's filings with the Securities and Exchange Commission, and such
information shall not be deemed filed with the Securities and Exchange
Commission, except as specifically otherwise provided in such other filings or
to the extent required by Item 402 of Regulation S-K.
James Chapman, Chairman
Andrew Barrett
Kevin Genda
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
OWNERSHIP OF COMMON STOCK BY DIRECTORS AND EXECUTIVE OFFICERS AND BENEFICIAL
OWNERS
The following table sets forth information regarding shares of the
Company's common stock, par value $0.01 per share, beneficially owned, as of
March 19, 2004, by the Company's directors, named executive officers and 5%
stockholders.
Number of Shares
Name and Address (1) Beneficially Owned Percentage of Class
-------------------- ------------------ -------------------
Andrew C. Barrett (3) (8) 0 *
James N. Chapman (3) (8) 0 *
John D. Chichester (4) (8) (9) 0 *
Kevin P. Genda (3) (8) (10) 0 *
Tammy L. Martin (2) (8) 0 *
Woody M. McGee (2) (3) (8) 0 *
Donald L. Paliwoda (2) (5) (8) 12,763 *
Andrew P. Tzamaras (2) (6) (8) 7,100 *
ARK CLO 2000-1, Limited 53,621,855 8.72%
C/O Patriarch Partners, LLC
112 South Tryon Street, Suite 700
Charlotte, NC 28284
Stephen Feinberg (7) 277,071,874 45.05%
299 Park Avenue,
New York, NY 10171
Wells Fargo Foothill, Inc. 76,747,150 12.48%
2450 Colorado Avenue, Suite 3000 West
Santa Monica, CA 90404
Foothill Partners III, L.P. 76,747,150 12.48%
2450 Colorado Avenue, Suite 3000 West
Santa Monica, CA 90404
All current directors and executive officers as a group (7 persons) 19,863 *
* Less than 1%
(1) For purposes of calculating the beneficial ownership of each
stockholder, it was assumed (in accordance with the Securities and
Exchange Commission's definition of "beneficial ownership") that such
stockholder had exercised all options, conversion rights or warrants by
which such stockholder had the right, within 60 days, to acquire shares
of such class of stock.
(2) Such person is an employee of the Company.
(3) Such person is a director of the Company.
65
(4) Such person is a former officer and former employee of the Company.
(5) Includes 12,763 shares that could be acquired within 60 days upon the
exercise of options granted pursuant to the Company's stock option
plan.
(6) Includes 6,800 shares, of which 3,800 expire on April 21, 2004, that
could be acquired within 60 days upon the exercise of options granted
pursuant to the Company's stock option plans.
(7) Cerberus Partners, L.P., a Delaware limited partnership, is the holder
of 225,907,083 shares of common stock of Davel and Styx Partners, L.P.,
a Delaware limited partnership, is the holder of 51,164,764 shares of
common stock of Davel. Stephen Feinberg possesses sole power to vote
and direct the disposition of all shares of common stock of Davel held
by Cerberus Partners, L.P. and Styx Partners, L.P.
(8) The address of such officers, unless otherwise noted, is 200 Public
Square, Suite 700, Cleveland, Ohio 44114.
(9) Options not exercised within 90 days from separation of employment
expire by terms of the stock options.
(10) Kevin Genda, a director of the Company, does not individually hold or
otherwise beneficially own any securities of the Company. Mr. Genda is
a Managing director of Cerberus Capital Management, L.P., an affiliate
of Cerberus Partners, L.P. and Styx Partners, L.P., which, as noted in
this beneficial ownership table, owns shares of common stock of the
Company, all of which are subject to the sole voting and investment
authority of Stephen Feinberg. Stephen Feinberg, in his capacity as the
holder of sole voting and investment authority with respect to such
shares, separately files statements with respect thereto pursuant to
Section 13 and Section 16 of the Securities Exchange Act of 1934, as
amended. Mr. Genda does not exercise any voting, investment or other
authority with respect to the shares of common stock of the Company
separately reported by Stephen Feinberg.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table summarizes information relating to the Company's
equity compensation plans, including individual compensation arrangements, as of
December 31, 2003:
Number of securities to Weighted average
be issued upon exercise exercise price of Number of securities
of outstanding options, outstanding options, remaining available for
Plan category warrants, and rights warrants, and rights future issuance
----------------------- -------------------- -----------------------
Equity Compensation plans approved by
security holders (a) 564,805 5.19 2,111,972
Equity compensation plans not approved by
security holders (b) (c) 202,717 2.33 26,406,104
------- ---- ----------
Total 767,522 4.44 28,518,076
======= ==== ==========
(a) Includes options to acquire 23,505 shares of common stock with a
weighted average exercise price of $22.00 that were originally
granted by companies acquired by the Registrant.
(b) The number of securities to be issued upon exercise of outstanding
options to acquire 25,850 shares of common stock under individual
compensation agreements granted by companies acquired by the
registrant and options to acquire 176,867 shares of common stock
granted under the PhoneTel 1999 Management Incentive Plan (the
"PhoneTel Plan"). The PhoneTel Plan provides for the issuance of
incentive and non-qualified stock options, stock appreciation rights
and other awards to purchase up to 537,223 additional shares of
common stock by officers, directors, and management employees. The
PhoneTel Plan will continue in effect until December 31, 2009,
unless sooner terminated. All outstanding options under the PhoneTel
Plan and individual compensation arrangements were exercisable at
December 31, 2003 and expire at various dates through March 8, 2005.
(c) The number of securities remaining available for future issuance
includes 25,780,208 of the 26,780,208 shares available under the
Company's 2000 Long-Term Equity Incentive Plan that were authorized
in connection with the PhoneTel Merger. (See Note 13 to the
Company's consolidated financial statements for the material
features of the plan). It also includes 537,223 and 88,673
securities available for future issuance under the PhoneTel Plan and
individual compensation arrangements, respectively.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Chichester, the Company's former Chief Executive Officer and former
Director is a director, executive vice president and a 49% shareholder of Urban
Telecommunications, Inc. ("Urban"). During the year ended December 31, 2003, the
Company earned revenue of $1,217,000 from various telecommunication contractor
services provided
66
to Urban, principally residence and small business facility provisioning and
inside wiring. Accounts receivable included $123,000 at December 31, 2003 due
from Urban. Additionally, in 2003, Urban was paid $125,000 for providing the
Company with pay telephone management and other services for the Company's
payphone installations located in and around New York, New York. In October 2003
the Company and Urban terminated its service relationship.
Mr. Renard, a former Director and Executive Officer of the Company entered
into a six-month consulting agreement following the termination of his
employment with the Company. In connection with the consulting agreement, Mr.
Renard provided regulatory consulting services in the consideration of the sum
$12,500 per month, plus reimbursement for the costs incident to the maintenance
of family medical insurance.
On or about November 25, 2002 the Company entered into a six month
consulting agreement with McGee & Associates, L.L.C. to provide restructuring
and integration management services to the Company. Mr. Woody McGee, the
Company's current Chief Executive Officer, is President, Chief Executive Officer
and sole owner of McGee & Associates, L.L.C. Pursuant to the terms of the
agreement, Mr. McGee provided consulting services in consideration of the sum of
$2,500 per day, plus reimbursement for business related travel expenses. During
2002 and 2003 McGee & Associates, L.L.C. was paid the sum of $205,697 and
$28,852 respectively, in accordance with the terms of the agreement.
Any future transactions between the Company and its officers, directors,
employees and affiliates that are outside the scope of the Company's employment
relationship with such person will be subject to the approval of a majority of
disinterested members of the Board of Directors.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
For the year ended December 31, 2003 and 2002, the Company paid Aidman,
Piser & Company, P.A. ("Aidman, Piser"), the Company's principal accountants,
the following fees for audit and non-audit services:
Audit Fees
Aidman, Piser billed the Company an aggregate of $154,000 and $177,500
for audit fees in 2003 and 2002, respectively.
Audit Related Fees
In 2002, Aidman, Piser billed the Company an aggregate of $77,000 for
assurance and related services applicable to the Company's joint proxy and
registration statement relating to the PhoneTel Merger.
Tax Fees
Aidman, Piser billed the Company $91,000 in 2003 and $71,000 in 2002
for income tax services rendered to the Company.
All Other Fees
Aidman, Piser did not bill the Company for any other services during
2003 and 2002.
The Audit Committee or the Board of Directors pre-approves all audit or
non-audit services and does not have a pre-approval policy for such services.
The Audit Committee or the Board of Directors pre-approved all audit and
non-audit services in 2003.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed with, and as part of, this Annual
Report on Form 10-K.
1. FINANCIAL STATEMENTS
See Part II.
2. FINANCIAL STATEMENT SCHEDULES
None
3. EXHIBITS
See Exhibit Index on the following page.
(b) Reports on Form 8-K.
The Registrant filed no reports on Form 8-K during the fourth quarter of
2003.
68
EXHIBIT INDEX
3.1 Restated Certificate of Incorporation of Davel Communications, Inc.
(incorporated by reference to Exhibit 3.1 to Registration Statement on
Form S-4 (Registration No. 333-67617) dated November 20, 1998).
3.2 Restated By-laws of Davel Communications, Inc. (incorporated by
reference to Exhibit 3.2 to Registration Statement on Form S-4
(Registration No. 333-67617) dated November 20, 1998).
3.3 Certificate of Amendment to the Certificate of Incorporation of Davel
Communications, Inc. (incorporated by reference from the Company's Form
8-K dated August 1, 2002).
10.1 Davel Communications, Inc. Amended and Restated 2000 Long-Term Equity
Incentive Plan, as amended through February 11, 2002 (incorporated by
reference from the Company's Form 10-K for the year ended December 31,
2001).
10.2 Amended, Restated, and Consolidated Credit Agreement, dated as of July
24, 2002, 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 (incorporated by reference from the Company's Form 8-K
dated August 1, 2002).
10.3 Amended, Restated, and Consolidated Security Agreement, dated as of
July 24, 2002, by Davel Financing Company, L.L.C., PhoneTel
Technologies, Inc., Cherokee Communications, Inc., Davel
Communications, Inc., and the domestic subsidiaries of each of the
foregoing, in favor of Foothill Capital Corporation, as Agent, and the
lenders as set forth in the Credit Agreement above (incorporated by
reference from the Company's Form 8-K for the year ended August 1,
2002).
10.4 First Amendment and Waiver to Amended, Restated, and Consolidated
Credit Agreement, dated as of March 31, 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 (incorporated by reference to
Exhibit 10.8 of the Company's Form 10-K filed with the Commission on
April 4, 2003)
10.5 Assignment of Claim Agreement dated as of March 7, 2003 by and between
Davel Communications, Inc. and Deutsche Bank Securities Inc.
(incorporated by reference to Exhibit 10.1 from the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003).
10.6 Assignment of Claim Agreement dated as of March 3, 2003 by and between
Davel Communications, Inc. and Deutsche Bank Securities Inc.
(incorporated by reference to Exhibit 10.2 from the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003).
10.7 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 Wells Fargo Foothill, Inc. (formerly Foothill Capital
Corporation), as Agent, and the lenders named therein (incorporated by
reference to Exhibit 10.1 from the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003).
10.8 Employment Agreement dated August 29, 2003 between Davel
Communications, Inc. and Woody McGee (incorporated by reference to
Exhibit 10.2 from the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003).
10.9 Payphone Field Service Agreement dated October 17, 2003 between Davel
Communications, Inc. and NSC Communications Public Service Corporation.
10.10 Commercial Service Agreement dated December 29, 2003 between Davel
Communications, Inc. and Comm South Companies, Inc.
69
10.11 Second Amendment and Waiver to Amended, Restated, and Consolidated
Credit Agreement, dated as of February 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 Wells Fargo Foothill, Inc.
(formerly Foothill Capital Corporation), as Agent, and the lenders
named therein.
10.12 Employment Agreement dated February 13, 2004 between Davel
Communications, Inc. and Tammy L. Martin.
10.13 Employment Agreement dated February 13, 2004 between Davel
Communications, Inc. and Donald L. Paliwoda.
10.14 Employment Agreement dated March 23, 2004 between Davel Communications,
Inc. and Andrew P. Tzamaras.
14.1 Code of Ethics and Business Conduct for Officers, Directors, and
Employees of Davel Communications, Inc.
21.1 Subsidiaries of Davel Communications, Inc.
31.1 Certification of Chief Executive Officer pursuant to Sarbanes-Oxley Act
of 2002 Section 302.
31.2 Certification of Chief Financial Officer pursuant to Sarbanes-Oxley Act
of 2002 Section 302.
32.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Sarbanes-Oxley Act of 2002 Section 906.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
DAVEL COMMUNICATIONS, INC.
By: /s/ WOODY M. MCGEE
------------------------------
Woody M. McGee
Chief Executive Officer
Date: March 30, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ WOODY M. MCGEE Chief Executive Officer and Director March 30, 2004
- ------------------------------------
Woody M. McGee
/s/ DONALD L. PALIWODA Chief Financial Officer March 30, 2004
- ------------------------------------
Donald L. Paliwoda
/s/ ANDREW C. BARRETT Director March 30, 2004
- ------------------------------------
Andrew C. Barrett
/s/ JAMES N. CHAPMAN Director March 30, 2004
- ------------------------------------
James N. Chapman
/s/ KEVIN P. GENDA Director March 30, 2004
- ------------------------------------
Kevin P. Genda
71