Back to GetFilings.com
================================================================================
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
-------- ---------
COMMISSION FILE NUMBER: 000-25207
DAVEL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-3538257
-------- ----------
(State or other jurisdiction of (I.R.S. Employer)
incorporation or organization) I.D. No.)
200 PUBLIC SQUARE, SUITE 700, CLEVELAND, OH 44114
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (216) 241-2555
Indicate by check mark whether the Registrant has (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of May 09, 2004, there were 615,018,963 shares of the Registrant's Common
Stock outstanding.
================================================================================
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
ITEM 1
Financial Statements:
Consolidated Balance Sheets................................................................ 1
Consolidated Statements of Operations...................................................... 2
Consolidated Statements of Cash Flows...................................................... 3
Notes to Consolidated Financial Statements................................................. 4
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 13
Liquidity and Capital Resources............................................................ 16
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk................................. 18
ITEM 4
Disclosure Controls and Procedures......................................................... 19
PART II OTHER INFORMATION
ITEM 6
Exhibits and Reports on Form 8-K........................................................... 19
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
MARCH 31
2004 DECEMBER 31
(UNAUDITED) 2003
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 5,340 $ 7,775
Accounts receivable 5,712 7,975
Other current assets 2,518 2,922
----------- -----------
Total current assets 13,570 18,672
Property and equipment, net 20,162 22,878
Location contracts, net 5,923 6,746
Other assets, net 1,956 2,026
----------- -----------
Total assets $ 41,611 $ 50,322
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and obligations under capital leases $ 1,986 $ 1,994
Accrued commissions payable 8,516 9,020
Accounts payable and other accrued expenses 13,692 15,847
----------- -----------
Total current liabilities 24,194 26,861
Long-term debt and obligations under capital leases 124,950 125,962
----------- -----------
Total liabilities 149,144 152,823
----------- -----------
Commitments and contingencies (Note 9) - -
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 (257,893) (252,861)
----------- -----------
Total shareholders' deficit (107,533) (102,501)
----------- -----------
Total liabilities and shareholders' deficit $ 41,611 $ 50,322
=========== ===========
The accompanying notes are an integral part of these financial statements.
1
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31
-----------------------------
2004 2003
------------- -------------
REVENUES:
Coin calls $ 8,831 $ 13,179
Non-coin calls 3,136 5,811
Dial-around compensation adjustments 1,216 3,928
------------- -------------
Total revenues 13,183 22,918
------------- -------------
OPERATING EXPENSES:
Telephone charges 4,019 7,055
Commissions 2,372 4,024
Service, maintenance and network costs 4,539 6,508
Depreciation and amortization 3,669 5,860
Selling, general and administrative 1,770 2,362
Exit and disposal activities 312 311
------------- -------------
Total costs and expenses 16,681 26,120
------------- -------------
Operating loss (3,498) (3,202)
OTHER INCOME (EXPENSE):
Interest expense, net (1,612) (1,586)
Other 78 46
------------- -------------
Total other income (expense) (1,534) (1,540)
------------- -------------
NET LOSS $ (5,032) $ (4,742)
============= =============
LOSS PER SHARE CALCULATION:
Net loss per common share, basic and diluted ($0.01) ($0.01)
============= =============
Weighted average number of shares, basic and diluted 615,018,963 615,018,963
============= =============
The accompanying notes are an integral part of these financial statements.
2
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED MARCH 31
---------------------------
2004 2003
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,032) $ (4,742)
Adjustments to reconcile net loss to net cash flow from operating activities:
Depreciation and amortization 3,669 5,860
Amortization of deferred financing costs and non-cash interest 921 1,288
Loss on disposal of assets 23 7
Other 51 -
Changes in current assets and current liabilities:
Accounts receivable 2,263 5,845
Other current assets 404 (534)
Accrued commissions payable (504) (708)
Accounts payable and accrued expenses (2,155) (1,210)
---------- ----------
Net cash from operating activities (360) 5,806
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets 47 (2)
Capital expenditures (216) (99)
Payments for location contracts (11) (41)
(Increase) decrease in other assets 41 (299)
---------- ----------
Net cash from investing activities (139) (441)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt (1,883) (4,666)
Principal payments under capital leases (53) (66)
---------- ----------
Net cash from financing activities (1,936) (4,732)
---------- ----------
Net increase (decrease) in cash and cash equivalents (2,435) 633
Cash and cash equivalents, beginning of period 7,775 6,854
---------- ----------
Cash and cash equivalents, end of period $ 5,340 $ 7,487
========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST PAID $ 691 $ 261
========== ==========
The accompanying notes are an integral part of these financial statements.
3
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2004
1. 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 44,000 payphones in 46 states and the District of
Columbia. The Company's headquarters is located in Cleveland, Ohio with field
service offices in 14 geographically dispersed locations.
The accompanying consolidated balance sheet of Davel and its subsidiaries at
March 31, 2004 and the related consolidated statements of operations and cash
flows for the three month periods ended March 31, 2004 and 2003 are unaudited.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. In the opinion of management, all adjustments necessary for a
fair presentation of such consolidated financial statements have been included.
Such adjustments consist only of normal, recurring items. Certain information
and footnote disclosures normally included in audited financial statements have
been omitted in accordance with generally accepted accounting principles for
interim financial reporting. These interim consolidated financial statements
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations appearing elsewhere in this Form
10-Q and with the Company's audited consolidated financial statements and the
notes thereto in the Company's Form 10-K for the year ended December 31, 2003.
The results of operations for the three-month period ended March 31, 2004 are
not necessarily indicative of the results for the full year.
On July 24, 2002, the Company restructured its long-term debt by completing the
debt-for-equity exchange described in Note 7. Immediately thereafter, on that
same date, a wholly owned subsidiary of Davel merged with and into PhoneTel
Technologies, Inc. ("PhoneTel") pursuant to the Agreement and Plan of
Reorganization and Merger, dated February 19, 2002, between the Company and
PhoneTel (the "PhoneTel Merger"). 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 PhoneTel Merger has been accounted for as a purchase business combination.
Accordingly, the results of operations of PhoneTel have been included in the
consolidated financial statements of the Company since the effective date of the
merger.
Certain reclassifications have been made to prior year balances to conform to
the current year presentation.
2. LIQUIDITY AND MANAGEMENT'S PLANS
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The Company has incurred losses
of approximately $46.2 million and $5.0 million for the year ended December 31,
2003 and the three months ended March 31, 2004, respectively. These losses were
primarily attributable to declining revenues attributable to increased
competition from providers of wireless communication services and the non-cash
asset impairment losses in 2003 as described in Note 4. In addition, as of March
31, 2004, the Company had a working capital deficit of $10.6 million, which
includes $1.9 million of Federal universal service fees and other past due
obligations, and the Company's liabilities exceeded it assets by $107.5 million.
Although the Company is currently in compliance with the financial covenants and
debt payments due under its credit facility, as amended, there can be no
assurance that the Company will be able to remain in compliance or refinance the
remaining balance due at maturity with its current or other lenders. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern.
4
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, respectively, include (i) the continued
removal of unprofitable payphones, (ii) reductions in telephone charges by
changing to competitive local exchange carriers ("CLECs") or other alternative
carriers, (iii) the evaluation, sale or closure of unprofitable district
operations, (iv) outsourcing payphone collection, service and maintenance
activities to reduce operating costs, and (v) the further curtailments of
operating expenses.
Based upon the progress or successful completion of certain of the above
initiatives, in April 2004, the Company formed a new committee of independent
members of the Company's Board of Directors to evaluate other strategic
opportunities available to the Company. In addition, as discussed in Note 7, the
Company has been engaged in discussions with its 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 credit facility.
Notwithstanding the ongoing efforts to improve operating results, the Company
may continue to face liquidity shortfalls as it relates to the Company's past
due obligations, including Federal universal service fees. As a result, the
Company might be required to dispose of assets to fund its operations or curtail
its capital and other expenditures to meet its debt service and other
obligations. There can be no assurances as to the Company's ability to execute
such dispositions, or the timing thereof, or the amount of proceeds that the
Company could realize from such sales. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
3. EXIT AND DISPOSAL ACTIVITIES
In the first quarter of 2003, the Company 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 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. This
charge was recorded in the fourth quarter of 2003 when incurred. In the first
quarter of 2004, the Company outsourced the servicing of additional payphones
and closed four additional district offices in Texas and Missouri to further
reduce its operating costs. The Company incurred an additional loss of $0.3
million relating to the closing of these district office facilities. Subsequent
to March 31, 2004, the Company continued to outsource the servicing of its
payphones and closed three additional district offices in North Carolina, New
York and Florida.
4. IMPAIRMENT 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"). A review was performed during the
second quarter of 2003 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 Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"), 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 in
the second quarter of 2003 to reduce the carrying value of such assets to
estimated fair value, less cost to sell. Fair value was determined based on the
higher
5
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, "Goodwill and Other
Intangible Assets", 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.
Asset impairment charges were as follows for the quarter ended June 30, 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.
5. DIAL-AROUND COMPENSATION
A dial-around call occurs when a non-coin call is placed from the Company's
public pay telephone which utilizes any interexchange carrier ("IXC") other than
the presubscribed carrier (the Company's dedicated provider of long distance and
operator assisted calls). The Company receives revenues from such carriers and
records those revenues from dial-around compensation based upon the per-call
rate in effect pursuant to orders issued by the Federal Communications
Commission (the "FCC") under section 276 of the Telecommunications Act of 1996
("Section 276") and the estimated number of dial-around calls placed from each
pay telephone during each month. Prior to 2001, the Company recorded revenue
from dial-around compensation based upon the current rate of $0.24 per call
($0.238 per call prior to April 21, 1999) and 131 monthly calls per phone, which
represented the monthly average compensable calls from a pay telephone and was
used by the FCC in initially determining the amount of dial-around compensation
to which payphone service providers ("PSP") were entitled, and which was
utilized until such time as the actual number of dial-around calls could be
tracked on a per pay telephone basis. The Company reports revenues from
dial-around compensation using the current $0.24 per-call rate and the Company's
estimate of the average monthly compensable calls per phone, which is based upon
the Company's historical collection experience and expected future developments.
As a result of orders issued by the FCC regarding dial-around compensation and
the resulting litigation, the amount of revenue payphone service providers
("PSPs") were entitle to receive and the amount PSPs actually received has
varied. In general, there have been underpayments of dial-around compensation
from IXCs and other carriers from November 6, 1996 through October 6, 1997 (the
"Interim Period") and overpayments to PSPs, including the Company, from October
7, 1997 through April 20, 1999 (the "Intermediate Period"). On January 31, 2002,
the FCC released its Fourth Order on Reconsideration and Order on Remand (the
"2002 Payphone Order") that provided a partial decision on how retroactive
dial-around compensation adjustments for the Interim Period and Intermediate
Period may apply. The 2002 Payphone Order increased the flat monthly dial-around
compensation rate for true-ups between individual IXCs and PSPs during the
Interim Period from $31.178 to $33.892 (the "Default Rate"). The Default Rate
was based on 148 calls per month at $0.229 per call. The Default Rate also
applied to flat rate dial-around compensation during the Intermediate Period
when the actual number of dial-around calls for each payphone was not available.
The 2002 Payphone Order excluded resellers but expanded the number of IXCs
required to pay dial-around compensation during the Interim and Intermediate
Periods. It also prescribed the Internal Revenue Service interest rate for
refunds as the interest rate to be used to calculate overpayments and
underpayments of dial-around compensation for the Interim Period and
Intermediate Period.
6
The 2002 Payphone Order kept in place the per-call compensation rate during the
Intermediate and subsequent periods but did not address the method of allocating
dial-around compensation among IXCs responsible for paying fixed rate per-phone
compensation. On October 23, 2002 the FCC released its Fifth Order on
Reconsideration and Order on Remand (the "Interim Order"), which resolved all
the remaining issues surrounding the Interim Period and the Intermediate Period
true-up and specifically addressed how flat rate monthly per-phone compensation
owed to PSPs would be allocated among the IXCs. 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 2002 Payphone Order
and prior orders issued by the FCC regarding dial-around compensation. 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. In the fourth
quarter of 2002, the Company recorded a $3.8 million charge as an adjustment to
revenues from dial-around compensation representing the estimated amount due by
the Company to certain dial-around carriers under the Interim Order. Of this
amount, $2.9 million and $3.6 million is included in accounts payable and other
accrued expenses in the accompanying consolidated balance sheets at March 31,
2004 and December 31, 2003, respectively. In April 2004, certain carriers
deducted approximately $0.4 million from their current dial-around compensation
payments, further 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, Inc (`WorldCom"), of which $3.9 million relates
to the amount due from WorldCom under the Interim Order (see Note 6). 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, $0.4
million and $1.2 million of net receipts from other carriers under the Interim
Order that was recognized as revenue in the third and fourth quarters of 2003
and the first quarter of 2004, respectively. Such revenues for the quarters
ended March 31, 2004 and 2003 have been reported as dial-around compensation
adjustments in the accompanying consolidated statements of operations. The
Company expects to receive a substantial amount of additional dial-around
compensation from various carriers, of which $0.7 million was received and will
be recognized as revenue subsequent to March 31, 2004 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 American Public
Communications Council (the "APCC") and the Regional Bell Operating Companies
("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
7
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.
6. 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 receive from the
purchaser 51% of the amount of the allowed claim in excess of the Scheduled
Debt included in WorldCom's plan of reorganization as confirmed by the
U. S. Bankruptcy Court. On April 21, 2004, WorldCom emerged from Chapter 11
bankruptcy protection. The Company is currently negotiating with WorldCom to
reconcile the Scheduled Debt to the amount of the Company's proof of claim.
Although the Company expects to settle its claim for an amount in excess of the
Scheduled Debt, there can be no assurance that the Company will be able to
collect 51% of such excess, if any, from the purchaser of its claim.
Of the $4.9 million of proceeds from the sale of the WorldCom bankruptcy claim,
approximately $1.0 million related to the recovery of the Company's accounts
receivable for unpaid dial-around compensation for the second and third quarters
of 2002, for which the Company had previously provided an allowance for doubtful
accounts, and approximately $3.9 million related to the Interim Order described
in Note 5. 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), $0.9 million was used to pay
certain accounts payable, and $1.0 million was deposited in escrow with the
Company's lenders. The remaining amount deposited in escrow at March 31, 2004 of
approximately $0.6 million is available to fund certain business initiatives
approved by the lenders.
During the first quarter of 2003, the Company received $4.6 million of refunds
of prior period telephone charges relating to the recently adopted new services
test ("New Services Test" or "NST") in certain states. Of this amount, $3.8
million and $0.8 million were recognized as reductions in telephone charges in
the fourth quarter of 2002 and the first quarter of 2003, respectively.
Approximately $2.8 million of these refunds were used to pay a portion of the
balance due on the Company's Senior Credit Facility 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.
8
During the fourth quarter of 2003, the Company received $1.4 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.
7. LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES
Following is a summary of long-term debt and obligations under capital leases as
of March 31, 2004 and December 31, 2003 (in thousands):
MARCH 31 DECEMBER 31
2004 2003
---------- ----------
CREDIT FACILITY, due December 31, 2005:
TERM NOTE A, ($50,000 face value) plus unamortized premium, discount and
capitalized interest of $12,104 at March 31, 2004....................................... $ 62,104 $ 61,644
TERM NOTE B, ($51,000 face value) plus unamortized premium, discount and
capitalized interest $12,608 at March 31, 2004.......................................... 63,608 65,077
NOTE PAYABLE, ($1,249 face value) due November 16, 2004..................................... 1,179 1,137
CAPITAL LEASE obligations with various interest rates and maturity dates through
2005.... ................................................................................... 45 98
---------- -----------
126,936 127,956
Less -- Current maturities.................................................................. (1,986) (1,994)
---------- -----------
$ 124,950 $ 125,962
========== ===========
CREDIT FACILITY
On July 24, 2002 (the "closing date"), immediately prior to the PhoneTel Merger,
the then existing PhoneTel junior lenders exchanged an amount of indebtedness
that reduced the then existing 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 then 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 then existing
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 of $101.0 million (the "Credit Facility"), including a $1.0
million loan origination fee. Following the exchange and the PhoneTel Merger,
the creditors of the Company in the aggregate owned 95.2% of the outstanding
common stock of the Company.
The combined restructured Credit Facility is due December 31, 2005 (the
"maturity date") and 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 three months
ended March 31, 2004 and the years ended December 31, 2003 and 2002,
approximately $2.9 million, $11.3 million and $4.6 million of interest,
respectively, was added to the principal
9
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.
The Company has accounted for the debt exchange discussed above as a troubled
debt restructuring and recorded a $181.0 million gain in 2002 relating to the
extinguishments of its former junior 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 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 Credit
Facility ($36.9 million) were initially 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 Credit Facility (amounts in thousands):
DAVEL PHONETEL TOTAL
---------- ---------- ----------
Face value of credit facilities................................................ $ 64,135 $ 36,865 $ 101,000
Premium: interest capitalization............................................... 24,122 -- 24,122
Discount: present value of acquired debt....................................... -- (4,658) (4,658)
---------- ---------- ----------
Initial carrying value......................................................... 88,257 32,207 120,464
Payment-in-kind interest in 2002 and 2003...................................... 10,093 5,811 15,904
Principal and interest payments in 2003 (709) (408) (1,117)
Amortization of premiums and discounts in 2002 and 2003........................ (10,229) 1,699 (8,530)
---------- ---------- ----------
Carrying value on December 31, 2003............................................ 87,412 39,309 126,721
Payment-in-kind interest in 2004............................................... 1,859 1,069 2,928
Principal and interest payments in 2004 (1,572) (900) (2,472)
Amortization of premiums and discounts in 2004................................. (1,808) 343 (1,465)
---------- ---------- ----------
Carrying value on March 31, 2004............................................... $ 85,891 $ 39,821 $ 125,712
========== ========== ==========
The Credit Facility is secured by substantially all assets of the Company and
was subordinate in right of payment to the Senior Credit Facility. The 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
lenders, and advanced payments of principal from excess cash flow and certain
types of cash receipts. The Credit Facility includes covenants that require the
Company to maintain a minimum level of combined earnings (EBITDA and Adjusted
EBITDA, as defined in the Credit Facility) and limits the incurrence 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 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 Credit Facility at December 31, 2002. On March 31, 2003, the
Company executed an amendment to its 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 amount) due under 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 terms of the First Amendment, the Company was not in
compliance with the new minimum Adjusted EBITDA covenant under the Credit
Facility, 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 lenders (the "Forbearance
10
Agreement") that granted forbearance with respect to defaults and cash payments
due under the terms of the 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 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 contained in the Credit Facility, and therefore, was in
default of the terms of the Credit Facility. On February 24, 2004, the Company
executed an amendment (the "Second Amendment") that waived all defaults through
the date of the amendment, reduced 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
reduced the minimum payments due under the Credit Facility to $100,000 per month
plus the monthly administrative 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. As defined in the Credit
Facility, "Regulatory Receipts" include prior year EUCL Charges and New Services
Test refunds from LECs and net dial-around true-up refunds from long-distance
carriers. As of March 31, 2004, the Company has made all payments and has
complied with all financial covenants required under the Second Amendment.
The Company has been engaged in discussions with its lenders regarding the
possibility of restructuring the debt outstanding under the 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 Credit Facility.
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 Credit Facility and
Senior Credit Facility 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 Credit Facility. In connection with the
PhoneTel Merger, the note was originally recorded at its net present value,
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 Credit Facility are
accelerated as a result of default.
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
then existing junior lenders of the Company and PhoneTel also agreed to a
substantial debt-for-equity exchange with respect to their outstanding
indebtedness. 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.
11
8. EARNINGS PER SHARE AND STOCK-BASED COMPENSATION
The treasury stock method was used to determine the dilutive effect of the
options and warrants on earnings per share data. Diluted loss per share is equal
to basic loss per share since the exercise of the outstanding options and
warrants would be anti-dilutive and resulted in no dilution for all periods
presented. In accordance with SFAS No. 128 and the requirement to report
"Earnings Per Share" data, the basic and diluted loss per weighted average
common share outstanding was $(0.01) in both periods during the three months
ended March 31, 2004 and 2003.
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 "intrinsic value method"). 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.
During the first quarter of 2004 and 2003, the Company did not incur any
stock-based employee compensation expense under the intrinsic value or fair
value based methods. Therefore, the reported amounts of net loss and net loss
per share were the same as the amounts that would have been reported if the fair
value method had been applied to all awards.
9. COMMITMENTS & CONTINGENCIES
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, as
well as the first and second amended complaints were 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 parties are currently engaged in the discovery process. The trial
originally scheduled for June 2004 has been continued to a date yet to be set by
the Court. 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.
12
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.
10. 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 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, which was
collected in the first quarter of 2004, was $123,000 at December 31, 2003.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
With the exception of historical information (information relating to the
Company's financial condition and results of operations at historical dates or
for historical periods), the matters discussed in this Management's Discussion
and Analysis of Financial Condition and Result of Operations ("MD&A") are
forward-looking statements that necessarily are based on certain assumptions and
are subject to certain risks and uncertainties. The forward-looking statements
are based on management's expectations as of the date hereof. Actual future
performance and results could differ materially from that contained in or
suggested by these forward-looking statements as a result of the factors set
forth in this MD&A and its other filings with the SEC. The Company assumes no
obligation to update any such forward-looking statements.
FINANCIAL CONDITION AND MANAGEMENT'S PLANS
The Company has incurred losses of approximately $46.2 million and $5.0 million
for the year ended December 31, 2003 and the three months ended March 31, 2004,
respectively. These losses were primarily attributable to declining revenues
attributable to increased competition from providers of wireless communication
services and the non-cash asset impairment losses in 2003 as described in Note 4
to the consolidated financial statements. In addition, as of
13
March 31, 2004, the Company had a working capital deficit of $10.6 million,
which includes $1.9 million of Federal universal service fees and other past due
obligations, and the Company's liabilities exceeded it assets by $107.5 million.
Although the Company is currently in compliance with the financial covenants and
debt payments due under its Credit Facility, as amended, there can be no
assurance that the Company will be able to remain in compliance or refinance the
remaining balance due at maturity with its current or other lenders. 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, respectively, include (i) the continued
removal of unprofitable payphones, (ii) reductions in telephone charges by
changing to competitive local exchange carriers ("CLECs") or other alternative
carriers, (iii) the evaluation, sale or closure of unprofitable district
operations, (iv) outsourcing payphone collection, service and maintenance
activities to reduce operating costs, and (v) the further curtailments of
operating expenses.
Based upon the progress or successful completion of certain of the above
initiatives, in April 2004, the Company formed a new committee of independent
members of the Company's Board of Directors to evaluate other strategic
opportunities available to the Company. In addition, as discussed in Note 7 to
the consolidated financial statements, the Company has been engaged in
discussions with its 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
Credit Facility.
Notwithstanding the ongoing efforts to improve operating results, the Company
may continue to face liquidity shortfalls as it relates to the Company's past
due obligations, including Federal universal service fees. As a result, the
Company 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.
GENERAL
During 2004, 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 Note 5 to the consolidated
financial statements).
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 owners of locations at which the Company's payphones are
installed ("Location Owners"). Service, maintenance and network costs represent
the cost of servicing and maintaining the payphones on an ongoing basis.
14
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
For the three months ended March 31, 2004, total revenues decreased
approximately $9.7 million, or 42.5%, to approximately $13.2 million from
approximately $22.9 million in the same period of 2003. This decrease was
primarily due to a reduction in the average number of payphones in service
resulting from the Company's aggressive program to remove unprofitable phones
and other reductions in phone count during 2003. The average number of payphones
in service during the first quarter of 2004 declined by approximately 22,000
phones, or 32.8%, to approximately 45,000 phones compared to approximately
67,000 phones in service during the first quarter of 2003. The decline in total
revenues was also attributable to the decrease in favorable adjustments to
dial-around compensation, as discussed below, and increased competition from the
wireless communications industry, resulting in lower average revenues per phone.
Coin call revenues decreased approximately $4.4 million, or 33.3%, to
approximately $8.8 million in the three months ended March 31, 2004 from
approximately $13.2 million in the first quarter of 2003. The decrease in coin
call revenues was primarily attributable to the decrease in the number of
average payphones in service, which declined by 32.8%.
Non-coin call revenues, which is comprised primarily of dial-around revenue and
operator service revenue, decreased approximately $2.7 million, or 46.6%, to
approximately $3.1 million in the three months ended March 31, 2004 from
approximately $5.8 million in the three months ended March 31, 2003. The
decrease was primarily attributable to the decrease in the number of average
payphones in service resulting from the Company's aggressive removal of
unprofitable payphones in 2003 and lower call volumes resulting from the growth
in wireless communication services. Dial-around revenue decreased approximately
$1.5 million, to approximately $1.8 million in the three months ended March 31,
2004 from approximately $3.3 million in the first quarter of 2003. Dial-around
revenues were unfavorably impacted by adjustments to accounts receivable of $0.6
million and $1.0 million in the first quarter of 2004 and 2003, respectively, to
reflect changes in accounting estimates of prior quarter dial-around revenues.
Long-distance revenues decreased approximately $0.8 million, to approximately
$1.2 million in the first quarter of 2004 from approximately $2.0 million in the
three months ended March 31, 2003. This decrease is attributable to fewer
payphones in service, fewer completed long distance calls per phone, and reduced
call time per call. Non-carrier revenues also decreased by $0.4 million compared
to the first quarter of 2003 due to installation and repair services provided to
a former related party that were discontinued in October 2003.
Dial-around revenue adjustments are comprised of receipts from various carriers
relating to the industry-wide true-up required under the FCC Interim Order (see
Note 5 to the consolidated financial statements). In the three months ended
March 31, 2003, the Company received approximately $4.9 million relating to the
sale of a portion of the Company's accounts receivable bankruptcy claim due from
WorldCom. Of this amount, $3.9 million related to the amount due from WorldCom
under the Interim Order applicable to dial-around compensation (see Note 6). In
accordance with the Company's accounting policy on regulated rate actions, the
Company recorded $1.2 million of dial-around revenue adjustments in the first
quarter of 2004, the period in which the Company received such revenues. The
Company expects to receive a substantial amount of additional dial-around
compensation from various carriers pursuant to the Interim Order, of which $0.7
million was received and will be recognized as revenue subsequent to March 31,
2004 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.
Telephone charges decreased approximately $3.0 million, or 42.9%, to
approximately $4.0 million for the quarter ended March 31, 2004 from
approximately $7.0 million in the three months ended March 31, 2003. The
decrease was primarily attributable to the decrease in the number of average
payphones in service resulting from the Company's aggressive removal of
unprofitable payphones in 2003 and lower line charges resulting from the use of
competitive local exchange carriers ("CLECs"). This decrease was offset in part
by approximately $0.8 million of net credits in the first quarter of 2003
related to amounts received under the FCC's "New Services Test" in certain
states. 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.
15
Commissions decreased approximately $1.6 million, or 40.0%, to approximately
$2.4 million in the three months ended March 31, 2004 from approximately $4.0
million in the three months ended March 31, 2003. This decrease was primarily
attributable to lower commissionable revenues resulting from the decrease in the
average number of payphones in service 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 decreased approximately $2.0 million, or
30.8%, to approximately $4.5 million in the three months ended March 31, 2004
from approximately $6.5 million in the three months ended March 31, 2003. In
2003, the Company implemented several cost reduction measures, including the
removal of unprofitable payphones and 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 maintenance and collection of its
payphones in an effort to further reduce its operating costs. While the Company
believes these changes will continue to have a favorable impact on operating
results in 2004, no assurances can be given regarding the amount of cost savings
the Company will be able to achieve.
Depreciation expense in the three months ended March 31, 2004 decreased
approximately $2.2 million, or 37.2%, from approximately $5.9 million in the
three months ended March 31, 2003 to $3.7 million recorded in the three months
ended March 31, 2004. This decrease was primarily attributable to the decline in
the number of average payphones in service and the reduction in the carrying
value of the Company's payphone assets and location contracts resulting from the
$9.7 million asset impairment charge recorded in the second quarter of 2003.
These charges were required to write-down the carrying values of such assets
their fair values as of June 30, 2003 (see Note 4 to the consolidated financial
statements).
Selling, general and administrative expenses decreased approximately $0.6
million, or 25.0%, to approximately $1.8 million in the three months ended March
31, 2004 from approximately $2.4 million in the three months ended March 31,
2003. The decrease was primarily attributable to reductions in rent, insurance,
personnel and professional fees associated with the Company's cost savings
initiatives implemented during 2003 and 2004.
In the three months ended March 31, 2004, the Company incurred $0.3 million of
exit and disposal activity costs. The Company outsourced the servicing,
collection and maintenance of certain payphones and closed four district office
facilities in Texas and Missouri to reduce the Company's future operating costs.
In the first quarter of 2003, the Company incurred a $0.3 million loss from exit
and disposal activities related to the outsourcing and closing of the Company's
warehouse and repair facility in Tampa, FL (see Note 3 to the consolidated
financial statements).
Interest expense in the three months ended March 31, 2004 and 2003 was
approximately $1.6 million in each quarter.
The Company has not recorded any provision or benefit for Federal and State
income taxes because of operating losses generated by the Company.
The net loss increased approximately $0.3 million, or 6.4%, to approximately
$5.0 million in the three months ended March 31, 2004 from approximately $4.7
million in the first quarter of 2003. The increase in the net loss was a result
of the decline in total revenues offset in part by the substantial reductions in
operating expenses as described above.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Historically, the Company's primary sources of liquidity have been cash from
operations and borrowings under various credit facilities. The Company's
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.
16
In the first quarter of 2004, operating activities used $0.4 million of net
cash, which resulted in a $ 2.7 million reduction in accounts payable,
commissions and other accrued expenses. Such payments were funded from
reductions in accounts receivable and other current assets and the Company's
operating cash. The Company also used its operating cash to make approximately
$1.9 million of principal payments relating to its long-term debt and capital
lease obligations. The Company's operating cash balance decreased by
approximately $2.4 million during the three months ended March 31, 2004.
In the three months ended March 31, 2003, operating activities provided
approximately $5.8 million of net cash, primarily due to collections of accounts
receivable, including $3.8 million of receipts relating to refunds of telephone
charges under the FCC's "New Services Test". The Company also received $4.9
million in March 2003 relating to the sale of a portion of the Company's
bankruptcy claim due from WorldCom. Approximately $1.8 million of these amounts
were used to reduce the Company's current liabilities for accounts payable,
commissions, and accrued expenses and $4.7 million was used for payments on the
Company's Senior Credit Facility. On May 2, 2003, the Company paid the remaining
balance, including interest, due under the Senior Credit Facility.
Subsequent to March 31, 2004, the Company received $0.7 million and paid $0.3
million of dial-around compensation to various carriers relating to the FCC's
Interim Order. The net amount received after March 31, 2004 will be used to pay
the Company's outstanding debt, as required under the terms of Company's Credit
Facility, as amended. The Company expects to receive additional regulatory
receipts, the net proceeds of which are required to be paid to the 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 the three months ended March 31, 2004 were $0.2 million
compared to $0.1 million in the first quarter of 2003. The on-going strategy of
removing underperforming phones, combined with the existence of an extensive
inventory of phone components, allows for minimal capital equipment
expenditures. Payments relating to new and existing location contracts for the
three months ended March 31, 2004 and 2003 were both less than $0.1 million.
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 Credit Facility of $101.0 million due December 31,
2005 (the "maturity date") originally consisted 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 first quarter
of 2004 and years ended December 31, 2003 and 2002, approximately $2.9 million,
$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 Credit Facility. On February 24, 2004, the
Company executed an amendment (the "Second Amendment") that waived all defaults
through the date of the amendment, reduced 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 reduced the minimum payments due under the Credit Facility to $100,000
per month plus the monthly administrative 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. As defined
in the Credit Facility, "Regulatory Receipts" include prior year EUCL Charges
and New Services Test refunds from LECs and net
17
dial-around true-up refunds from long-distance carriers. As of March 31, 2004,
the Company has made all payments and has complied with all covenants required
under the Second Amendment.
The Company has been engaged in discussions with its lenders regarding the
possibility of restructuring the debt outstanding under the 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 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
then existing junior lenders of the Company and PhoneTel also agreed to a
substantial debt-for-equity exchange with respect to their outstanding
indebtedness in connection with the PhoneTel Merger. 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.
IMPACT OF INFLATION
Inflation is not considered a material factor affecting the Company's
business. General operating expenses such as salaries, employee benefits and
occupancy costs are, however, subject to normal inflationary pressures.
SEASONALITY
The Company's revenues from its payphone 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks inherent in the Company's
financial instruments that arise from transactions entered into in the normal
course of business. The Company's long-term obligations consist primarily of the
amounts due under the 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
18
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.
ITEM 4. 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 March 31, 2004. 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 March 31, 2004. There were no material changes in the Company's
internal controls over financial reporting during the first quarter of 2004.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index.
(b) The Company filed a Current Report on Form 8-K, dated March 31, 2004,
reporting that the Company issued a press release announcing the results
of operations for the year ended December 31, 2003 under Item 9,
Regulation FD Disclosure.
19
EXHIBIT INDEX
Exhibit No. Description
10.1 Payphone Field Service Agreement dated April 1, 2004 between
Davel Communications, Inc. and Coinmach Corporation.
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.
20
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Form 10-Q to be signed on its behalf by the
undersigned thereunto duly authorized.
DAVEL COMMUNICATIONS, INC.
Date: May 14, 2004 /s/ DONALD L. PALIWODA
---------------------------------
Donald L. Paliwoda
Chief Financial Officer
21