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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 November 12, 2004, there were 615,018,963 shares of the Registrant's
Common Stock outstanding.
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DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
ITEM 1
Financial Statements:
Consolidated Balance Sheets............................................................. 1
Consolidated Statements of Operations................................................... 2
Consolidated Statements of Cash Flows................................................... 3
Notes to Consolidated Financial Statements.............................................. 4
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operations... 15
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk.............................. 22
ITEM 4
Disclosure Controls and Procedures...................................................... 23
PART II OTHER INFORMATION
ITEM 1
Legal Proceedings....................................................................... 23
ITEM 6
Exhibits................................................................................ 23
PART I. FINANCIAL INFORMATION
- -----------------------------
ITEM 1. FINANCIAL STATEMENTS
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
- ---------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30
2004 DECEMBER 31
(UNAUDITED) 2003
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,313 $ 7,775
Accounts receivable 5,460 7,975
Other current assets 1,617 2,922
---------------- ----------------
Total current assets 11,390 18,672
Property and equipment, net 16,150 22,878
Location contracts, net 4,515 6,746
Other assets, net 1,563 2,026
---------------- ----------------
Total assets $ 33,618 $ 50,322
================ ================
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and obligations under
capital leases $ 2,624 $ 1,994
Accrued commissions payable 7,404 9,020
Accounts payable and other accrued expenses 11,378 15,847
---------------- ----------------
Total current liabilities 21,406 26,861
Long-term debt and obligations under capital leases 124,768 125,962
---------------- ----------------
Total liabilities 146,174 152,823
---------------- ----------------
Commitments and contingencies - -
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 (262,916) (252,861)
---------------- ----------------
Total shareholders' deficit (112,556) (102,501)
---------------- ----------------
Total liabilities and shareholders' deficit $ 33,618 $ 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 SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------------------- -----------------------------------
2004 2003 2004 2003
--------------- -------------- ------------------ ---------------
REVENUES:
Coin calls $ 8,605 $ 12,872 $ 26,355 $ 39,571
Dial-around compensation 2,142 3,606 6,363 10,363
Dial-around compensation adjustments 2,196 4,016 4,618 7,944
Operator service and other 1,643 3,026 4,571 8,282
--------------- -------------- ------------------ ---------------
Total revenues 14,586 23,520 41,907 66,160
--------------- -------------- ------------------ ---------------
OPERATING EXPENSES:
Telephone charges 3,156 5,895 11,151 19,082
Commissions 2,201 3,603 6,818 11,083
Service, maintenance and network costs 4,119 6,409 12,551 19,551
Depreciation and amortization 2,806 3,843 9,480 15,742
Selling, general and administrative 2,426 2,840 5,992 7,641
Asset impairment charges - - - 9,686
Goodwill impairment - - - 17,455
Exit and disposal activities 358 - 1,263 311
--------------- -------------- ------------------ ---------------
Total costs and expenses 15,066 22,590 47,255 100,551
--------------- -------------- ------------------ ---------------
Operating income (loss) (480) 930 (5,348) (34,391)
OTHER INCOME (EXPENSE):
Interest expense, net (1,757) (1,485) (5,038) (4,734)
Other 95 (126) 331 (14)
--------------- -------------- ------------------ ---------------
Total other income (expense) (1,662) (1,611) (4,707) (4,748)
--------------- -------------- ------------------ ---------------
NET LOSS $ (2,142) $ (681) $ (10,055) $ (39,139)
=============== ============== ================== ===============
LOSS PER SHARE:
Net loss per common share, basic and diluted ($0.01) ($0.01) ($0.02) ($0.06)
=============== ============== ================== ===============
Weighted average number of shares, basic and diluted 615,018,963 615,018,963 615,018,963 615,018,963
=============== ============== ================== ===============
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)
- ------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30
---------------------------------------
2004 2003
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (10,055) $ (39,139)
Adjustments to reconcile net loss to net cash flow from operating activities:
Depreciation and amortization 9,480 15,742
Amortization of deferred financing costs and non-cash interest 3,272 4,118
(Gain) loss on disposal of assets (151) 202
Asset impairment charges - 9,686
Goodwill impairment - 17,455
Other - 233
Changes in current assets and current liabilities:
Accounts receivable 2,515 7,479
Other current assets 1,305 602
Accrued commissions payable (1,616) (1,696)
Accounts payable and accrued expenses (4,469) (7,804)
---------------- ----------------
Net cash from operating activities 281 6,878
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets 388 3
Capital expenditures (668) (522)
Payments for location contracts (17) (166)
(Increase) decrease in other assets 375 (351)
---------------- ----------------
Net cash from investing activities 78 (1,036)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt (3,729) (5,864)
Principal payments under capital leases (92) (158)
---------------- ----------------
Net cash from financing activities (3,821) (6,022)
---------------- ----------------
Net decrease in cash and cash equivalents (3,462) (180)
Cash and cash equivalents, beginning of period 7,775 6,854
---------------- ----------------
Cash and cash equivalents, end of period $ 4,313 $ 6,674
================ ================
SUPPLEMENTAL CASH FLOW INFORMATION
INTEREST PAID $ 1,766 $ 707
================ ================
The accompanying notes are an integral part of these financial statements.
3
DAVEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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 one of the largest independent payphone service providers 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 41,000 payphones in 45 states and the District of
Columbia. The Company's headquarters is located in Cleveland, Ohio with field
service offices in five geographically dispersed locations. The Company also
utilizes subcontractors to collect and service the majority of its pay
telephones in various parts of the United States.
The accompanying consolidated balance sheet of Davel and its subsidiaries at
September 30, 2004 and the related consolidated statements of operations and
cash flows for the nine month periods ended September 30, 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 nine-month period ended September 30,
2004 are not necessarily indicative of the results for the full year.
Certain reclassifications have been made to prior year balances to conform to
the current year presentation.
2. MOBILEPRO TRANSACTION
On September 3, 2004, the secured lenders of the Company entered into a Loan
Purchase Agreement and Transfer and Assignment of Shares (as amended by letter
agreement dated November 15, 2004, the "Purchase Agreement") with MobilePro
Corp., its wholly owned subsidiary, Davel Acquisition, Inc. (together with
MobilePro Corp., "MobilePro") and the Company. Under the Purchase Agreement,
Davel Acquisition, Inc acquired from the secured lenders 100% of the Company's
senior secured debt in the approximate principal amount of $102 million, a $1.3
million note payable by the Company to one of the secured lenders, and
approximately 95.2% of the Company's issued and outstanding common stock owned
by the secured lenders, all for a cash purchase price of $14.0 million (the
"MobilePro Transaction"). Pursuant to the terms of the Purchase Agreement,
subject to certain limitations, the secured lenders have agreed to reimburse the
Company for the litigation cost and any losses resulting from a patent
infringement lawsuit in which the Company is named as a defendant (see Note 10).
The closing of the MobilePro Transaction occurred on November 15, 2004 and
resulted in a change in control of the Company.
Provision was also made in the Purchase Agreement for the holders of the
Company's common stock other than the secured creditors (the "Minority
Stockholders"), whose holdings comprise approximately 4.8% of the outstanding
Davel stock. MobilePro has agreed to purchase all of the shares of common stock
held by the Minority Stockholders within 180 days of the closing date of the
MobilePro Transaction. The purchase price to be offered to the Minority
Stockholders shall be an amount per share of not less than $0.015, which, at the
discretion of MobilePro, may be paid in cash or securities of MobilePro. The
form of such purchase could be through a tender offer, a short-form merger, or
some other means as MobilePro may determine. Prior to undertaking the purchase,
MobilePro must retain an investment banker or other financial advisor to render
an opinion that the terms of the purchase are fair, from a financial point of
view, to the Minority Stockholders. MobilePro has deposited into a third-party
escrow account at the closing of the transaction $450,000 of the purchase price,
which is the approximate amount necessary to purchase for $0.015 per share the
shares of Davel common stock currently held by the Minority Stockholders. In
the event that the purchase is not made within 180 days of the closing of the
MobilePro Transaction, the amount held in escrow would be distributed pro rata
to the Minority Shareholders as a special distribution from MobilePro.
4
MobilePro funded the purchase price paid pursuant to the Purchase Agreement
from the proceeds of a $15.2 million secured note payable to Airlie Opportunity
Master Fund, Ltd. (the "MobilePro Credit Agreement"). Immediately following the
closing of the MobilePro Transaction, the Company executed a joinder agreement
with Airlie Opportunity Master Fund, Ltd. in which the Company has agreed to
become jointly and severally liable with MobilePro under the MobilePro Credit
Agreement. In addition, the MobilePro Credit Agreement has become secured by
substantially all of the assets of the Company and is senior in right of payment
to the Company's Credit Facility pursuant to a security agreement executed by
MobilePro.
The MobilePro Credit Agreement provides for an initial principal payment of $2.2
million which is to be paid by MobilePro following the closing of the MobilePro
Transaction. Interest on the outstanding principal balance is payable quarterly
in arrears at an annual rate of 15%. In addition, the MobilePro Credit Agreement
provides for payment-in-kind interest at a rate of 8% per annum which is added
to principal on a quarterly basis and is payable at maturity, along with the
outstanding principal balance, on November 15, 2005. MobilePro also has the
option to extend the maturity date of the note for an additional six months upon
payment of the lesser of (i) $1,315,582 or (ii) a 1.5% loan extension fee and
accelerated payment of the next two quarterly cash interest payments.
3. 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 $10.1 million for the year ended December 31,
2003 and the nine months ended September 30, 2004, respectively. These losses
were primarily due 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 5. In addition, as of September
30, 2004, the Company had a working capital deficit of $10.0 million, which
includes $1.6 million of federal universal service fees and other past due
obligations, and the Company's liabilities exceeded its assets by $112.6
million. Although MobilePro, as the Company's sole secured lender, has waived
all financial covenant defaults and has agreed to waive certain payments not
previously made by the Company under the terms of the Credit Facility, the
Company was not in compliance with the terms of its Credit Facility (see Note
8). 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 (directors not employed by the Company nor affiliated with the
Company or its major equity holders) 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
as either 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. As discussed in Note 2, the Company
executed the Purchase Agreement with its secured lenders and MobilePro and has
become a majority owned subsidiary of MobilePro. Due to its recent occurrence,
the effects of this event on the Company's financial condition and liquidity are
not yet fully determinable. However, as a result, the Company may be able to
gain access to additional capital or other funding as a result of the MobilePro
Transaction.
Notwithstanding the ongoing efforts to improve operating results, the Company,
on a stand-alone basis, may continue to face liquidity shortfalls as it relates
to the Company's past due obligations, including federal universal
5
service fees. In the event the Company does not obtain the continuing financial
support of its parent, including forbearance, if necessary, relating to payments
due to MobilePro under the Company's Credit Facility, 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.
4. 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 2004, the Company outsourced the servicing of additional payphones and closed
thirteen district offices located in Texas, Missouri, North Carolina, New York,
Florida, Tennessee, Georgia, Mississippi, and the District of Columbia to
further reduce its operating costs. The Company incurred an additional loss of
$1.3 million relating to the closing of these additional district office
facilities. The Company is planning to close four additional district office
facilities in the fourth quarter of 2004 to complete its plan to outsource the
servicing and maintenance of the majority of the Company's payphones. The
estimated additional cost of these exit and disposal activities is not expected
to be material.
5. IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
The Company reviews long-lived assets anticipated to be held and used, as well
as 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 internally reported and readily measurable
on a periodic basis. 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 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.
6
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. No further
impairment was indicated and no loss was incurred in the nine months ended
September 30, 2004.
6. 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 currently 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. At September 30, 2004
and December 31, 2003, accounts receivable included $4.5 million and $7.4
million, respectively arising from dial-around compensation. Revenues from
dial-around compensation were $6.4 million and $10.4 million in the nine months
ended September 30, 2004 and 2003, respectively. Dial-around compensation
adjustments, which consist of amounts received by the Company under the Interim
Order and other adjustments as described below, were $4.6 million in the first
nine months of 2004 and $7.9 million in the nine months ended September 30,
2003.
In the second quarter of 2004, the Company reviewed its method of estimating
accounts receivable relating to dial-around compensation, which includes
estimates of expected future cash receipts based upon the historical pattern of
payments received in the past. Due to the increasing volatility in historic
payment patterns and the negative effects of recent unilateral carrier
deductions and adjustments on the results of such estimates, the Company has
concluded that the method previously used by the Company may not be indicative
of amounts to be received in the future. Accordingly, while still predicated on
historical cash collections, the Company has changed its method of estimating
such future cash collections relating to dial-around compensation, which the
Company believes will result in a more accurate estimate of future cash receipts
and accounts receivable. This change in accounting estimate, together with the
adjustment applicable to prior quarters, resulted in a $0.9 million non-cash
charge to revenue in the quarter ended June 30, 2004, which is included in
dial-around compensation adjustments in the accompanying consolidated statements
of operations. The Company previously recorded reductions in accounts receivable
applicable to prior quarters of $0.6 million in the first quarter of 2004, a
portion of which related to deductions by long distance carriers for duplicate
payments and uncompleted calls placed through resellers, and $1.0 million in the
first quarter of 2003. Such reductions in accounts receivable have been reported
as reductions in revenue from dial-around compensation.
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 entitled 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
7
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.
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 subsequently revised $.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, $2.3 million and $3.6 million is included in accounts payable and other
accrued expenses in the accompanying consolidated balance sheets at September
30, 2004 and December 31, 2003, respectively. In October 2004, certain carriers
deducted approximately $0.5 million from their current dial-around compensation
payments, further reducing this liability. The remaining amount outstanding will
be paid or deducted from future quarterly payments of dial-around compensation
to be received from the applicable dial-around carriers.
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 MCI, Inc. ("MCI", formerly WorldCom, Inc.), of which $3.9
million relates to the amount due from MCI under the Interim Order (see Note 7).
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 $5.5 million of receipts from other carriers under the Interim Order
that was recognized as revenue in the third and fourth quarters of 2003 and the
first nine months of 2004, respectively. Such revenues, less the $0.9 million
charge in the second quarter of 2004 relating to the change in the Company's
method of estimating accounts receivable as described above, have been reported
as dial-around compensation adjustments in the accompanying consolidated
statements of operations for the nine months ended September 30, 2004 and 2003.
Although the Company is entitled to receive a substantial amount of additional
dial-around compensation pursuant to the Interim Order, such amounts, subject to
certain limitations, have been assigned to the Company's former secured lenders
in exchange for a reduction in the Company's secured debt (see Note 8).
8
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 supported
an approximate doubling of the current $0.24 rate. On August 12, 2004, the FCC
released an order to increase the dial-around compensation rate from $0.24 to
$.494 per call (the "2004 Order"). The new rate became effective September 27,
2004, 30 days after publication of the 2004 Order in the Federal Register, and
may be subject to appeal by IXCs or other parties. Although the 2004 Order is
effective for the fourth quarter of 2004, the Company will not receive payments
under the 2004 Order until April 2005; therefore, the Company is unable to
determine the potential increase in revenue due to the uncertainty regarding the
effect of the rate increase, if any, on dial-around call volumes.
Regulatory actions and market factors, often outside the Company's control,
could significantly affect the Company's dial-around compensation revenues.
These factors include (i) the possibility of administrative proceedings or
litigation seeking to modify the dial-around compensation rate, and (ii) ongoing
technical or other difficulties in the responsible carriers' ability and
willingness to properly track or pay for dial-around calls actually delivered to
them.
7. SALE OF MCI 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 MCI. Of this amount, approximately $1.0
million related to the recovery of the Company's accounts receivable for unpaid
dial-around compensation for the second and third quarters of 2002, for which
the Company had previously provided an allowance for doubtful accounts, and
approximately $3.9 million related to the Interim Order described in Note 6. In
accordance with the Company's policy on regulated rate actions, the amount
relating to the Interim Order was recognized as an adjustment to dial-around
revenue in the accompanying consolidated statements of operations during the
first quarter of 2003, the period in which such revenue was received. In March
2003, the Company used $3.0 million of the sales proceeds to pay a portion of
the Company's balance due under the Company's Senior Credit Facility (including
a $2.2 million prepayment of such debt), $0.9 million was used to pay certain
accounts payable, and $1.0 million was deposited in escrow with the Company's
lenders and used to fund certain business initiatives approved by the lenders.
The remaining amount deposited in escrow at September 30, 2004 of approximately
$0.2 million was used to fund acquisition expenses relating to the MobilePro
Transaction.
The amount received by the Company relating to the partial sale of the MCI
bankruptcy claim was equal to 51% of the amount listed in the debtor's schedule
of liabilities (the "Scheduled Debt") filed by MCI (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 is entitled to receive from the
purchaser 51% of the amount of the allowed claim in excess of the Scheduled Debt
included in MCI's plan of reorganization as confirmed by the U. S. Bankruptcy
Court. On April 21, 2004, MCI emerged from Chapter 11 bankruptcy protection and
on October 25, 2004, the Company entered into a settlement agreement with MCI
and the purchaser of its claim. It is anticipated that in November 2004, the
Company will receive from MCI approximately $2.5 million in cash and MCI common
stock in full settlement of the remaining portion of its claim, including the
Company's retained interest. In accordance with the Company's accounting policy
on regulated rate actions, such revenue will be recognized as an adjustment to
dial-around revenue in the fourth quarter of 2004.
During the nine months ended September 30, 2003, the Company received $4.7
million of refunds of prior period telephone charges relating to the new
services test ("New Services Test" or "NST") in certain states. Of this amount,
$3.8 million, $0.8 million, and $0.1 million were recognized as reductions in
telephone charges in the fourth quarter of 2002, first quarter of 2003, and the
third quarter of 2003, respectively. Approximately $2.8 million of these refunds
were used to pay a portion of the balance due on the Company's Senior Credit
Facility 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 and independent actions,
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
9
additional NST refunds in the future, such amounts, subject to certain
limitations, have been assigned to the Company's former secured lenders in
exchange for a reduction in the Company's secured debt (see Note 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. However, the right to receive such refunds, subject to certain
limitations, has been assigned to the Company's former secured lenders in
exchange for a reduction in the Company's secured debt (see Note 8). EUCL and
NST refunds have been included in the accompanying consolidated statements of
operations as a reduction of telephone charges.
8. LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES
Following is a summary of long-term debt and obligations under capital leases as
of September 30, 2004 and December 31, 2003 (in thousands):
SEPTEMBER 30 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 $13,231 at September 30, 2004 .................. $ 63,231 $ 61,644
TERM NOTE B, ($51,000 face value) plus unamortized premium, discount and
capitalized interest of $11,891 at September 30, 2004 .................. 62,891 65,077
NOTE PAYABLE, ($1,280 face value) due September 29, 2005 ................. 1,265 1,137
CAPITAL LEASE obligations with various interest rates and maturity dates
through 2005 ............................................................. 5 98
--------- ---------
127,392 127,956
Less -- Current maturities ............................................... (2,624) (1,994)
--------- ---------
$ 124,768 $ 125,962
========= =========
SALE OF REGULATORY RECEIPTS AND CREDIT FACILITY
On November 11, 2004, the Company executed an agreement with its secured lenders
(the "Exchange Agreement") to assign its right to receive certain future
payments relating to "Regulatory Receipts" (NST refunds, EUCL refunds, and
dial-around compensation received pursuant to the Interim Order, as defined in
the Exchange Agreement) in exchange for an $18.0 million reduction in the
principal balance of its Credit Facility. The Company assigned to the secured
lenders the right to receive up to $18.0 million of Regulatory Receipts
otherwise due to the Company not including the proceeds from the settlement of
the Company's MCI bankruptcy claim, which the Company expects to receive in
November 2004 (see Note 7), and after the Company receives and retains for its
own use $0.7 million of Regulatory Receipts. The Company will recognize an
$18.0 million gain relating to the Exchange Agreement in the fourth quarter of
2004.
On November 15, 2004, the Company's secured lenders sold their interests in the
Credit Facility and the Company's common stock to a wholly owned subsidiary of
MobilePro Corp., which became the Company's sole secured lender and the holder
of 95.2% of the outstanding common stock of the Company. Immediately following
the closing of the MobilePro Transaction, the Company executed a joinder
agreement and became jointly and severally obligated with MobilePro on the
$15.2 million MobilePro Credit Agreement used to fund the acquisition (see
Note 2).
CREDIT FACILITY
On July 24, 2002, (the "closing 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"). On that same 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
10
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 lenders of the Company's Credit Facility 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 nine months
ended September 30, 2004 and the years ended December 31, 2003 and 2002,
approximately $8.9 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.
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 lenders. 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.................................... 5,670 3,259 8,929
Principal and interest payments in 2004............................. (3,306) (1,900) (5,206)
Amortization of premiums and discounts in 2004...................... (5,375) 1,053 (4,322)
---------- -------------- -----------
Carrying value on September 30, 2004................................ $ 84,401 $ 41,721 $ 126,122
========== ============== ===========
The Credit Facility is secured by substantially all assets of the Company and
was previously 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
11
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. The First Amendment did not affect payments due
after December 31, 2003.
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
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 was 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 June 30, 2004, the Company was not in compliance with the minimum EBITDA
and Adjusted EBITDA covenants, as defined in the Credit Facility, and did not
make a $1.4 million debt payment related to Regulatory Receipts received by the
Company during the second quarter of 2004. On August 11, 2004, the Company
executed an amendment (the "Third Amendment") that waived all defaults through
the date of the amendment and provided for the deferred payment of approximately
$1.4 million of Regulatory Receipts. Under the Third Amendment, such amount is
due in three equal quarterly installments of $466,000 on April 1, July 1 and
October 1, 2005.
As of September 30, 2004, the Company was not in compliance with the minimum
EBITDA and Adjusted EBITDA covenants, as defined in the Credit Facility, and did
not make the scheduled monthly payments of $100,000 each due on October 1 and
November 1, 2004. As described in Note 2 and above, the remaining outstanding
balance due under the Credit Facility was purchased by a wholly owned subsidiary
of MobilePro Corp. on November 15, 2004. On November 15, 2004, the Company and
this subsidiary of MobilePro Corp. executed an amendment to the Credit Facility
(the "Fourth Amendment") that waived all defaults through the date of the
amendment and the monthly payments that were due on October 1 and November 1,
2004.
NOTE PAYABLE
In connection with the PhoneTel Merger, the Company assumed a $1.1 million note
payable to Cerberus Partners, L.P. ("Cerberus") that provides for payment of
principal, together with deferred interest at 5% per annum, on
12
November 17, 2004. Cerberus and its affiliates were 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. On November 15, 2004, Cerberus assigned its
interest in the note payable to a subsidiary of MobilePro Corp. in connection
with the Purchase Agreement (see Note 2). Also on November 15, 2004, the Company
and MobilePro executed an amendment to extend the maturity date of the note
until September 29, 2005.
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.
9. EARNINGS PER SHARE AND STOCK-BASED COMPENSATION
The treasury stock method was used to determine the dilutive effect of the
options and warrants on earnings per share data. Diluted 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 $0.02 and $0.06 during the nine months ended
September 30, 2004 and 2003, respectively.
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 nine-month periods ended September 30, 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.
10. COMMITMENTS & CONTINGENCIES
On or about September 16, 2004 the Company was served with a complaint, in civil
action number 04-4303 captioned John R. Gammino v. Cellco Partnership d/b/a
Verizon Wireless, et. al. filed in the United States District
13
Court for the Eastern District of Pennsylvania. Plaintiff claims that the
Company's use of certain international call blocking technology infringes on one
or more patents owned by the Plaintiff John R. Gammino (the "Gammino Patents").
Also named as defendants in the suit are Cellco Partnership d/b/a Verizon
Wireless, Verizon Communications, Inc., Vodafone Group PLC, AT&T Corporation and
Sprint Corporation. The claims alleged by the Plaintiff seek, among other
damages, $7.6 million in royalty fees from the Company. On November 8, 2004, the
Company responded by filing its answer, affirmative defenses and counterclaims.
The Company continues to review and investigate the allegations set forth in the
complaint, continues to assess the validity of the Gammino Patents and is in the
process of determining whether the technology purchased by the Company from
third parties infringes upon the Gammino Patents. Additionally, the Company is
assessing any and all rights it may have for indemnification by third parties
from whom the international call blocking services are acquired. The Company
intends to vigorously defend itself in this matter and pursue its counterclaims;
however, the Company cannot at this time predict its likelihood of success on
the merits or its success in seeking indemnification from the third parties from
whom it purchases the call blocking services.
In connection with the MobilePro Transaction, the former secured lenders,
subject to certain limitations, have agreed to reimburse the Company for the
litigation cost and any losses resulting from the Gammino lawsuit. The former
secured lenders have agreed to fund such costs from future Regulatory Receipts
that were assigned to them pursuant to the Exchange Agreement (see Note 8). Any
such Regulatory Receipts will be deposited into a third-party escrow account and
used to reimburse the Company for costs incurred. The secured lenders are not
required to fund the escrow account or otherwise reimburse the Company for
amounts, if any, in excess of actual Regulatory Receipts collected. Any amount
remaining in the escrow account at the conclusion of the litigation is to be
returned to the former secured lenders.
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 had been continued to November 2004; however,
has been delayed by motion of the plaintiff and approval of the court. It is
anticipated that the trial will be scheduled for March 2005. 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.
14
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.
11. RELATED PARTY TRANSACTIONS
The Company's former chief executive officer, whose tenure ended in August 2003,
was, during such tenure, 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.
MOBILEPRO TRANSACTION AND ASSIGNMENT OF REGULATORY RECEIPTS
On September 3, 2004, the secured lenders of the Company entered into a Loan
Purchase Agreement and Transfer and Assignment of Shares (as amended by letter
agreement dated November 15, 2004, the "Purchase Agreement") with MobilePro
Corp., its wholly owned subsidiary, Davel Acquisition, Inc. (together with
MobilePro Corp., "MobilePro") and the Company. Under the Purchase Agreement,
Davel Acquisition, Inc acquired from the secured lenders 100% of the Company's
senior secured debt in the approximate principal amount of $102 million, a $1.3
million note payable by the Company to one of the secured lenders, and
approximately 95.2% of the Company's issued and outstanding common stock owned
by the secured lenders, all for a cash purchase price of $14.0 million (the
"MobilePro Transaction"). Pursuant to the terms of the Purchase Agreement,
subject to certain limitations, the secured lenders have agreed to reimburse the
Company for the litigation cost and any losses resulting from a patent
infringement lawsuit in which the Company is named as a defendant (see Note 10
to the consolidated financial statements). The closing of the MobilePro
Transaction occurred on November 15, 2004 and resulted in a change in control of
the Company.
Provision was also made in the Purchase Agreement for the holders of the
Company's common stock other than the secured creditors (the "Minority
Stockholders"), whose holdings comprise approximately 4.8% of the outstanding
Davel stock. MobilePro has agreed to purchase all of the shares of common stock
held by the Minority Stockholders within 180 days of the closing date of the
MobilePro Transaction. The purchase price to be offered to the Minority
Stockholders shall be an amount per share of not less than $0.015, which, at the
discretion of MobilePro, may be paid in cash or securities of MobilePro. The
form of such purchase could be through a tender offer, a short-form merger, or
some other means as MobilePro may determine. Prior to undertaking the purchase,
MobilePro must retain an investment banker or other financial advisor to render
an opinion that the terms of the purchase are fair, from a financial point of
view, to the Minority Stockholders. MobilePro has deposited into a third-party
escrow account at the closing of the transaction $450,000 of the purchase price,
which is the approximate amount necessary to purchase for $0.015 per share the
shares of Davel common stock currently held by the Minority Stockholders. In
the event that the purchase is not made within 180 days of the closing of the
MobilePro Transaction, the amount held in escrow would be distributed pro rata
to the Minority Shareholders as a special distribution from MobilePro.
15
On November 11, 2004, the Company executed an agreement with its secured lenders
(the "Exchange Agreement") to assign its right to receive certain future
payments relating to "Regulatory Receipts" (NST refunds, EUCL refunds, and
dial-around compensation received pursuant to the Interim Order, as defined in
the Exchange Agreement) in exchange for an $18.0 million reduction in the
principal balance of its Credit Facility. The Company assigned to the secured
lenders the right to receive up to $18.0 million of Regulatory Receipts
otherwise due to the Company not including the proceeds from the settlement of
the Company's MCI bankruptcy claim, which the Company expects to receive in
November 2004 (see Note 7 to the consolidated financial statements), and after
the Company receives and retains for its own use $0.7 million of Regulatory
Receipts. The Company will recognize an $18.0 million gain relating to the
Exchange Agreement in the fourth quarter of 2004.
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. The Company has incurred losses
of approximately $46.2 million and $10.1 million for the year ended December 31,
2003 and the nine months ended September 30, 2004, respectively. These losses
were primarily due 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 5 to the consolidated financial
statements. In addition, as of September 30, 2004, the Company had a working
capital deficit of $10.0 million, which includes $1.6 million of federal
universal service fees and other past due obligations, and the Company's
liabilities exceeded its assets by $112.6 million. Although MobilePro, as the
Company's sole secured lender, has waived all financial covenant defaults and
has agreed to waive certain payments not previously made by the Company under
the terms of the Credit Facility, the Company was not in compliance with the
terms of its Credit Facility (see Note 8). 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 (directors not employed by the Company nor affiliated with the
Company or its major equity holders) 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
as either 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.
16
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. As discussed in Note 2 to the
consolidated financial statements, the Company executed the Purchase Agreement
with its secured lenders and MobilePro and has become a majority owned
subsidiary of MobilePro. Due to its recent occurrence, the effects of this event
on the Company's financial condition and liquidity are not yet fully
determinable. However, as a result, the Company may be able to gain access to
additional capital or other funding as a result of the MobilePro Transaction.
Notwithstanding the ongoing efforts to improve operating results, the Company,
on a stand-alone basis, may continue to face liquidity shortfalls as it relates
to the Company's past due obligations, including federal universal service fees.
In the event the Company does not obtain the continuing financial support of its
parent, including forbearance, if necessary, relating to payments due to
MobilePro under the Company's Credit Facility, 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. Such
operator service 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 6 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.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
For the nine months ended September 30, 2004, total revenues decreased
approximately $24.3 million, or 36.7%, to approximately $41.9 million from
approximately $66.2 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 and 2004. The average number of
payphones in service during the nine months ended September 30, 2004 declined by
approximately 18,000 phones, or 29.0%, to approximately 44,000 phones compared
to approximately 62,000 phones in service during the same period of 2003. The
decline in total revenues was also attributable to 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 $13.3 million, or 33.6%, to
approximately $26.3 million in the nine months ended September 30, 2004 from
approximately $39.6 million in the nine months ended September 30, 2003. The
decrease in coin call revenues was primarily attributable to the decrease in the
average number of payphones in service,
17
which declined by 29.0%, and lower revenues per phone resulting from increased
competition from wireless communications.
Revenue from dial-around compensation decreased approximately $4.0 million, or
38.5%, to approximately $6.4 million in the nine months ended September 30, 2004
from approximately $10.4 million in the same period of 2003. The decrease was
primarily attributable to the decrease in the average number of 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 revenues were also unfavorably impacted by
adjustments to accounts receivable of $0.6 million and $1.0 million in the nine
months ended September 30, 2004 and 2003, respectively, to reflect deductions by
long-distance carriers for duplicate payments and uncompleted calls placed
through resellers and for changes in accounting estimates of prior quarter
dial-around revenues. As discussed in Note 6 to the consolidated financial
statements, on August 12, 2004, the FCC released an order to increase the
dial-around compensation rate from $0.24 to $.494 per call (the "2004 Order").
The new rate became effective on September 27, 2004 and may be subject to appeal
by IXCs or other parties. Although the 2004 Order is expected to result in a
substantial increase in dial-around revenue in the fourth quarter of 2004, the
Company will not receive payments under the 2004 order until April 2005;
therefore the Company is currently unable to determine the amount of this
increase due to the uncertainty regarding the effect of the rate increase, if
any, on dial-around call volumes.
Dial-around revenue adjustments are comprised of receipts from various carriers
relating to the industry-wide true-up required under the FCC Interim Order and
other adjustments (see Note 6 to the consolidated financial statements). In the
nine months ended September 30, 2003, the Company received approximately $7.9
million of dial-around revenue adjustment, of which $4.9 million related to the
sale of a portion of the Company's accounts receivable bankruptcy claim due from
MCI. Of this amount, $3.9 million related to the amount due from MCI under the
Interim Order applicable to dial-around compensation (see Note 7 to the
consolidated financial statements). The net dial-around compensation adjustment
for the nine months ended September 30, 2004 was approximately $4.6 million,
which included a non-cash charge for $0.9 million applicable to prior quarters
relating to the change in the Company's method of estimating accounts receivable
from dial-around compensation and the resulting adjustment to accounts
receivable under that method. In addition, in accordance with the Company's
accounting policy on regulated rate actions, the Company recorded $5.5 million
of dial-around revenue adjustments during the nine months ended September 30,
2004, the period in which the Company received such revenues. It is anticipated
that in November 2004, the Company will receive approximately $2.5 million
relating to the settlement of its MCI bankruptcy claim which will be recognized
as revenue in fourth quarter of 2004. Although the Company expects to receive a
substantial amount of additional dial-around compensation from various carriers
pursuant to the Interim Order, the Company will only be able to retain the first
$0.7 million of Regulatory Receipts the Company ultimately collects. The next
$18.0 million in Regulatory Receipts has been assigned to its secured lenders
pursuant to the Exchange Agreement executed on November 11, 2004 (see Note 8 to
the consolidated financial statements).
Operator service and other revenues, which is comprised of long-distance
revenues received from operator service providers and other non-carrier
revenues, decreased approximately $3.7 million, or 44.6%, to approximately $4.6
million in the nine months ended September 30, 2004 from approximately $8.3
million in the nine months ended September 30, 2003. Of these amounts,
long-distance revenues decreased approximately $2.3 million, to approximately
$4.0 million in the nine months ended September 30, 2004 from approximately $6.3
million in the nine months ended September 30, 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 $1.4 million compared to the nine months ended September 30, 2003 primarily
due to installation and repair services provided to a former related party that
were discontinued in October 2003.
Telephone charges decreased approximately $7.9 million, or 41.4%, to
approximately $11.2 million in the nine months ended September 30, 2004 from
approximately $19.1 million in the nine months ended September 30, 2003. The
decrease was primarily attributable to the decrease in the average number of
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"). Telephone charges were also
favorably impacted in the third quarter of 2004 by $0.5 million of refunds
relating to amounts overcharged by LECs in prior years. This decrease in
telephone charges was offset in part by approximately $0.9 million of net
credits in the nine months ended September 30, 2003 related to refunds of end
user common line charges and amounts received under the FCC's "New Services
Test" in certain states. The Company is continuing its strategy to reduce line
charges 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
18
the impact of further telephone charge reductions at this time. However, the
ability of the CLECs to continue to provide local access services to the Company
at the current rates may be adversely impacted by the FCC's recent ruling which
eliminated the requirement of the incumbent LECs to make elements of their
networks available on an unbundled basis to new entrants at cost-based rates
(the "UNE-P Ruling"). The Company is unable, at this time, to determine the
impact of the UNE-P Ruling on its strategy to continue to reduce local access
charges.
Commission expense decreased approximately $4.3 million, or 38.7%, to
approximately $6.8 million in the nine months ended September 30, 2004 from
approximately $11.1 million in the nine months ended September 30, 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 $7.0 million, or
35.7%, to approximately $12.6 million in the nine months ended September 30,
2004 from approximately $19.6 million in the nine months ended September 30,
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 nine months ended
September 30, 2004, the Company also began to outsource the service, maintenance
and collection of its payphones in an effort to further reduce its operating
costs. Through September 30, 2004, the Company has outsourced its operations for
a majority of the Company's payphones and has closed twenty-four district
offices. The Company plans to outsource its operations of four additional
district offices in the fourth quarter of 2004. While the Company believes these
changes will continue to have a favorable impact on operating results in the
future, no assurances can be given regarding the amount of cost savings the
Company will be able to achieve.
Depreciation and amortization expense in the nine months ended September 30,
2004 decreased approximately $6.2 million, or 39.5%, from approximately $15.7
million in the nine months ended September 30, 2003 to $9.5 million recorded in
the nine months ended September 30, 2004. This decrease was primarily
attributable to the decline in the average number of 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 to their fair values as of June
30, 2003 (see below and Note 5 to the consolidated financial statements).
Selling, general and administrative ("SG&A") expenses decreased approximately
$1.6 million, or 21.1%, to approximately $6.0 million in the nine months ended
September 30, 2004 from approximately $7.6 million in the nine months ended
September 30, 2003. The decrease was primarily attributable to reductions in
professional fees, rent, insurance, and other office expenses associated with
the Company's cost savings initiatives implemented during 2003 and 2004. Such
cost savings were partially offset by expenses relating to the MobilePro
Transaction (see Note 2 to the consolidated financial statements) and severance
costs incurred at the end of the third quarter of 2004 in connection with
reductions in administrative staff. The Company expects further reductions in
SG&A expenses in the remainder of 2004 and in 2005.
Asset impairment losses totaling $27.1 million were incurred in the nine months
ended September 30, 2003. The loss consisted of a $9.7 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 4 to the consolidated financial statements).
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. These impairment charges were recorded in the
second quarter of 2003. No further impairment was indicated and no loss was
incurred in the nine months ended September 30, 2004.
In the nine months ended September 30, 2004, the Company incurred $1.3 million
of exit and disposal activity costs. The Company outsourced the servicing,
collection and maintenance of certain payphones and closed thirteen district
office facilities in Texas, Missouri, North Carolina, New York, Florida,
Tennessee, Georgia, Mississippi, and the District of Columbia to reduce the
Company's future operating costs. In the nine months ended September 30, 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 4 to the consolidated financial statements).
19
Interest expense in the nine months ended September 30, 2004 was approximately
$5.0 million compared to $4.7 million in the nine months ended September 30,
2003. This increase in net interest expense was primarily due to the increase in
the principal balance of the Company's Credit Facility resulting from interest
capitalized in 2003.
The Company has not recorded any provision or benefit for Federal and State
income taxes because of operating losses generated by the Company.
The Company had a net loss of $39.1 million in the nine months ended September
30, 2003. Excluding the asset impairment charges of approximately $27.1 million
in the nine months ended September 30, 2003, the net loss decreased
approximately $1.9 million, or 15.8%, to approximately $10.1 million in the nine
months ended September 30, 2004 from approximately $12.0 million in the nine
months ended September 30, 2003. The decrease in the loss occurred because the
Company's ongoing efforts to reduce operating expenses, as noted above, exceeded
the decline in revenues.
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.
During the nine months ended September 30, 2004, operating activities provided
approximately $0.3 million of net cash, which included $5.5 million of receipts
relating to dial-around compensation received in connection with the FCC's
Interim Order (see Note 6 to the consolidated financial statements). Such
receipts, as well as other amounts received from the reductions in accounts
receivable and other current assets, were used to reduce accounts payable,
commissions and other accrued expenses by approximately $6.1 million. The
Company also used its operating cash and net cash provided by operating
activities to make approximately $3.8 million of principal payments relating to
its long-term debt and capital lease obligations. As a result, the Company's
operating cash balance decreased by approximately $3.5 million during the nine
months ended September 30, 2004.
During the nine months ended September 30, 2003, operating activities provided
approximately $6.9 million of net cash, primarily due to collections of accounts
receivable, including $4.7 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 MCI (see Note 7 to the consolidated financial
statements). Approximately $2.8 million of these amounts were used to reduce the
Company's current liabilities for accounts payable, commissions, and accrued
expenses, $5.8 million was used for payments on the Company's Senior Credit
Facility and $1.0 was deposited in escrow with the Company's lenders. On May 2,
2003, the Company paid the remaining balance, including interest, due under the
Senior Credit Facility.
On October 25, 2004, the Company entered into a settlement agreement with MCI
and the purchaser of a portion of the Company's MCI dial-around bankruptcy
claim. The Company is to receive from MCI approximately $2.5 million in cash and
MCI common stock in full settlement of the remaining portion of its claim,
including the Company's retained interest. In accordance with the Company's
accounting policy on regulated rate actions, such revenue will be recognized as
an adjustment to dial-around revenue in the fourth quarter of 2004. In addition,
the net amount received will be used for working capital purposes and to pay the
Company's outstanding debt due to MobilePro, as required under the terms of the
Company's Credit Facility, as amended. Although the Company expects to receive
additional amounts of dial-around compensation pursuant to the Interim Order,
such amounts, subject to certain limitations, have been assigned the Company's
former secured lenders under the Exchange Agreement (see Note 8 to the
consolidated financial statements).
20
Capital expenditures for the nine months ended September 30, 2004 were $0.7
million compared to $0.5 million in the nine months ended September 30, 2003.
The Company's on-going strategy of removing underperforming phones, combined
with the existence of an extensive inventory of phone components, allows for
minimal capital equipment expenditures. Payments relating to new and existing
location contracts for the nine months ended September 30, 2004 and 2003 were
$0.1 million and $0.2 million, respectively.
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 is due December 31,
2005 (the "maturity date") and 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 nine months
ended September 30, 2004 and years ended December 31, 2003 and 2002,
approximately $8.9 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 dial-around true-up refunds from
long-distance carriers.
As of June 30, 2004, the Company was not in compliance with the minimum EBITDA
and Adjusted EBITDA covenants, as defined in the Credit Facility, and did not
make a $1.4 million debt payment related to Regulatory Receipts received by the
Company during the second quarter of 2004. On August 11, 2004, the Company
executed an amendment (the "Third Amendment") that waived all defaults through
the date of the amendment and provided for the deferred payment of approximately
$1.4 million of Regulatory Receipts. Under the Third Amendment, such amount is
due in three equal quarterly installments of $466,000 on April 1, July 1 and
October 1, 2005.
As of September 30, 2004, the Company was not in compliance with the minimum
EBITDA and Adjusted EBITDA covenants, as defined in the Credit Facility, and did
not make the scheduled monthly payments of $100,000 each due on October 1 and
November 1, 2004. On November 11, 2004, the Company executed the Exchange
Agreement with its secured lenders to assign its right to receive up to $18.0
million of future payments relating to Regulatory Receipts in exchange for an
$18.0 million reduction in the principle balance of its Credit Facility. On
November 15, 2004, the Company's secured lenders sold their interests in the
Credit Facility and the Company's common stock to a wholly owned subsidiary of
MobilePro Corp., which became the Company's sole secured lender and the holder
of 95.2% of the outstanding common stock of the Company (see above and Note 2 to
the consolidated financial statements). On November 15, 2004, the Company and
this subsidiary of MobilePro Corp. executed an amendment to the Credit Facility
(the "Fourth Amendment") that waived all defaults through the date of the
amendment and the monthly payments that were due on October 1 and November 1,
2004.
21
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 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.
22
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 September 30, 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 September 30, 2004. There were no material
changes in the Company's internal controls over financial reporting during the
first nine months of 2004.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On or about September 16, 2004 the Company was served with a complaint, in civil
action number 04-4303 captioned John R. Gammino v. Cellco Partnership d/b/a
Verizon Wireless, et. al. filed in the United States District Court for the
Eastern District of Pennsylvania. Plaintiff claims that the Company's use of
certain international call blocking technology infringes on one or more patents
owned by the Plaintiff John R. Gammino (the "Gammino Patents"). Also named as
defendants in the suit are Cellco Partnership d/b/a Verizon Wireless, Verizon
Communications, Inc., Vodafone Group PLC, AT&T Corporation and Sprint
Corporation. The claims alleged by the Plaintiff seek, among other damages, $7.6
million in royalty fees from the Company. On November 8, 2004, the Company
responded by filing its answer, affirmative defenses and counterclaims.
The Company continues to review and investigate the allegations set forth in the
complaint, continues to assess the validity of the Gammino Patents and is in the
process of determining whether the technology purchased by the Company from
third parties infringes upon the Gammino Patents. Additionally, the Company is
assessing any and all rights it may have for indemnification by third parties
from whom the international call blocking services are acquired. The Company
intends to vigorously defend itself in this matter and pursue its counterclaims;
however, the Company cannot at this time predict its likelihood of success on
the merits or its success in seeking indemnification from the third parties from
whom it purchases the call blocking services.
In connection with the MobilePro Transaction (see Note 2 to the consolidated
financial statements), the former secured lenders, subject to certain
limitations, have agreed to reimburse the Company for the litigation cost and
any losses resulting from the Gammino lawsuit. The former secured lenders have
agreed to fund such costs from future Regulatory Receipts that were assigned to
them pursuant to the Exchange Agreement (see Note 8 to the consolidated
financial statements). Any such Regulatory Receipts will be deposited into a
third-party escrow account and used to reimburse the Company for costs incurred.
The secured lenders are not required to fund the escrow account or otherwise
reimburse the Company for amounts, if any, in excess of actual Regulatory
Receipts collected. Any amount remaining in the escrow account at the conclusion
of the litigation is to be returned to the former secured lenders.
In addition to legal proceedings disclosed in the Company's Form 10K for the
year ended December 31, 2003 and elsewhere herein, the Company is involved in
routine litigation arising in the normal course of its business which it
believes will not materially affect its financial position or results of
operations.
ITEM 6. EXHIBITS
The Exhibits listed on the accompanying Index to the Exhibits are filed as part
of this Report.
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
10.1 Loan Purchase Agreement and Transfer and Assignment of Shares
dated September 3, 2004, by and among MobilePro Corp., its
wholly-owned subsidiary, Davel Acquisition Corp., Davel
Communications, Inc., Wells Fargo Foothill, Inc., as Agent,
and the lenders that are signatories to the Amended, Restated,
and Consolidated Credit Agreement dated July 24, 2002, as
amended.
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.
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
Davel Communications, Inc.
200 Public Square, Suite 700
Cleveland, Ohio 44114
www.davelgroup.com
WEBSITE ACCESS TO UNITED STATES SECURITIES AND EXCHANGE COMMISSION FILINGS
All reports filed electronically by Davel Communications, Inc. with the United
States Securities and Exchange Commission (SEC), including the Annual Report on
Form 10-K, quarterly reports on Form 10-Q, and current event reports on Form
8-K, as well as any amendments to those reports, are accessible at no cost on
the SEC's Web site at www.sec.gov.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Form 10-Q to be signed on its behalf by the
undersigned thereunto duly authorized.
DAVEL COMMUNICATIONS, INC.
Date: November 15, 2004 /s/ DONALD L. PALIWODA
--------------------------------
Donald L. Paliwoda
Chief Financial Officer
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