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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1998
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission file number 0-22610
DAVEL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 59-3538257
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10120 Windhorst Road
Tampa, Florida 33619
(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (813) 628-8000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $0.01 par value per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
As of March 31, 1999, the aggregate market value of the voting stock held
by non-affiliates of the registrant was $48,760,586. As of March 31, 1999,
there were 10,536,155 shares of the registrant's Common Stock outstanding.
Documents incorporated by reference:
Information contained in the registrant's 1998 definitive proxy material to
be filed with the Securities and Exchange Commission has been incorporated by
reference in Part III of this Annual Report on Form 10-K.
1
PART I
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934:
Certain of the statements contained in the body of this Report are forward-
looking statements (rather than historical facts) that are subject to risks and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements. In the preparation of this Report,
where such forward-looking statements appear, The Company has sought to
accompany such statements with meaningful cautionary statements identifying
important factors that could cause actual results to differ materially from
those described in the forward-looking statements. An additional statement
summarizing the principal risks and uncertainties inherent in the Company's
business is included herein under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Regulatory Impact on
Revenue." Readers of this Report are encouraged to read these cautionary
statements carefully.
ITEM 1. BUSINESS
General Overview
Davel Communications, Inc. (the "Company" or "Davel") was incorporated on
June 9, 1998 under the laws of the State of Delaware to effect the merger (the
"Peoples Merger"), on December 23, 1998, of Davel Communications Group, Inc.
("Old Davel"), with Peoples Telephone Company, Inc. ("Peoples Telephone"). The
merger was accounted for as a pooling-of-interests and accordingly the results
of both companies have been restated as if they had been combined for all
periods presented.
As a result of the Peoples Merger and the acquisition of Communications
Central, Inc. (the "CCI Acquisition"), the Company is the largest domestic
independent payphone service provider in the United States, with approximately
twice the number of payphones as the second largest domestic independent
payphone service provider. The Company's principal executive offices are located
at 10120 Windhorst Road, Tampa, Florida 33619, and its telephone number is (813)
628-8000.
The Company owns and operates a network of nearly 85,000 payphones in 42
states and the District of Columbia, providing it with one of the broadest
geographic coverages of any payphone service provider in the country. The
Company's installed payphone base generates revenue through both coin calls
(local and long-distance) and non-coin calls (calling card, credit card, prepaid
calling card, collect, toll-free and third-party billed calls). The Company
also provides operator assisted services to its payphones through contractual
relationships with various interexchange carriers ("IXCs"), including Sprint and
AT&T, and through its own long-distance switching equipment. A significant
portion of the Company's payphones are located in high-traffic areas such as
shopping centers, convenience stores, truck stops, service stations, grocery
stores, restaurants and airports.
As part of the Telecommunications Act of 1996, Congress directed the
Federal Communications Commission ("FCC") to ensure widespread access to
payphones for the general
2
public. Industry reports estimate that there are approximately 2.1 million
payphones currently operating in the United States, of which approximately 1.8
million are operated by the five regional Bell operating companies ("RBOCs"),
AT&T and GTE. The remaining approximately 350,000 payphones are owned by more
than 1,000 independent payphone providers ("IPPs") and more than 1000 smaller
local exchange carriers ("LECs"). The Company believes that its scale,
geographic reach and proven integration expertise position it to play a leading
role in the consolidation of the fragmented payphone industry. The Company's
strategy is to increase its nationwide presence through internal growth
primarily focusing on regional and national accounts and through targeted
strategic acquisitions, generally in existing markets or contiguous markets.
Industry Overview
Today's telecommunications marketplace was principally shaped by the 1984
court-approved divestiture by AT&T of its local telephone operations (the "AT&T
Divestiture") and the many regulatory changes adopted by the FCC and state
regulatory authorities in response to the AT&T Divestiture, including the
authorization of the connection of competitive or independently owned payphones
to the public switched network. The "public switched network" is the traditional
domestic landline public telecommunications network used to carry, switch and
connect telephone calls. The connection of independently owned payphones to the
public switched network has resulted in the creation of additional business
segments in the telecommunications industry. Prior to these developments, only
the consolidated Bell system or independent LECs were permitted to own and
operate payphones. Following the AT&T Divestiture, the independent payphone
sector developed as a competitive alternative to the consolidated Bell system
and other LECs by providing more responsive customer service, lower cost of
operations and higher commissions to the owners or operators of the premises at
which a payphone is located ("Location Owners").
Prior to the AT&T Divestiture, the LECs could refuse to provide payphone
service to a business operator or, if service was installed, would typically pay
no or relatively small commissions for the right to place a payphone on the
business premises. Following the AT&T Divestiture and the FCC's authorization of
payphone competition, IPPs began to offer Location Owners higher commissions on
coin calls made from the payphones in order to obtain the contractual right to
install the equipment on the Location Owners' premises. Initially, coin revenue
was the only source of revenue for the payphone operators because they were
unable to participate in revenues from non-coin calls. However, the operator
service provider ("OSP") industry emerged and enabled the competitive payphone
operators to compete more effectively with the regulated telephone companies by
paying commissions to payphone owners for non-coin calls. For the first time,
IPPs were able to receive non-coin call revenue from their payphones. With this
incremental source of revenue from non-coin calls, IPPs were able to compete
more vigorously on a financial basis with RBOCs and other LECs for site location
agreements, as a complement to the improved customer service and more efficient
operations provided by the IPPs.
3
As part of the AT&T Divestiture, the United States was divided into Local
Access Transport Areas ("LATAs"). RBOCs were authorized to provide telephone
service that both originates and terminates within the same LATA ("intraLATA")
pursuant to tariffs filed with and approved by state regulatory authorities.
They also provide payphone service primarily in their own respective
territories, and are now authorized to share revenues from telecommunications
services between LATAs ("interLATA"). Long-distance companies, such as Sprint,
AT&T and MCI Worldcom, provide interLATA services, and in some circumstances,
may also provide local or long-distance service within LATAs. An interLATA long-
distance telephone call generally begins with an originating LEC transmitting
the call from the originating payphone to a point of connection with a long-
distance carrier. The long-distance carrier, through its owned or leased
switching and transmission facilities, transmits the call across its long-
distance network to the LEC servicing the local area in which the recipient of
the call is located. This terminating LEC then delivers the call to the
recipient.
Business Strategy
The Company's objective is to increase revenues and earnings through
acquisitions, internal sales growth and continued reductions in its overall cost
structure. The Company has implemented the following strategy to meet its
objective.
Utilize Advanced Payphone Technology. The Company's payphones utilize
"smart" technology which provides voice synthesized calling instructions,
detects and counts coins deposited during each call, informs the caller at
certain intervals of the time remaining on each call, identifies the need for
and the amount of an additional deposit in order to continue the call, and other
functions associated with the completion of calls. Through the use of a non-
volatile, electronically erasable, programmable read-only memory chip, the
payphones can also be programmed and reprogrammed from the Company's central
computer facilities to update rate information or to direct different kinds of
calls to particular carriers. The Company's payphones can also distinguish
coins by size and weight, report to a remote location the total amount of coins
in the coin box, perform self-diagnosis and automatically report problems to a
pre-programmed service number. Virtually all of the Company's payphones operate
on power available from the payphone lines, thereby avoiding the need for and
reliance upon an additional power source at the installation location.
Apply Sophisticated Monitoring and Management Information Systems. The
Company utilizes proprietary and non-proprietary software that continuously
tracks coin and non-coin revenues from each payphone as well as expenses
relating to that payphone, including commissions payable to the Location Owners.
The software allows the Company to generate detailed financial information by
customer, by location and by payphone, which allows it to monitor the
profitability and operating condition of each location and payphone.
Provide Outstanding Customer Service. The technology used by the Company
enables it to (i) respond quickly to equipment malfunctions and (ii) maintain
accurate records of payphone activity which can be verified by customers. The
Company strives to minimize "downtime" on its payphones by identifying service
problems immediately. The Company's standard of performance is to repair
malfunctions within 24 hours of their occurrence, thereby minimizing downtime
and lost revenues. The Company's ability to service payphones promptly allows it
to retain existing customers and attract new ones. The Company employs both
advanced telecommunications technology and trained field technicians as part of
its
4
commitment to provide superior customer service. The records generated through
the Company's technology allow for the more timely and accurate payment of
commissions to Location Owners.
Develop Strong Relationships with Service Providers and Suppliers. As part
of its strategy to continue to reduce operating costs, the Company has formed
strategic alliances with a number of service and equipment providers. The
Company has formed alliances with a number of LECs and competitive local
exchange carriers to purchase local line access services, and has agreements
with a number of IXCs to provide operator services to its payphones for call
traffic not carried by its switch. In addition, the Company's consistent volume
of new payphone installations has allowed it to negotiate favorable purchasing
arrangements with a number of payphone equipment providers.
Facilitate Growth Through Internal Sales and Marketing. The Company
actively seeks to install new payphones through its sales and marketing efforts
to obtain additional contracts with new and existing accounts. The Company
conducts site surveys to examine various factors, including population density,
traffic patterns and historical usage information. The Company intends to
install approximately 8,000 payphones in 1999, compared with 6,884 payphones
installed in 1996, 6,311 payphones installed in 1997 and 7,233 payphones
installed in 1998, exclusive of acquisitions.
Pursue Strategic Acquisitions. The Company intends to use its experience in
identifying, negotiating and integrating strategic acquisitions in its continued
consolidation of the fragmented payphone industry. Strategic acquisitions have
enabled the Company to expand its market presence and further its strategy of
concentrating its payphones more rapidly than with internal sales growth alone.
Concentrating its payphones in close proximity allows the Company to plot more
efficient collection routes. The Company believes that route density contributes
to cost savings. Because smaller companies typically are not able to achieve
the economies of scale that may be realized by the Company, the integration of
acquired payphones into the Company's network of payphones often results in
lower operating costs than the seller of such payphones had been able to
realize. By clustering its payphones around its regional offices, the Company
is able to leverage its existing infrastructure through more efficient service
and collection routes which leads to a lower overall cost structure. For
example, since integrating the CCI Acquisition (as defined below), Davel has
been able to increase the number of payphones per technician to an average of
186 from 167 as a result of greater payphone density, workforce rationalizations
and computerized route design. The Company believes it will be able to increase
this number from 186 to approximately 210 upon the complete integration of the
operations of Peoples Telephone.
Acquisitions
The Company generates growth by pursuing the acquisition of payphone
companies or assets within its existing market areas and in areas in which the
Company desires to establish a new market presence. In the merger with Peoples
Telephone in December 1998, the Company added approximately 43,000 payphones to
its network. In the CCI Acquisition on February 3, 1998, the Company added
19,543 payphones to its network. In addition, during 1998, the Company added an
additional 4,019 payphones to its network through other acquisitions. The
Company believes that it is well positioned to capitalize on the fragmented
nature of the independent payphone industry by maintaining an active acquisition
program. The Company seeks to acquire payphone companies or assets that can
provide cost savings and economies of
5
scale through integration into the Company's service and maintenance, long-
distance and management information networks and believes that further
acquisitions present a significant growth opportunity for the Company.
Listed below is a summary of acquisitions completed by Old Davel and Peoples
Telephone during 1998 and 1997.
Number of Purchase Price
Company Date Payphones (In thousands)
- -------------------------------------- -------------- ----------- --------------
Eat N' Park Restaurants December 1998 136 $ 286
Call Communications, Inc. August 1998 1,251 2,948
Communications Central Inc. February 1998 19,543 109,117
Indiana Telecom January 1998 2,632 11,317
Tele/Data Pay Telephone August 1997 183 511
Blair Telephone June 1997 1,255 3,868
Quarter Call June 1997 954 2,160
Mid-Eastern April 1997 117 233
All others (less than 70 phones
each) 481 362
-------------------------------
Totals 26,552 $130,802
Integration Plan
The Company believes that it can achieve cost savings through the
combination of the payphone routes, management information systems and
administrative functions of Old Davel, Peoples Telephone and CCI. The Company
has formed a transition team (the "Transition Team") consisting of senior
members of management to oversee integration of the companies. Each senior
executive on the Transition Team is managing the transition process in one of
the following major functional areas of the Company's operations: field
operations, network operations, equipment repair and supply, human resources,
finance and accounting, legal and regulatory, sales and marketing, and customer
service. The Transition Team has begun the process of identifying and developing
potential areas of cost savings and revenue enhancement. Members of the
Transition Team have recommended strategies for achieving their objectives in
the most cost-effective manner, including specific recommendations for
eliminating redundant functions, employees and facilities. The integration of
CCI's operations into those of Old Davel has been virtually completed, and the
Transition Team expects the integration process with Peoples Telephone to be
substantially complete by the end of the 1999.
Operations
As of December 31, 1998 and December 31, 1997, the Company owned and
operated 84,384 and (treating the Peoples Telephone payphones as pooled together
with the Old Davel payphones) 59,009 payphones, respectively, an increase of
25,375 installed payphones. The CCI Acquisition in February 1998, increased the
number of installed payphones by 19,543 units.
6
Coin Calls
The Company's payphones generate coin revenues primarily from local calls.
Historically, the maximum rate that LECs and independent payphone companies
could charge for local calls was generally set by state regulatory authorities
and in most cases was $0.25 or $0.35 through October 6, 1997. In ensuring "fair
compensation" for all calls, the FCC previously determined that local coin rates
from payphones should be generally deregulated by October 7, 1997, but provided
for possible modifications or exemptions from deregulation upon a detailed
showing by an individual state that there are market failures within the state
that would not allow market-based rates to develop. On July 1, 1997, a federal
court issued an order which upheld the FCC's authority to deregulate local coin
call rates. In accordance with the FCC's ruling and the court order, certain
LECs and IPPs, including the Company, began to increase rates for local coin
calls from $.25 to $.35 commencing October 7, 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Regulatory Impact on Revenue -- Local Coin Rates."
InterLATA long distance coin calls are carried by the Company's long
distance switching equipment and long distance carriers that have agreed to
provide service to the Company's payphones. The Company pays a charge to a long
distance carrier each time that carrier transports a long distance call for
which the Company receives coin revenue. The Company's payphones also generate
coin revenue from intraLATA long distance calls.
Non-Coin Calls
The Company also receives revenues from non-coin calls made from its
payphones. Non-coin calls include credit card, calling card, prepaid calling
card, collect and third-party billed calls. Certain non-coin calls from the
Company's payphones are handled by the Company's subsidiary, DavelTel, Inc.
("DavelTel"). DavelTel's switching equipment is located in Tampa, Florida. See
"Technology." DavelTel performs certain of the operator services necessary to
complete non-coin calls.
The services needed to complete a non-coin call include providing an
automated or live operator to answer the call, verifying billing information,
validating calling cards and credit cards, routing and transmitting the call to
its destination, monitoring the call's duration and determining the charge for
the call, and billing and collecting the applicable charge. The Company has
contracted with an operator service provider to provide live operators to
handle calls that require operator services. Billing information is verified and
collect calls and credit cards are validated by the Company's switch through one
of several companies that provide on-line access to validation databases. The
Company contracts for transport of its calls over networks operated by long
distance carriers. The Company's switch is programmed to select the most cost-
effective carrier and transmission circuit then available to the Company to
complete the call as dialed. Billing and collection of call charges is performed
for the Company by one of several service bureaus specializing in that activity.
The Company realizes additional revenues from certain long distance
companies pursuant to FCC regulation as compensation for "dial-around" non-coin
calls made from its
7
payphones. A dial-around call is made by dialing an access code for the purpose
of reaching a long distance company other than the one designated by the
payphone operator by making a "toll free" call, generally by dialing a 1-
800/888/877 number, a 950-number or a seven-digit "1010XXX" code before dialing
"0" for operator service. See "Business--Regulation."
Payphone Base
In addition to payphones acquired by the Company (see "Acquisitions"), the
Company's payphone base includes payphones installed by the Company. The
following table sets forth, for the last three fiscal years, the number of
Company payphones acquired, installed and removed during the year as well as the
net increase in Company payphones in operation.
1998 1997 1996
--------- --------- --------
Acquired 23,691 2,861 2,767
Installed 7,233 6,311 6,884
Removed (5,549) (3,953) (5,239)
Net Increase 25,375 5,219 4,412
Most of the Company's payphones are located in proximity to one of the
Company's divisional offices, from which Company employees operate and service
payphones and conduct sales and marketing efforts. The following table sets
forth the number of payphones operated by Old Davel and Peoples Telephone in
each state and the District of Columbia as of December 31, 1998, 1997 and 1996:
December 31
------------------------------------------------------------------
State 1998 1997 1996
- -------------------------- ----------------- ---------------- -----------------
Alabama 2,357 692 614
Arkansas 528 45 27
Arizona 779 745 706
California 3,760 3,830 3,737
Colorado 447 33 55
District of Columbia 511 460 447
Delaware 119 97 73
Florida 15,708 12,851 12,612
Georgia 5,357 2,838 2,020
Iowa 747 784 959
Illinois 2,626 1,713 1,683
Indiana 2,947 895 856
Louisiana 2,580 1,676 1,502
Kansas 13 9 9
Kentucky 1,436 913 794
Massachusetts 534 410 344
Maine 52 39 39
Maryland 3,464 3,258 2,495
Michigan 504 406 398
Minnesota 471 - 33
Missouri 366 170 143
Mississippi 2,201 1,205 1,055
North Carolina 4,586 3,578 3,299
8
North Dakota 10 - -
Nebraska 32 36 66
New Hampshire 80 57 47
Nevada 388 404 427
New York 6,022 6,022 5,930
New Jersey 611 588 562
Ohio 2,719 1,583 1,286
Oklahoma 102 10 -
Oregon 11 12 12
Pennsylvania 3,472 2,691 1,456
Rhode Island 76 42 58
South Carolina 2,892 2,219 2,051
South Dakota 1 3 4
Tennessee 4,763 2,632 2,488
Texas 4,237 2,015 2,095
Vermont 18 17 18
Virginia 5,917 3,372 2,917
Utah 272 248 187
Washington - 1 1
Wisconsin 266 149 144
West Virginia 402 261 138
Wyoming - - 3
----------------- ---------------- -----------------
Totals 84,384 59,009 53,790
================= ================ =================
The Company selects locations for its payphones where there is typically
high demand for payphone service, such as convenience stores, truck stops,
service stations, grocery stores, shopping centers, restaurants, hotels and
airports. For many locations, historical information regarding an installed
payphone is available because payphone operators are often obligated pursuant to
agreements to provide this information to Location Owners for their payphones.
In locations where historical revenue information is not available, the Company
relies on its site survey to examine geographic factors, population density,
traffic patterns and other factors in determining whether to install a payphone.
The Company's marketing staff attempts to obtain agreements to install the
Company's payphones ("Location Agreements") at locations with favorable
historical data regarding payphone revenues.
Location Agreements generally provide for revenue sharing with the
applicable Location Owners. The Company's Location Agreements generally provide
commissions based on fixed percentages of revenues and are generally of three to
five-year terms. The Company can generally terminate a Location Agreement on 30
days' notice to the Location Owner if the payphone does not generate sufficient
revenue.
The Company routinely monitors its payphone base and removes
underperforming payphones, which it often relocates to locations with more
potential for profitability. In particular, the Company often removes and
relocates a number of payphones following acquisitions because its performance
criteria are generally more stringent than the criteria of the payphone
operators from which it acquires payphones.
9
Service and Maintenance
The Company employs field service technicians, each of whom collects coin
boxes from, and cleans and maintains an average of approximately 200 payphones.
The technicians also respond to trouble calls made by a Location Owner, by a
user of a payphone or by the telephone itself as part of its internal diagnostic
procedures. Some technicians are also responsible for the installation of new
payphones. Due to the proximity of most of the Company's payphones to one of
the Company's divisional offices and the ability of the field service
technicians to perform on-site service and maintenance functions, the Company is
able to limit the frequency of trips to the payphone as well as the number of
employees needed to service the payphones.
Customers, Sales and Marketing
The Company employs marketing personnel for its payphone operations in each
of its regions of operation. Regional marketing personnel are responsible for
finding desirable locations for payphones and obtaining Location Agreements with
Location Owners within their geographic areas. The Company believes that using
regional marketing personnel provides better market penetration because of their
familiarity with and proximity to their regions. To date, IPPs have had a
competitive advantage over LECs due to their ability to offer commissions to
Location Owners for both local and long-distance calls. Historically, LECs
generally were unable to derive revenues from interstate calls and non-coin,
interLATA calls, and consequently, were unable to offer commissions on such
calls. Recently enacted rules adopted pursuant to the Telecommunications Act
grant LECs the ability to select the long-distance carrier for interLATA long-
distance calls in conjunction with the Location Owner. This will enable LECs to
derive revenues from and pay commissions on these calls in the future. See "
Business--Regulation."
The Company's customers are a diverse group of small-, medium-sized and
large businesses which are frequented by individuals often needing payphone
access. The majority of the Company's customers are convenience stores, truck
stops, service stations, grocery stores, shopping centers, hotels and airports.
As of December 31, 1998, corporate payphone accounts of 50 or more payphones
represented approximately 36% of the Company's installed payphones.
Service and Equipment Suppliers
The Company's primary suppliers provide payphone components, local line
access, billing and collection services and long distance services. In order to
promote acceptance by end users accustomed to using LEC-owned payphone
equipment, the Company utilizes payphones designed to be similar in appearance
and operation to payphones owned by LECs.
The Company's primary supplier of circuit boards for new payphone
installations is Protel, Inc. of Lakeland, Florida, a leading supplier of
payphone equipment. The Company also purchases circuit boards manufactured by
other suppliers for repair of installed payphones utilizing circuit boards
provided by other manufacturers. The Company primarily utilizes the billing and
collection services of ILD Teleservices, Inc. and obtains local line access from
various LECs, including BellSouth, GTE, Ameritech, SBC Communications, US West
and various other suppliers of local line access. New sources of local line
access are expected to emerge as competition is authorized in local service
markets. Long-distance services are
10
provided to the Company through the use of its own long-distance switching
equipment and by various long-distance and operator service providers, including
Sprint, AT&T, MCI Worldcom, WilTel, LCI and others.
The Company expects the availability of such products and services to
continue in the future, however, the continuing availability of alternative
sources cannot be assured. Transition from the Company's existing suppliers, if
necessary, could have a disruptive influence on the Company's operations and
could give rise to unforeseen delays and/or expenses. The Company is not aware
of any current circumstances that would require the Company to seek alternative
suppliers for any of the products or services used in the operation of its
business.
Assembly and Repair of Payphones
The Company assembles and repairs payphone equipment for its own use. The
assembly of payphone equipment provides the Company with technical expertise
used in the operation, service, maintenance and repair of its payphones. The
Company assembles payphones from standard payphone components purchased from
component manufacturers. These components include a metal case, an integrated
circuit board incorporating a microprocessor, a handset and cord, and a coin box
and lock. All of the components purchased by the Company are available from
several suppliers, and Davel does not believe that the loss of any supplier
would have a material adverse effect on its assembly operations.
The Company's payphones comply with all FCC requirements regarding the
performance and quality of payphone equipment and have all of the operating
characteristics required by the regulatory authorities of most states,
including: free access to local emergency ("911") telephone numbers and, where
not available, to local directory assistance; dial-around access to all locally
available long-distance companies; the capability of receiving incoming calls at
no charge; and automatic coin return capability for incomplete calls.
Technology
The payphone equipment installed by the Company makes use of
microprocessors to provide voice synthesized calling instructions, detect and
count coins deposited during each call, inform the caller at certain intervals
of the time remaining on each call, identify the need for and the amount of an
additional deposit and other functions associated with completion of calls.
Through the use of non-volatile, electronically erasable, programmable read-only
memory chips, the payphones can also be programmed and reprogrammed from the
Company's central computer facilities to update rate information or to direct
different kinds of calls to particular carriers.
The Company's payphones can distinguish coins by size and weight, report to
a remote location the total coinage in the coin box, perform self-diagnosis and
automatically report problems to a pre-programmed service number, and
immediately report attempts at vandalism or theft. Virtually all of the
payphones operate on power available from the telephone lines, thereby avoiding
the need for and reliance upon an additional power source at the installation
location.
The Company utilizes proprietary and non-proprietary software that tracks
the coin and non-coin revenues from each payphone as well as expenses relating
to that payphone, including
11
commissions payable to the Location Owners. The software allows the Company to
generate detailed financial information by Location Owner, location and
payphone, which allows the Company to monitor the profitability and operating
condition of each location and payphone.
The Company provides all technical support required to operate the
payphones, such as computers and software and hardware specialists, at its
headquarters in Tampa, Florida. The Company's manufacturing support operations
provide materials, equipment, spare parts and accessories. Each of the Company's
divisional offices maintains inventories for immediate access by field service
technicians.
The Company maintains switching equipment in Tampa, Florida which receives
calls, routes calls through transmission lines to their destination and records
information about the source, destination and duration of the call. Long-
distance calls from the Company's payphones that are not handled by its switch
or an unbundled services arrangement are serviced by long-distance companies
that pay commissions to the Company for those calls. The Company expects in the
future to make increasing use of the long distance services of Sprint as a
result of a Telecommunications Services Term Agreement signed in January 1999.
Regulation
The FCC and state regulatory authorities have traditionally regulated
payphone and long-distance services, with regulatory jurisdiction being
determined by the interstate or intrastate character of the service and the
degree of regulatory oversight varying among jurisdictions. On September 20 and
November 8, 1996, the FCC adopted initial rules and policies to implement
Section 276 of the Telecommunications Act of 1996 (the "Telecommunications
Act"). The Telecommunications Act substantially restructured the
telecommunications industry, included specific provisions related to the
payphone industry and required the FCC to develop rules necessary to implement
and administer the provisions of the Telecommunications Act on both an
interstate and intrastate basis. Among other provisions, the Telecommunications
Act granted the FCC the power to preempt state payphone regulations to the
extent that any state requirements are inconsistent with the FCC's
implementation of Section 276.
Federal Regulation of Local Coin and Dial-Around Calls
The Telephone Operator Consumer Services Improvement Act of 1990 ("TOCSIA")
established various requirements for companies that provide operator services
and for call aggregators, including payphone service providers ("PSPs"), who
send calls to those OSPs. The requirements of TOCSIA as implemented by the FCC
included call branding, information posting, rate quotations, the filing of
informational tariffs and the right of payphone users to access any OSP to make
non-coin calls. TOCSIA also required the FCC to take action to limit the
exposure of payphone companies to undue risk of fraud upon providing this "open
access" to carriers.
TOCSIA further directed the FCC to consider the need to provide
compensation for IPPs for dial-around calls. Accordingly, the FCC ruled in May
1992 that IPPs were entitled to dial-around compensation. Because of the
complexity of establishing an accounting system for determining per call
compensation for these calls, and for other reasons, the FCC temporarily set
this compensation at $6.00 per payphone per month based on an assumed average of
15 interstate carrier access code dial-around calls per month and a rate of
$0.40 per call. The
12
failure by the FCC to provide compensation for 800 "toll free" dial-around calls
was challenged by the IPPs, and a federal court subsequently ruled that the FCC
should have provided compensation for these toll free calls.
In 1996, recognizing that independent payphone providers had been at a
severe competitive disadvantage under the existing system of regulation and had
experienced substantial increases in dial-around calls without a corresponding
adjustment in compensation, Congress enacted Section 276 to promote both
competition among payphone service providers and the widespread deployment of
payphones throughout the nation. Section 276 directed the FCC to implement rules
by November 1996 which would:
. create a standard regulatory scheme for all public payphone service
providers
. establish a per call compensation plan to ensure that all payphone service
providers are fairly compensated for each and every completed intrastate
and interstate call except for 911 emergency and telecommunications relay
service calls;
. terminate subsidies for LEC payphones from LEC-regulated base operations;
. prescribe, at a minimum, nonstructural safeguards to eliminate
discrimination between LEC and independent payphone service providers and
remove the LEC payphones from the LEC's regulated asset base;
. provide for the RBOCs to have the same rights that independent payphone
service providers have to negotiate with Location Owners over the selection
of interLATA carrier services subject to the FCC's determination that the
selection right is in the public interest and subject to existing contracts
between the Location Owners and interLATA carriers;
. provide for the right of all payphone service providers to choose the
local, intraLATA and interLATA carriers subject to the requirements of, and
contractual rights negotiated with, Location Owners and other valid state
regulatory requirements;
. evaluate the requirement for payphones which would not normally be
installed under competitive conditions but which might be desirable as a
matter of public policy, and establish how to provide for and maintain such
payphones if it is determined that they are required; and
. preempt any state requirements which are inconsistent with the FCC's
regulations implementing Section 276.
In September and November 1996, the FCC issued the 1996 Payphone Order. In
the 1996 Payphone Order, the FCC determined that the best way to ensure fair
compensation to independent and LEC PSPs for each and every call was to
deregulate to the maximum extent possible the price of all calls originating
from payphones. For local coin calls, the FCC mandated that deregulation of the
local coin rate would not occur until October 1997 in order to provide a period
of orderly transition from the previous system of state regulation.
To achieve fair compensation for dial-around calls through deregulation and
competition, the FCC in the 1996 Payphone Order directed a two-phase transition
from a regulated market.
13
In the first phase, November 1996 to October 1997, the FCC prescribed flat-rate
compensation payable to the PSPs by the IXCs in the amount of $45.85 per month
per payphone. This rate was arrived at by determining that the deregulated local
coin rate was a valid market-based surrogate for dial-around calls. The FCC
applied a market-based, deregulated coin rate of $0.35 per call to a finding
from the record that there was a monthly average of 131 compensable dial-around
calls per payphone. This total included both carrier access code calls dialed
for the purpose of reaching a long distance company other than the one
designated by the PSP as well as 800 "toll free" calls. The monthly, per phone
flat-rate compensation of $45.85 was to be assessed only against IXCs with
annual toll-call revenues in excess of $100 million and allocated among such
IXCs in proportion to their gross long-distance revenues. During the second
phase of the transition to deregulation and market-based compensation (initially
from October 1997 to October 1998, but subsequently extended in a later order by
one year to October 1999), the FCC directed the IXCs to pay the PSPs on a per-
call basis for dial-around calls at the assumed deregulated coin rate of $0.35
per call. At the conclusion of the second phase, the FCC set the market-based
local coin rate, determined on a payphone-by-payphone basis, as the default per-
call compensation rate in the absence of a negotiated agreement between the PSP
and the IXC. To facilitate per-call compensation, the FCC required the PSPs to
transmit payphone-specific coding digits which would identify each call as
originating from a payphone and required the LECs to make such coding available
to the PSPs as a tariffed item included in the local access line service.
In July 1997, the Court responded to an appeal of the 1996 Payphone Order,
finding that the FCC erred in (1) setting the default per-call rate at $0.35
without considering the differences in underlying costs between dial-around
calls and local coin calls, (2) assessing the flat-rate compensation against
only the carriers with annual toll-call revenues in excess of $100 million, and
(3) allocating the assessment of the flat-rate compensation based on gross
revenues rather than on a factor more directly related to the number of dial-
around calls processed by the carrier. The Court also assigned error to other
aspects of the 1996 Payphone Order concerning inmate payphones and the
accounting treatment of payphones transferred by an RBOC to a separate
affiliate.
In response to the Court's remand, the FCC issued the 1997 Payphone Order
in October of 1997. The FCC determined that distinct and severable costs of
$0.066 were attributable to coin calls that did not apply to the costs incurred
by the PSPs in providing access for dial-around calls. Accordingly, the FCC
adjusted the per call rate during the second phase of interim compensation to
$0.284 (which is $0.35 less $0.066). While the FCC tentatively concluded that
the $0.284 default rate should be utilized in determining compensation during
the first phase and reiterated that PSPs were entitled to compensation for each
and every call during the first phase, it deferred for later the decision on the
precise method of allocating the initial interim period (November 1996 through
October 1997) flat-rate payment obligation among the IXCs and the number of
calls to be used in determining the total amount of the payment obligation.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order,
FCC 98-481, which extended and waived certain requirements concerning the
provision by the LECs of payphone-specific coding digits which identify a call
as originating from a payphone. Without the transmission of payphone-specific
coding digits some of the IXCs have claimed they are unable to identify a call
as a payphone call eligible for dial-around compensation. With the stated
purpose of ensuring the continued payment of dial-around compensation the FCC,
by
14
Memorandum and Order issued on April 3, 1998, left in place the requirement for
payment of per-call compensation for payphones on lines that do not transmit the
requisite payphone-specific coding digits, but gave the IXCs a choice for
computing the amount of compensation for payphones on LEC lines not transmitting
the payphone-specific coding digits of either accurately computing per-call
compensation from their databases or paying per-phone, flat-rate compensation
computed by multiplying the $0.284 per call rate by the nationwide average
number of 800 subscriber and access code calls placed from RBOC payphones for
corresponding payment periods. Accurate payments made at the flat rate are not
subject to subsequent adjustment for actual call counts from the applicable
payphone.
On May 15, 1998, the Court again remanded the per-call compensation rate to
the FCC for further explanation without vacating the $0.284 per call rate. The
Court opined that the FCC had failed to explain adequately its derivation of the
$0.284 default rate. The Court stated that any resulting overpayment would be
subject to refund and directed the FCC to conclude its proceedings within a six-
month period from the effective date of the Court's decision.
In response to the Court's second remand, the FCC conducted further
proceedings and sought additional comment from interested parties to address the
relevant issues posed by the Court. On February 4, 1999, the FCC released the
Third Report and Order on Reconsideration of the Second Report and Order (the
"1999 Payphone Order"), in which the FCC abandoned its efforts to derive a
"market-based" default dial-around compensation rate and instead adopted a
"cost-based" rate of $0.24 per dial-around call. This new rate will become
effective on April 21, 1999, and will serve as the default rate through January
31, 2002. The new rate will also be applied retroactively to the period
beginning on October 7, 1997, less a $0.002 amount to account for FLEX ANI
payphone tracking costs, for a net compensation rate of $0.238 applicable during
this retroactive period. It also appears from the 1999 Payphone Order that this
new rate will be applied to the initial "interim" period, running from November
8, 1996 through October 7, 1997; however, the 1999 Payphone Order deferred a
final ruling on the interim period treatment to a later, as yet unreleased,
order. The FCC has further ruled that an adjustment will be made for all
payments or credits (with applicable interest at 11.25%) due and owing between
the IXCs and the PSPs, including Davel. It is possible that the final
implementation of the 1999 Payphone Order, including resolution of this
retroactive adjustment and the outcome of any related administrative or judicial
appeals, could have a material adverse effect on the Company. See "Effect of
Federal Regulation of Local Coin and Dial-Around Calls" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Regulatory Impact on Revenue--Dial-Around Compensation."
Effect of Federal Regulation of Local Coin and Dial-Around Calls
Dial-Around Calls. Based on the FCC's tentative conclusion in the 1997
Payphone Order, the Company adjusted the amounts of dial-around compensation
previously recorded for the period November 7, 1996 to June 30, 1997 from the
initial $45.85 per-phone, per-month rate to $37.20 ($0.284 per call multiplied
by 131 calls). Based on this adjustment, the Company recorded a provision in the
three-month period ended September 30, 1997 to reflect reduced dial-around
compensation. In addition, beginning with the third quarter of 1997, the Company
recorded dial-around compensation at the same rate of $37.20 per payphone per
month. Based on the reduction in the per-call compensation rate in the 1999
Payphone Order, the Company further reduced, through an adjustment to non-coin
revenues totaling $9.0 million, the amounts of dial-around compensation
previously recorded for the period from November 7, 1996 to
15
December 31, 1998. The adjustment included approximately $6.0 million to adjust
revenue recorded during the period November 7, 1996 to October 6, 1997 from
$37.20 per-phone per-month to $31.18 per phone per month ($0.238 per call
multiplied by 131 calls). The remaining $3.0 million of the adjustment was to
adjust revenues recorded during the period October 7, 1997 through December 31,
1998 to actual dial-around call volumes for the period multiplied by $0.238 per
call. The Company believes that it is legally entitled to fair compensation
under the Telecommunications Act for dial-around calls which were delivered to
any carrier during the period from November 7, 1996 to December 31, 1998.
While the amount of $0.24 per call constitutes the Company's assessment of
the minimum level of fair compensation, certain IXCs have asserted in the past,
are asserting and are expected to assert in the future, that the appropriate
level of fair compensation should be lower than $0.24 per call or should be
determined by requiring the user to deposit coinage at the time of making a
dial-around call.
The payments for dial-around calls prescribed in the 1997 Payphone Order
significantly increased dial-around compensation revenues to the Company over
the levels received prior to implementation of the Telecommunications Act
(although the 1999 Payphone Order has now moderated those increases). However,
market forces and factors outside the Company's control could significantly
affect the resulting revenue impact. These factors include the following: (1)
the final resolution of the $0.24 rate recently ordered by the FCC and the
possibility of subsequent appeals to the courts, (2) resolution by the FCC of
the method of allocating the initial interim period flat-rate assessment among
the IXCs and the number of calls to be used in determining the amount of the
assessment, (3) the possibility of other litigation seeking to modify or
overturn the 1999 Payphone Order or portions thereof, (4) the IXCs' reaction to
the FCC's recognition that existing regulations do not prohibit an IXC from
blocking 800 subscriber numbers from payphones in order to avoid paying per-call
compensation on such calls and (5) 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.
Local Coin Call Rates. As a result of the Telecommunications Act and in
accordance with the FCC's initial rulings implementing Section 276 of the Act
(which were upheld on appeal by the U.S. Supreme Court), rates for local coin
calls placed from payphones have been effectively deregulated. The Company and
other PSPs have utilized this new deregulatory environment as an opportunity to
adjust prices in an effort to maximize revenues from this call category. In
deciding to deregulate local coin rates for payphones the FCC did, however,
provide for possible modifications or exemptions from deregulation, either upon
its own motion in response to consumer complaints or where an individual state
regulatory body makes a detailed showing that there are market failures within
the state that would not allow market-based rates to develop. While no such
action has been taken to date by the FCC or state regulators, no assurances can
be given as to the future regulatory treatment of local coin call rates,
including the potential re-regulation of those rates or other modifications.
Moreover, the Company cannot predict with any certainty the ultimate impact of
local coin rate deregulation upon its operations.
16
Initial experience with local coin call rate increases indicates that price
sensitivity of consumers for the service does exist and has resulted and will
result in a potentially material reduction in the number of coin calls made. The
Company is unable to predict the ultimate impact on its operations of local coin
call rate deregulation.
Other Provisions of the Telecommunications Act and FCC Rules
As a whole, the Telecommunications Act and FCC Rules significantly alters
the competitive framework of the payphone industry. The Company believes that
implementation of the Telecommunications Act has addressed certain historical
inequities in the payphone marketplace and has, in part, led to a more equitable
competitive environment for all payphone providers. However, there are numerous
uncertainties in the implementation and interpretation of the Telecommunications
Act which make it impossible for the Company to provide assurance that the
Telecommunications Act will result in a long-term positive impact. The Company
has identified the following such uncertainties:
. Various matters pending in several federal courts and raised before the
Congress which, while not directly challenging Section 276, relate to the
validity and constitutionality of the Telecommunications Act, as well as
other uncertainties related to the impact, timing and implementation of the
Telecommunications Act.
. The 1996 Payphone Order required that LEC payphone operations be removed
from the regulated rate base on April 15, 1997. The LECs were also required
to make the access lines that are provided for their own payphones equally
available to IPPs and to ensure that the cost to payphone providers for
obtaining local lines and services met the FCC's new services test
guidelines, which require that LECs price payphone access lines at the cost
to the LEC plus a reasonable margin of profit. Proceedings are now pending
in various stages and formats, before numerous state regulatory bodies
across the nation to resolve these issues.
. In the past, RBOCs were allegedly impaired in their ability to compete with
the IPPs because they were not permitted to select the interLATA carrier to
serve their payphones. Recent changes to the FCC Rules remove this
restriction. Under the new rules, the RBOCs are now permitted to
participate with the Location Owner in selecting the carrier of interLATA
services to their payphones effective upon FCC approval of each RBOC's
Comparably Efficient Interconnection plans. Existing contracts between
Location Owners and payphone or long-distance providers which were in
effect as of February 8, 1996 are grandfathered and will remain in effect.
. The 1996 Payphone Order preempts state regulations that may require IPPs to
route intraLATA calls to the LEC by containing provisions that allow all
payphone providers to select the intraLATA carrier of their choice.
Outstanding questions exist with respect to 0+ local and 0- call routing
whose classification will await the outcome of various state regulatory
proceedings or initiatives.
. The 1996 Payphone Order determined that the administration of programs for
maintaining public interest payphones should be left to the states within
certain guidelines. Various state proceedings are underway in reviewing
this issue.
17
Billed Party Preference and Rate Disclosure
The FCC previously issued a Second Notice of Proposed Rulemaking regarding
Billed Party Preference and associated call rating issues, including potential
rate benchmarks and caller notification requirements for 0+ and interstate long-
distance calls. On January 29, 1998, the FCC released its Second Report and
Order on Reconsideration entitled In the Matter of Billed Party Preference for
InterLATA 0+ Calls, Docket No. 92-77. Effective July 1, 1998, all carriers
providing operator services were required to give consumers using payphones the
option of receiving a rate quote before a call is connected when making a 0+
interstate call.
State and Local Regulation
State regulatory authorities have primarily been responsible for regulating
the rates, terms, and conditions for intrastate payphone services. Regulatory
approval to operate payphones in a state typically involves submission of a
certification application and an agreement by the Companies to comply with
applicable rules, regulations and reporting requirements. The states that
currently permit independent payphone providers to supply local and long-
distance payphone service, and the District of Columbia, have adopted a variety
of state-specific regulations that govern rates charged for coin and non-coin
calls, as well as a broad range of technical and operational requirements. The
Telecommunications Act contains provisions that require all states to allow
payphone competition on fair terms for both LECs and IPPs. State authorities
also regulate LECs' tariffs for interconnection of independent payphones, as
well as the LECs' own payphone operations and practices.
The Company is also affected by state regulation of operator services. Most
states have capped the rates that consumers can be charged for coin toll calls
and non-coin local and intrastate toll calls made from payphones. In addition,
the Company must comply with regulations designed to afford consumers notice at
the payphone location of the long-distance company servicing the payphone and
the ability to access alternate carriers. The Company believes that it is
currently in material compliance with all regulatory requirements pertaining to
their offerings of operator services directly or through other long-distance
companies.
In accordance with requirements under the Telecommunications Act, state
regulatory authorities are currently reviewing the rates that LECs charge IPPs
for local line access and associated services. Local line access charges have
been reduced in certain states and the Company believes that selected states'
continuing review of local line access charges, coupled with competition for
local line access service resulting from implementation of the
Telecommunications Act, could lead to more options available to the Company for
local line access at competitive rates. The Company cannot provide assurance,
however, that such options or local line access rates will become available. The
Telecommunications Act also contains other provisions which will affect the
rates payphone providers can charge for local coin calls and other aspects of
the regulation of payphone services by the states, although the extent of any
future federal preemption of state regulation cannot be accurately predicted.
18
The Company believes that an increasing number of municipalities and other
units of local government have begun to impose taxes, license fees and operating
rules on the operations and revenues of payphones. The Company believes that
some of these fees and restrictions may be in violation of provisions of the
Telecommunications Act prohibiting barriers to entry into the business of
operating payphones and the policy of the Telecommunications Act to encourage
wide deployment of payphones. However, in at least one instance, involving a
challenge to a payphone ordinance adopted by the Village of Huntington Park,
California, the FCC declined to overturn a total ban on payphones in a downtown
area. The proliferation of local government licensing, restriction, taxation and
regulation of payphone services could have an adverse affect on the Company and
other PSPs unless the industry is successful in resisting or moderating this
trend.
Competition
The Company competes for payphone locations directly with LECs and IPPs.
The Company also competes, indirectly, with long-distance companies, which can
offer Location Owners commissions on long-distance calls made from LEC-owned
payphones. Most LECs and long-distance companies against which the Company
competes and some IPPs may have substantially greater financial, marketing and
other resources than the Company. In addition, many LECs, faced with competition
from the Company and other IPPs, have increased their compensation arrangements
with Location Owners to offer more favorable commission schedules.
The Company believes the principal competitive factors in the payphone
business are (1) the commission payments to a Location Owner and the opportunity
for a Location Owner to obtain commissions on both local and long-distance calls
from the same provider, (2) the ability to serve accounts with locations in
several LATAs or states, (3) the quality of service and the availability of
specialized services provided to a Location Owner and payphone users, and (4)
responsiveness to customer service needs. The Company believes it is currently
competitive in each of these areas.
The Company competes with long-distance carriers that provide dial-around
services which can be accessed through the Company's payphones. Certain national
long-distance operator service providers and prepaid calling card providers have
implemented extensive advertising promotions and distribution schemes which have
increased dial-around activity on payphones owned by LECs and IPPs, including
the Company, thereby detracting from the Company's primary OSPs. However, the
Company receives compensation for dial-around calls placed from its payphones.
See "Regulation."
The Company also competes with providers of wireless communications
services for both local and long distance traffic. Certain providers of wireless
communication services have recently introduced rate plans that are
competitively priced with certain of the products offered by the Company.
Employees
As of December 31, 1998, the Company had 958 full-time employees, none of
whom is the subject of a collective bargaining agreement. The Company believes
that its relationship with its employees is good.
19
ITEM 2. PROPERTIES
The Company leases approximately 48,500 square feet in Tampa, Florida that
includes two locations for executive office space, a divisional office for
payphone operations and facilities for the assembly of payphones. The Company
also leases approximately 40 divisional offices for payphone operations in
various geographical locations. In addition, the Company operates a regional
distribution and assembly center in approximately 10,000 square feet in
Jacksonville, Illinois, which the Company leases from its Chairman. The Company
also leases 18,000 square feet of warehouse space in Jacksonville, Illinois from
its Chairman. The Company believes that these facilities are adequate to meet
the Company's needs in the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
On September 29, 1998, the Company announced that it was exercising its
contractual rights to terminate a merger agreement (the "Davel/PhoneTel Merger
Agreement") with PhoneTel Technologies, Inc. ("PhoneTel"), based on breaches of
representations, warranties and covenants by PhoneTel. On October 1, 1998, the
Company filed a lawsuit in Delaware Chancery Court seeking damages, rescission
of the Davel/PhoneTel Merger Agreement and a declaratory judgment that such
breaches occurred. On October 27, 1998, PhoneTel answered the complaint and
filed a counterclaim against the Company alleging that the Davel/PhoneTel Merger
Agreement had been wrongfully terminated. At the same time, PhoneTel also filed
a third party claim against Peoples Telephone (acquired by Davel in the Peoples
Merger) alleging that Peoples Telephone wrongfully caused the termination of the
Davel/PhoneTel Merger Agreement. The counterclaim and third party claim seek
specific performance by Davel of the transactions contemplated by the
Davel/PhoneTel Merger Agreement and damages and other equitable relief from
Davel and Peoples Telephone. The Company believes that it has meritorious claims
against PhoneTel and intends to defend vigorously against the counterclaim
against Davel and the third party claim against Peoples Telephone initiated by
PhoneTel. The Company at this time cannot predict the outcome of this
litigation.
In December 1995, Cellular World, Inc. filed a complaint in Dade County
Circuit Court against Peoples and its subsidiary, PTC Cellular, Inc., alleging
wrongful interference with Cellular World's business relationship with Alamo
Rent-A-Car, and alleged misappropriation of Cellular World's trade secrets
concerning Cellular World's proprietary cellular car phone rental system
equipment. Cellular World is seeking damages alleged to exceed $10 million.
Formal discovery is nearly completed. Pending completion of discovery, the
Company expects the trial to be scheduled for May or June 1999. Based on the
proceedings conducted to date, the Company believes that it has several
meritorious legal and factual defenses. The Company at this time cannot predict
the outcome of this litigation.
The Company is involved in other litigation arising in the normal course of
its business which it believes will not materially affect its financial position
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 22, 1998, the Company held its 1998 Annual Meeting of
Stockholders in Chicago, Illinois. Two proposals were brought before the
stockholders for a vote. The first
20
was a proposal to approve and adopt the merger agreement between Davel and
Peoples Telephone. Of the 5,777,998 shares of Davel Common Stock outstanding on
the record date of November 11, 1998, 5,458,242 shares, or 94.47%, voted in
person or by proxy. On the Peoples Telephone Merger proposal, 4,941,676 votes,
or 85.5%, were cast in favor of the proposal, 10,572 votes, or 0.18%, were cast
against the proposal or withheld, and there were 7,900 abstentions, representing
0.14%, and 498,094 broker non-votes, or 8.62% of the shares represented by
proxy.
The second stockholder proposal was to elect seven members of the Company's
Board of Directors. The Company's directors hold one-year terms and are subject
to annual re-election by the stockholders. Each nominee who was proposed for
election was elected by the stockholders. The following tabulation displays the
names of each nominee elected, the number of votes cast for each nominee, and
the number of votes withheld for each nominee.
Name of Nominee Number of Votes For Number of Votes Withheld
- ------------------ ------------------- ------------------------
F. Philip Handy 5,451,710 6,532
Michael E. Hayes 5,451,710 6,532
David R. Hill 5,451,710 6,532
Robert D. Hill 5,451,710 6,532
Thomas M. Vitale 5,451,710 6,532
A. Jones Yorke 5,451,710 6,532
Samuel Zell 5,451,710 6,532
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
Market Information. The Company's Common Stock trades on the NASDAQ
------------------
National Market System. The following table sets forth, for the periods
indicated, the high and low closing prices on the NASDAQ National Market System
from January 1, 1996 through December 31, 1998.
High Low
---- ---
1996
----
First Quarter 13.75 12.50
Second Quarter 20.00 12.75
Third Quarter 20.75 15.00
Fourth Quarter 19.00 15.25
1997
----
First Quarter 18.25 14.75
Second Quarter 18.00 12.00
Third Quarter 23.25 15.25
Fourth Quarter 29.00 21.25
21
1998
----
First Quarter 28.50 24.38
Second Quarter 29.25 21.25
Third Quarter 25.25 10.88
Fourth Quarter 19.75 9.00
As of March 31, 1999, there were approximately 427 holders of record of the
Common Stock, not including stockholders whose shares were held in "nominee" or
"street" name. The last sale price of the Company's Common Stock on March 31,
1999 was $7.00 per share.
Dividends. The Company did not pay any dividends on its Common Stock
---------
during 1998 and does not intend to pay any Common Stock dividends in the
foreseeable future. It is the current policy of the Company's Board of
Directors to retain earnings to finance the growth and development of the
Company's business. The payment of dividends is effectively prohibited by the
Company's Senior Credit Facility. Payment of cash dividends, if made in the
future, will be determined by the Company's Board of Directors based on the
conditions then existing, including the Company's financial condition, capital
requirements, cash flow, profitability, business outlook and other factors.
22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data presented below under the captions "Operating
Data" and "Balance Sheet Data" are derived from the audited consolidated
financial statements of the Company. The selected financial data should be read
in conjunction with the financial statements and notes thereto included
elsewhere in this Annual Report and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Year ended December 31 (1)
-------------------------------------------------------------------
(In thousands, except per share data)
1998 (2) 1997 1996 1995 1994
------------ ------------ ------------ ------------ -----------
Revenue $195,594 $159,243 $143,979 $144,192 $139,171
Expenses 221,376 153,200 140,665 146,516 135,024
------------ ------------ ------------ ------------ -----------
Operating Income (loss) (25,782) 6,043 3,314 (2,324) 4,147
Other expense (23,881) (13,084) (12,519) (10,844) (12,947)
Income taxes - 2,459 1,868 2,186 (3,439)
------------ ------------ ------------ ------------ -----------
Loss from continuing operations before
Extraordinary item (49,663) (9,500) (11,073) (15,354) (5,361)
Gain (loss) from discontinued operations 607 2,092 (1,114) (17,867) (9,279)
Extraordinary loss from extinguishment of debt (17,856) - - (3,327) -
------------ ------------ ------------ ------------ -----------
Net loss $(66,912) $ (7,408) $(12,187) $(36,548) $(14,640)
======== ======== ======== ======== ========
Basic and diluted loss per share:
Continuing operations before extraordinary item $ (5.68) $ (1.27) $ (1.47) $ (1.92) $ (0.66)
Gain (loss) from discontinued operations 0.07 0.25 (0.13) (2.18) (1.14)
Extraordinary loss from extinguishment of debt (1.98) - - (0.40) -
Net loss $ (7.59) $ (1.02) $ (1.60) $ (4.50) $ (1.80)
Weighted average common shares outstanding 9,029 8,407 8,317 8,236 8,148
Balance Sheet Data:
Total assets $273,018 $180,786 $184,732 $193,399 $223,626
Long-term debt and obligations under capital leases,
Less current maturities 225,451 107,076 106,956 102,782 98,386
Mandatorily redeemable preferred stock - 16,284 15,079 13,886 -
Shareholders' equity 1,649 20,290 28,641 42,278 75,393
(1) On December 23, 1998, the Company consummated its merger with Peoples
Telephone which was accounted for as a pooling-of-interests. Accordingly,
all financial data has been restated to reflect the combined operations of
Old Davel and Peoples Telephone for all periods presented.
(2) The year ended December 31, 1998, includes the results of CCI from the date
of the CCI Acquisition, February 3, 1998.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
Certain of the statements contained below are forward-looking statements
(rather than historical facts) that are subject to risks and uncertainties that
could cause actual results to differ materially from those described in the
forward-looking statements.
General
On December 23, 1998, the Company and Peoples Telephone merged together in
a transaction accounted for as a pooling-of-interests. As such, the results of
both companies have been restated as if they had been combined for all periods
presented.
During 1998, 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 collected from the payphones.
Non-coin calls made from the Company's payphones generate revenues in an
amount that depends upon whether the Company or a long distance company handles
the call. If the non-coin call is handled by the Company through its switch or
an "unbundled" services arrangement, the Company recognizes non-coin revenues
equal to the total amount charged for the call. If the non-coin call is handled
by a long distance company, the Company generally recognizes revenues in an
amount equal to the commission on that call paid to the Company by the long
distance company. Under an unbundled services arrangement, the Company
performs certain functions necessary to service non-coin calls, uses the long
distance company's switching equipment and its other services on an as-needed
basis, and pays the long distance company on an unbundled basis for the operator
services actually used to complete 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; this is commonly referred to as "dial-around"
access. See "Business--Regulation." The Company also derives revenue from
certain LECs for intraLATA non-coin calls. See "Business-Operations."
The principal costs related to the ongoing operation of the Company's
payphones include telephone charges, commissions, and service, maintenance and
network costs. Telephone charges consist of payments made by the Company to
LECs and long distance carriers for access charges and use of their networks.
Commission expense represents payments to Location Owners. Service, maintenance
and network costs represent the cost of servicing and maintaining the payphones
on an ongoing basis, costs related to the operation of the Company's switch and,
in connection with unbundled services arrangements, the fees paid for those
services.
24
Regulatory Impact on Revenue
Local Coin Rates
In ensuring "fair compensation" for all calls, the FCC previously
determined that local coin rates from payphones should be generally deregulated
by October 7, 1997, but provided for possible modifications or exemptions from
deregulation upon a detailed showing by an individual state that there are
market failures within the state that would not allow market-based rates to
develop. On July 1, 1997, a federal court issued an order which upheld the
FCC's authority to deregulate local coin call rates. In accordance with the
FCC's ruling and the court order, certain LECs and independent payphone service
providers, including the Company, increased rates for local coin calls from $.25
to $.35. Given the lack of direction on the part of the FCC on specific
requirements for obtaining a state exemption, the Company's inability to predict
the responses of individual states or the market, and the Company's inability to
provide assurance that deregulation, if and where implemented, will lead to
higher local coin call rates, the Company is unable to predict the ultimate
impact on its operations of local coin rate deregulation. In 1998, the Company
experienced lower coin call volumes on its payphones resulting from the
increased rates, growth in wireless communication services and changes in call
traffic and the geographic mix of the Company's payphones.
Dial-Around Compensation
On September 20, 1996, the Federal Communications Commission ("FCC")
adopted rules which became effective November 7, 1996 (the "1996 Payphone
Order"), initially mandating dial-around compensation for both access code calls
and 800 subscriber calls at a flat rate of $45.85 per payphone per month (131
calls multiplied by $0.35 per call). Commencing October 7, 1997 and ending
October 6, 1999 the $45.85 per payphone per month rate was to transition to a
per-call system at the rate of $0.35 per call. Several parties challenged
certain of the FCC regulations including the dial-around compensation rate. On
July 1, 1997, a federal court vacated certain portions of the FCC's 1996
Payphone Order, including the dial-around compensation rate.
In accordance with the court's mandate, on October 9, 1997, the FCC adopted
a second order (the "1997 Payphone Order"), establishing a rate of $0.284 per
call for the first two years of per-call compensation (October 7, 1997 through
October 6, 1999). The IXCs were required to pay this per-call amount to
payphone service providers, including the Company, beginning October 7, 1997.
On May 15, 1998, the court again remanded the per-call compensation rate to the
FCC for further explanation without vacating the $.284 default rate.
In accordance with the court's second mandate, on February 4, 1999, the FCC
released a third order (the "1999 Payphone Order"), in which the FCC abandoned
its efforts to derive a "market based" default dial-around compensation rate and
instead adopted a "cost based" rate of $.24 per dial-around call. This rate
will become effective on April 21, 1999, and will serve as a default rate
through January 31, 2002. The new rate will also be applied retroactively to
the period beginning on October 7, 1997, less a $.002 amount to account for FLEX
ANI payphone tracking costs, for a net compensation rate of $.238 applicable
during this retroactive period. It also appears from the 1999 Payphone Order
that this new rate will be applied to the initial "interim" period, running from
November 7, 1996 through October 7, 1997; however, the 1999 Payphone Order
deferred a final ruling on the interim period treatment to a later, as yet
25
unreleased, order. Upon establishment of the interim period, the FCC has
further ruled that a true-up will be made for all payments or credits (with
applicable interest at 11.25%) due and owing between the IXCs and the PSPs,
including the Company, for the payment period commencing on November 7, 1996
through the effective date of the new $.24 per call rate.
Based on the FCC's conclusion in the 1997 Payphone Order, the Company
adjusted the amounts of dial-around compensation previously recorded for the
period November 7, 1996 to June 30, 1997 from the initial $45.85 rate to $37.20
($0.284 per call multiplied by 131 calls). As a result of this adjustment, the
provision recorded in the year ended December 31, 1997 for reduced dial-around
compensation is approximately $3.3 million. For periods beginning November 7,
1996, prior to the release of the 1999 Payphone Order, the Company has recorded
dial-around compensation at the rate of $37.20 per payphone per month.
The Company believes that it is legally entitled to fair compensation under
the Telecommunications Act for dial-around calls which the Company delivered to
any carrier during the period from November 7, 1996 to October 6, 1997. Based on
the information available, the Company believes that the minimum amount it is
entitled to as fair compensation under the Telecommunications Act for the period
from November 7, 1996 to October 6, 1997 is $31.18 per payphone per month (131
calls multiplied by $0.238 per call) and the Company, based on the information
available to it, does not believe that it is reasonably possible that the amount
will be materially less than $31.18 per payphone per month.
While the amount of $0.24 per call constitutes the Company's assessment of
the minimum level of fair compensation following the April 21, 1999 effective
date, certain IXCs have asserted in the past, are asserting and are expected to
assert in the future that the appropriate level of fair compensation should be
lower than $0.24 per call.
The payment levels for dial-around calls prescribed in the 1996 and 1997
Payphone Orders significantly increase dial-around compensation revenues to the
Company over the levels received prior to implementation of the
Telecommunications Act (although the 1999 Payphone Order has now moderated those
increases). However, market forces and factors outside the Company's control
could significantly affect these revenue increases. These factors include the
following: (i) the final resolution of the $.24 rate recently ordered by the FCC
and the possibility of subsequent appeals to the courts, (ii) the resolution by
the FCC of the method of allocating the initial interim period flat-rate
assessment among the IXCs and the number of calls to be used in determining the
amount of the assessment, (iii) the possibility of other litigation seeking to
modify or overturn the 1999 Payphone Order or portions thereof, (iv) the IXCs'
reaction to the FCC's recognition that existing regulations do not prohibit an
IXC from blocking 800 subscriber numbers from payphones in order to avoid paying
per-call compensation on such calls, and (v) 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.
26
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
information from the Company's Consolidated Statements of Operations, included
elsewhere in this Form 10-K, expressed as a percentage of total revenues.
Year ended December 31,
------------------------------------
1998 1997 1996
--------- ---------- ---------
REVENUES:
Coin calls 67.7% 63.8% 66.7%
Non-coin calls, net of dial-around compensation adjustments 32.3 36.2 33.3
----- ----- -----
Total revenues 100.0 100.0 100.0
----- ----- -----
COSTS AND EXPENSES:
Telephone charges 23.3 24.4 26.1
Commissions 24.0 22.5 24.0
Service, maintenance and network costs 22.2 19.0 19.2
Depreciation and amortization 19.7 16.1 16.3
Selling, general and administrative 16.3 14.2 13.1
Non-recurring items 5.5 - (1.0)
Restructuring charge 2.2 - -
----- ----- -----
Total operating costs and expenses 113.2 96.2 97.7
----- ----- -----
Operating income (loss) (13.2) 3.8 2.3
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
For the year ended December 31, 1998, total revenues from continuing
operations increased approximately $36.4 million or 22.8%, compared to the year
ended December 31, 1997, increasing from $159.2 million in the year ended
December 31, 1997, to $195.6 million in the year ended December 31, 1998. This
growth was primarily attributable to an increase from 59,009 (treating the
Peoples Telephone payphones as pooled together with the Old Davel payphones)
payphones on December 31, 1997 to 84,384 payphones on December 31, 1998. The
growth in the number of payphones was primarily due to the CCI Acquisition,
consisting of 19,543 installed payphones, and the acquisition of Indiana Telcom
by Peoples Telephone in January 1998, consisting of 2,632 installed payphones.
Coin call revenues increased approximately $30.8 million, or 30.3%, rising from
$101.7 million in 1997 to $132.5 million in 1998, driven primarily by the
increase in the number of installed payphones. While coin call revenues
increased during the period on an aggregate basis, coin call revenues on a per-
phone, per-month basis decreased due to lower coin call volumes resulting from
the growth in wireless communication services and changes in call traffic and
the geographic mix of the Company's payphones.
Non-coin call revenues increased approximately $5.5 million, or 9.6%,
increasing from $57.6 million in the year ended December 31, 1997 to $63.1
million in the year ended December 31, 1998. The increase in non-coin call
revenues was primarily attributable to the growth in the number of installed
payphones. While non-coin call revenues increased during the period on an
aggregate basis, non-coin call revenues on a per-phone, per-month basis
decreased due to lower
27
call volumes resulting primarily from the growth in wireless communication
services. Non-coin call revenues were further reduced, through an adjustment
totaling $9.0 million resulting from the adjustment to the dial-around
compensation rate prescribed in the 1999 Payphone Order. The adjustment included
approximately $6.0 million to adjust revenue recorded during the period November
7, 1996 to October 6, 1997 from $37.20 per-phone per-month to $31.18 per phone
per month ($0.238 per call multiplied by 131 calls). The remaining $3.0 million
of the adjustment was to adjust revenues recorded during the period October 7,
1997 through December 31, 1998 to actual dial-around call volumes for the period
multiplied by $0.238 per call.
Telephone charges increased $6.7 million, or 17.2%, increasing from $38.9
million in the year ended December 31, 1997 to $45.6 million in the year ended
December 31, 1998. The increase in telephone charges was primarily attributable
to the growth in the number of installed payphones. Telephone charges for the
year 1998 decreased to 23.3% of total revenues compared to 24.4% in the prior
year. The decrease in telephone charges as a percentage of revenues was due to
reductions in line access charges on a per-phone per-month basis as a result of
rate reductions received from certain LECs with which the Company has negotiated
agreements for the provision of local access services, based on increased call
volumes as a result of the CCI Acquisition.
Commissions increased $11.1 million, or 31.0%, rising from $35.9 million in
the year ended December 31, 1997, to $47.0 million in the year ended December
31, 1998. The increase in commissions was primarily attributable to the growth
in the number of installed payphones. Commissions increased to 24.0% of total
revenues compared to 22.5% in the prior year. The increase in commissions as a
percentage of total revenues was primarily attributable to the CCI Acquisition
which included a higher proportion of national accounts than those previously
serviced by the Company. National accounts typically receive higher commission
rates than local and regional accounts due primarily to their higher revenues.
Service, maintenance and network costs rose $13.0 million, increasing from
$30.3 million in the year ended December 31, 1997 to $43.3 million in the year
ended December 31, 1998. The increase was primarily attributable to the growth
in the number of installed payphones. Service, maintenance and network costs
increased to 22.2% of total revenues compared to 19.0% in the prior year. The
increase in service, maintenance and network costs as a percentage of total
revenues was primarily attributable to the CCI Acquisition. Service, maintenance
and network costs in 1998 include the network costs related to the CCI payphones
which primarily direct long distance call traffic to an unbundled services
agreement. In 1997, the Company had a higher mix of long distance call traffic
directed to commission plans which do not include a cost component in service,
maintenance and network costs.
Depreciation and amortization expense increased approximately $13.0
million, or 50.7%, from the prior year, rising from $25.6 million in 1997 to
$38.6 million in 1998, driven by the increase in the number of installed
payphones. Approximately $10.0 million of the increase in depreciation and
amortization expense was related to the CCI Acquisition.
Selling, general and administrative expenses increased approximately $9.2
million, or 40.8%, from the prior year, increasing from $22.6 million in the
year ended December 31, 1997 to $31.8 million in the year ended December 31,
1998. The increase was primarily attributable to selling, general and
administrative expenses related to the CCI Acquisition. The Company
28
continued to operate the former corporate office of CCI through August 1998,
when CCI's administrative functions were combined into the Company's facilities
in other locations. In addition, the Company eliminated nine duplicative field
offices during the year in the integration of CCI's operations with Old Davel's
operations.
The Company recognized a non-recurring charge of approximately $10.8
million in 1998 for costs associated with the Peoples Merger, consisting
primarily of legal, accounting and investment banking fees, change of control
payments to former executives of Peoples Telephone, printing costs and other
expenses related to the transaction. In addition, the Company recognized
restructuring charges during the year ended December 31, 1998 of approximately
$4.3 million related to the integration and restructuring of Old Davel. The
restructuring charges were primarily related to severance pay for terminated
employees, lease termination costs and costs related to the closing of redundant
facilities.
Other income and expense decreased approximately $3.4 million, from income
of $0.5 million in the year ended December 31, 1997 to expense of $2.9 million
in the year ended December 31, 1998. This decrease resulted primarily from the
recognition of a $2.8 million impairment loss on an investment held by Peoples
Telephone prior to the merger with Old Davel. The remaining decrease was
primarily due to a reduction in interest income as a result of lower cash
balances available for investment.
Interest expense in 1998 increased approximately $7.4 million, or 54.3%,
rising from $13.6 million in 1997 to $21.0 million in 1998. This increase
resulted primarily from the incurrence of $120.0 million in indebtedness in
connection with the CCI Acquisition and refinancing of Old Davel's credit
facility.
Loss from continuing operations before extraordinary item increased
approximately $40.2 million from the prior year. Loss before extraordinary item
increased approximately $41.6 million from approximately $7.4 million in 1997 to
approximately $49.0 million in 1998.
The Company's gain on discontinued operations included $0.6 million of a
gain realized on the sale of the Peoples Telephone investment in Shared
Technologies Cellular, Inc. (STC) Common Stock which was received in 1995 as
proceeds from the sale of Peoples Telephone cellular telephone operations which
were treated as discontinued operations in 1995. The Company's loss from
discontinued operations in 1997 represents a $2.4 million loss on the sale of
the inmate phone division and received $0.3 million related to its previously
discontinued cellular telephone operations.
In the year ended December 31, 1998, the Company recorded an extraordinary
loss of $17.9 million, consisting of approximately $12.9 million in premiums and
fees related to the repurchase of $100.0 million principal amount of Peoples
Telephone's outstanding 12 1/4% Senior Notes due 2002 in connection with the
refinancing of the combined companies' credit facilities as part of the Peoples
Merger. The Company also recorded approximately $5.0 million in extraordinary
losses related to the write-off of unamortized debt issuance costs related to
the refinancing of the existing credit facilities of Old Davel and Peoples
Telephone.
Net loss increased approximately $59.5 million from approximately $7.4
million in 1997 to approximately $66.9 million in 1998.
29
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
For the year ended December 31, 1997, total revenues from continuing
operations increased approximately $15.3 million or 10.6%, increasing from
$144.0 million in the year ended December 31, 1996 to $159.2 million in the year
ended December 31, 1997. This growth was primarily attributable to an increase
from 53,790 (treating the Peoples Telephone payphones as pooled together with
the Old Davel payphones) payphones on December 31, 1996 to 59,009 payphones on
December 31, 1997. Coin call revenues increased approximately $5.7 million, or
6.0%, rising from $95.9 million in the year ended December 31, 1996 to $101.7
million in the year ended December 31, 1997, driven primarily by the increase in
the number of installed payphones.
Non-coin call revenues increased approximately $9.6 million, or 19.9%,
increasing from $48.0 million in the year ended December 31, 1996 to $57.6
million in the year ended December 31, 1997. The increase in non-coin call
revenues was primarily attributable to approximately $6.1 million in additional
revenues resulting from an increase in the rate of dial-around call compensation
associated with the implementation of the Telecommunications Act, which became
effective in November 1996, and approximately $3.5 million in additional non-
coin call revenues resulting from the growth in the number of installed
payphones.
Telephone charges increased approximately $1.3 million, or 3.4%, increasing
from $37.6 million in the year ended December 31, 1996 to $38.9 million in the
year ended December 31, 1997. The increase in telephone charges was primarily
attributable to the growth in the number of installed payphones. Telephone
charges for the year 1997 decreased to 24.4% of total revenues compared to 26.1%
in the prior year. The decrease in telephone charges as a percentage of
revenues was due to reductions in line access charges on a per-phone per-month
basis as a result of rate reductions received from certain LECs with which the
Company has agreements for the provision of local access services.
Commissions increased approximately $1.3 million, or 3.8%, rising from
$34.5 million in the year ended December 31, 1996 to $35.8 million in the year
ended December 31, 1997. The increase in commissions was primarily attributable
to the growth in the number of installed payphones. Commissions for 1997
decreased to 22.5% of total revenues compared to 24.0% in the prior year. The
decrease in commissions as a percentage of total revenues was primarily
attributable to higher payphone revenues. A portion of the Company's Location
Agreements exclude certain types of call traffic from commission calculations,
and some others are based on flat monthly rates set by the agreements, resulting
in a disproportionate increase in payphone revenues over commissions.
Service, maintenance and network costs increased $2.6 million, or 9.4%,
increasing from $27.7 million in the year ended December 31, 1996 to $30.3
million in the year ended December 31, 1997. The increase was primarily
attributable to the growth in the number of installed payphones. Service,
maintenance and network costs in 1998 decreased to 19.0% of total revenues
compared to 19.2% in the prior year. The decrease in service, maintenance and
network costs as a percentage of total revenues was primarily attributable to
higher payphone revenues during the year and increasing operating efficiencies
achieved through increasing density in the Company's payphone routes resulting
from expansion of its installed base of payphones.
30
Depreciation and amortization expense increased approximately $2.2 million,
or 9.2%, from the prior year, rising from $23.5 million in 1996 to $25.6 million
in 1997, driven by the increase in the number of installed payphones.
Selling, general and administrative expenses increased approximately $3.7
million, or 19.2%, from the prior year, increasing from $18.9 million in the
year ended December 31, 1996 to $22.6 million in the year ended December 31,
1997. The increase was primarily attributable to additional costs associated
with the opening and operation of three new divisional sales and service offices
and the hiring of support personnel needed to service the Company's expanding
base of installed payphones.
Other income and income expense decreased approximately $0.1 million or
22.9% in 1997 over 1996, decreasing to $0.5 million in 1997 from $0.6 million in
1996. The decrease was primarily due to a reduction in interest income as a
result of lower cash balances available for investment.
Interest expense increased approximately $0.4 million, or 3.2%, rising from
$13.2 million in the year ended December 31, 1996 to approximately $13.6 million
in the year ended December 31, 1997. This increase resulted primarily from an
increase in long-term debt in the last two quarters of 1996 and during 1997 for
the acquisition of payphone companies and payphone assets.
In the year ended December 31, 1996, the Company recognized income of
approximately $1.5 million in connection with settlements of loans and
employment contracts with former officers of Peoples Telephone, Peoples
Telephone's former equity interest in the operating results of an unconsolidated
affiliate and amounts related to the resolution of outstanding litigation
involving Peoples Telephone.
Losses from continuing operations improved approximately $1.6 million, or
14.2%, from the prior year period, decreasing from a loss of $11.1 million in
the year ended December 31, 1996 to a loss of $9.5 million in the year ended
December 31, 1997.
The Company's loss from discontinued operations in 1996 represents a $1.8
million loss on the operations of the Company's inmate phone division. The
Company also recorded a gain of $0.7 million, net of income taxes of $0.4
million from the sale of its hospitality division, and a loss of $0.1 million,
net of income taxes of $0.1 million, from the sale of its remanufacturing
division.
The Company's earnings on discontinued operations in 1997 included income
of approximately $0.3 million related to a payment on a promissory note that had
been fully reserved resulting from the sale of Peoples Telephone's cellular
telephone operations in 1995. On December 19, 1997, the Company sold the
remaining operating assets of its inmate phone division to Talton Holdings, Inc.
for approximately $10.6 million in cash, plus additional contingent
consideration based on a formula which shares incremental profits from certain
existing contracts and from Talton's closing on certain pending bids. This
transaction resulted in a gain on sale of approximately $4.2 million. The gain,
combined with an operating loss of approximately $2.4 million, resulted in
earnings of approximately $1.8 million from the discontinued inmate division in
1997.
31
Net loss decreased approximately $4.8 million from a loss of approximately
$12.2 million in 1996 to a loss of approximately $7.4 million in 1997.
Liquidity and Capital Resources
Cash Flows
As of December 31, 1998, the Company had a current ratio of 1.12 to 1,
decreasing from 1.58 to 1 at December 31, 1997. From 1997 to 1998, working
capital decreased from approximately $21.3 million as of December 31, 1997 to
approximately $5.8 million as of December 31, 1998. The change in the Company's
working capital is primarily a result of the application of approximately $11.3
million of cash in January 1998 by Peoples Telephone to acquire the assets of
Indiana Telcom.
The Company's capital expenditures, exclusive of acquisitions, for the
years ended December 31, 1998 and 1997 were $11.9 million and $7.0 million,
respectively. The Company's capital expenditures primarily consisted of costs
associated with the installation of new payphones. The Company made acquisitions
of payphones totaling approximately $118.5 million and $7.1 million during the
years 1998 and 1997, respectively. In 1998, the Company financed its capital
expenditures and acquisitions primarily with an increase in long-term debt of
approximately $127.2 million. Net cash used in operating activities in the year
ended December 31, 1998 totaled approximately $6.3 million and consisted
primarily of the funding of operating losses and the increase in accounts
receivable from dial-around compensation. In 1997, the Company financed its
capital expenditures and acquisitions primarily with approximately $13.7 million
in cash provided by continuing operations and an increase of $2.1 million in
long-term debt.
Credit Agreement
In connection with the merger with Peoples Telephone on December 23, 1998,
the Company entered into a senior credit facility ("Senior Credit Facility")
with NationsBank, N.A. (the "Administrative Agent") and the other lenders named
therein. The Senior Credit Facility provides for borrowings by Davel from time
to time of up to $280.0 million for working capital and other corporate
purposes.
Indebtedness of the Company under the Senior Credit Facility is secured by
substantially all of its and its subsidiaries' assets, including but not limited
to their equipment, inventory, receivables and related contracts, investment
property, computer hardware and software, bank accounts and all other goods and
rights of every kind and description and is guaranteed by Davel and all its
subsidiaries.
The Company's borrowings under the Senior Credit Facility bear interest at
a floating rate and may be maintained as Base Rate Loans (as defined in the
Senior Credit Facility) or, at the Company's option, as Eurodollar Loans (as
defined in the Senior Credit Facility). Base Rate Loans shall bear interest at
the Base Rate (defined as the higher of (i) the applicable prime lending rate of
NationsBank, N.A. or (ii) the Federal Reserve reported certificate of deposit
rate plus 1%). Eurodollar Loans shall bear interest at the Eurodollar Rate (as
defined in the Senior Credit Facility), plus a margin based on leverage.
32
The Company is required to pay the lenders under the Senior Credit Facility
a commitment fee, payable in arrears on a quarterly basis, on the average unused
portion of the Senior Credit Facility during the term of the facility. The
Company is also required to pay an annual agency fee to the Agent. In addition,
the Company was also required to pay an arrangement fee for the account of each
bank in accordance with the banks' respective pro rata share of the Senior
Credit Facility. The Agent and the lenders will receive such other fees as have
been separately agreed upon with the Agent.
The Senior Credit Facility requires the Company to meet certain financial
tests, including, without limitation, maximum levels of Senior Secured Debt as a
ratio of EBITDA (as defined in the Senior Credit Facility), minimum interest and
fixed charge ratios and maximum amount of capital expenditures. The Senior
Credit Facility also contains certain covenants which, among other things, will
limit the incurrence of additional indebtedness, prepayments of other
indebtedness (including the Notes), liens and encumbrances and other matters
customarily restricted in such agreements.
In the first quarter of 1999, the Company gave notice to the Administrative
Agent that lower than expected performance in the first quarter of 1999 would
result in the Company's inability to meet certain financial covenants contained
in the Senior Credit Facility. On April 8, 1999, the Company and the Lenders
agreed to the First Amendment to Credit Agreement and Consent and Waiver (the
"First Amendment") which waived compliance, for the fiscal quarter ending March
31, 1999, with the financial covenants set forth in the Senior Credit Facility.
In addition, the First Amendment waived any event of default related to two
acquisitions made by the Company in the first quarter of 1999, and waived the
requirement that the Company deliver annual financial statements to the Lenders
within 90 days of December 31, 1998, provided that such financial statements
shall be delivered no later than April 15, 1999. The First Amendment contained
amendments that provided for the following:
. amendment of the applicable percentages for Eurodollar Loans for the period
between April 1, 1999 and June 30, 2000 at each pricing level to 0.25%
higher than those in the previous pricing grid
. prepayment of debt from receipt of dial-around compensation accounts
receivable related to the period November 1996 through October 1997
. further limitations on permitted acquisitions as defined in the Credit
Agreement through June 30, 2000
. during the period April 1, 1999 to June 30, 2000, required lenders' consent
for the making of loans or the issuance of letters of credit if the sum of
revolving loans outstanding plus letter of credit obligations outstanding
exceeds $50.0 million
. the introduction of a new covenant to provide certain operating data to the
Lenders on a monthly basis
. increases in the maximum allowable ratio of funded debt to EBITDA through
the quarter ended June 30, 2000
. decreases in the minimum allowable interest coverage ratio through the
quarter ended June 30, 2000
. decreases in the minimum allowable fixed charge coverage ratio through the
quarter ended June 30, 2000
33
The Company believes that it is probable that it will comply with the loan
covenants for the next twelve months and, as such, has not classified the
obligations under the Senior Credit Facility as current liabilities.
The First Amendment also places limits on capital expenditures and required
the payment of an amendment fee equal to the product of each Lender's commitment
multiplied by 0.35%.
The Senior Credit Facility contains customary events of default, including
without limitation, payment defaults, breaches of representations and
warranties, covenant defaults, cross-defaults to certain other indebtedness,
certain events of bankruptcy and insolvency, judgment defaults, failure of any
guaranty or security document supporting the Senior Credit Facility to be in
full force and effect, and a change of control of the Company.
The Company believes that cash generated from operations and available
borrowings under the Senior Credit Facility will be sufficient to fund the
Company's forseeable cash requirements, including capital expenditures through
December 23, 2003. The Company also believes that it will be able to fund any
future acquisitions through a combination of cash generated from operations,
additional borrowing and the issuance of shares of the Company's Common Stock.
There can be no assurance, however, that the Company will continue to expand at
its current rate or that additional financing will be available when needed or,
if available, will be available on terms acceptable to the Company.
Impact of Inflation
Inflation is not a material factor affecting the Company's business.
General operating expenses such as salaries, employee benefits and occupancy
costs are, however, subject to normal inflationary pressures.
Seasonality
The Company's revenues from its payphone operating regions are affected by
seasonal variations, geographic distribution of payphones and type of location.
Because many of the Company's payphones are located outdoors, weather patterns
have differing effects on the Company's results depending on the region of the
country where the payphones are located. Most of the Company's payphones in
Florida produce substantially higher call volume in the first and second
quarters than at other times during the year, while the Company's payphones
throughout the midwestern and eastern United States produce their highest call
volumes during the second and third quarters. While the aggregate effect of the
variations in different geographical regions tend to counteract the effect of
one another, the Company has historically experienced higher revenue and income
in the second and third quarters than in the first and fourth quarters. Changes
in the geographical distribution of its payphones may in the future result in
different seasonal variations in the Company's results.
Year 2000 Issue
The Company is working to resolve the potential impact of the year 2000 on
the ability of the Company's computerized information systems to accurately
process information that may be date-sensitive. Any of the Company's programs
that recognize a date using "00" as the year 1900 rather than the year 2000
could result in errors or system failures. The
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Company utilizes a number of computer programs across its entire operation. The
Company has assessed the impact of the year 2000 on both its computer programs
and its computer systems. As the Company acquires other payphone assets, it will
continue to assess the impact of the year 2000 on such acquired assets. To date,
the Co