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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 000-25207
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DAVEL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-3538257
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 PUBLIC SQUARE, SUITE 700, CLEVELAND, OH 44114
(address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(216) 241-2555
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No __
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. __
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes __ No x
As of June 30, 2003 the aggregate market value of the voting and
nonvoting common equity held by non-affiliates of the registrant was
approximately $1,308,310 based upon the closing price on June 30, 2003 of $0.01.
As of March 19, 2004, there were 615,018,963 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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DAVEL COMMUNICATIONS, INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1 Business........................................................................................ 1
Item 2 Properties...................................................................................... 14
Item 3 Legal Proceedings............................................................................... 15
Item 4 Submission of Matters to a Vote of Security Holders............................................. 16
PART II
Item 5 Market for the Registrant's Common Stock and Related Stockholder Matters........................ 16
Item 6 Selected Consolidated Financial Data............................................................ 17
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations........... 17
Item 7A Quantitative and Qualitative Disclosures About Market Risk...................................... 28
Item 8 Financial Statements............................................................................ 29
Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure............ 59
Item 9A Disclosure Controls and Procedures.............................................................. 59
PART III
Item 10 Directors and Executive Officers of the Registrant.............................................. 59
Item 11 Executive Compensation.......................................................................... 61
Item 12 Security Ownership of Certain Beneficial Owners and Management.................................. 65
Item 13 Certain Relationships and Related Transactions.................................................. 66
Item 14 Principal Accountant Fees and Services.......................................................... 67
PART IV
Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K................................. 68
PART I
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934:
Certain of the statements contained in the body of this Report are
forward-looking statements (rather than historical facts) that are subject to
risks and uncertainties that could cause actual results to differ materially
from those described in the forward-looking statements. In the preparation of
this Report, where such forward-looking statements appear, the Company has
sought to accompany such statements with meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those described in the forward-looking statements. A description
of the principal risks and uncertainties inherent in the Company's business is
included herein under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Readers of this Report are
encouraged to read these cautionary statements carefully.
ITEM 1. BUSINESS
GENERAL OVERVIEW
Davel Communications, Inc. ("Davel" or the "Company") was incorporated
on June 9, 1998 under the laws of the State of Delaware. The Company is the
largest independent payphone service provider in the United States. The Company
operates in a single business segment within the telecommunications industry,
operating, servicing, and maintaining a system of payphones throughout the
United States. The Company's headquarters is located in Cleveland, Ohio (having
been relocated from Tampa, Florida after completion of the merger of its wholly
owned subsidiary with PhoneTel Technologies, Inc. ("PhoneTel" and the "PhoneTel
Merger" -- see Note 5 to the consolidated financial statements for acquisition
activities and for exit and disposal activities), with field service offices in
17 geographically dispersed locations.
As of December 31, 2003, the Company owned and operated a network of
approximately 47,000 payphones in 46 states and the District of Columbia,
providing it with one of the broadest geographic ranges of coverage of any
payphone service provider ("PSP") in the country. The Company's installed
payphone base generates revenue through both coin calls (local and
long-distance), non-coin calls (calling card, credit card, collect, and
third-party billed calls using the Company's preselected operator services
providers such as Opticom) and dial-around calls (utilizing a 1-800, 1010XXX or
similar "toll free" dialing method to select a carrier other than the Company's
pre-selected carrier). A significant portion of the Company's payphones are
located in high-traffic areas such as convenience stores, shopping centers,
truck stops, service stations, and grocery stores.
As part of the Telecommunications Act of 1996 ("1996 Telecom Act"),
Congress directed the Federal Communications Commission ("FCC") to ensure
widespread access to payphones for use by the general public. The most recent
estimates of payphone deployment released by the FCC suggest that there are
approximately 1.5 million payphones currently operating in the United States, of
which approximately 0.8 million are operated by the Regional Bell Operating
Companies ("RBOCs") and approximately 0.1 million are operated by the smaller
independent local exchange carriers ("LECs"). The remaining approximately 0.6
million payphones are owned or managed by the major long distance carriers such
as Sprint and AT&T and more than 1,000 independent payphone providers ("IPPs")
currently operating in the United States.
Effective as of February 19, 2002, certain lenders entered into a
credit agreement (the "Senior Credit Facility") with Davel Financing Company,
L.L.C., PhoneTel and Cherokee Communications, Inc., a wholly owned subsidiary of
PhoneTel. On that date, the existing junior lenders of the Company and PhoneTel
also agreed to a substantial debt-for-equity exchange with respect to their
outstanding indebtedness (see Note 4 to the consolidated financial statements --
Debt Restructuring). The Senior Credit Facility provided for a combined $10
million line of credit which the Company and PhoneTel shared $5 million each.
The Company and PhoneTel each borrowed the amounts available under their
respective lines of credit on February 20, 2002, which amounts were used to pay
merger related expenses and accounts payable.
On July 24, 2002, a wholly owned subsidiary of Davel merged with and
into PhoneTel pursuant to the Agreement and Plan of Reorganization and Merger,
dated February 19, 2002, between the Company and PhoneTel
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and its subsidiary. PhoneTel was a payphone service provider, based in
Cleveland, Ohio, that operated an installed base of approximately 28,000
payphones in 45 states and the District of Columbia. Management believes the
PhoneTel Merger has reduced operating costs by leveraging the combined
infrastructure of the companies.
In connection with the PhoneTel Merger, 100% of the voting shares in
PhoneTel were acquired and each share of common stock of PhoneTel was converted
into 1.8233 shares of common stock of the Company, or an aggregate of
223,236,793 shares with a fair value of approximately $8.0 million. The fair
value of the Davel common stock was derived using an average market price per
share of Davel common stock of $0.036, which was based on an average of the
closing prices for a range of trading days (July 19, 2002 through July 29, 2002)
around the closing date of the acquisition. In addition 1,077,024 warrants and
339,000 options of PhoneTel were converted into 1,963,738 warrants and 618,107
stock options of the Company, respectively, with an aggregate value of $6,000.
The warrants subsequently expired by their terms in November 2002. Direct costs
and expenses of the merger amounted to $1.1 million and were included in the
purchase price. -- See Note 5 to the consolidated financial statements for
acquisition activities.
In connection with the merger, the Company and PhoneTel effectuated the
debt exchanges, and amended, restated, and consolidated their respective junior
credit facilities into a combined restructured junior credit facility with a
face value of $101.0 million due December 31, 2005 (the "Debt Restructuring" and
the "Junior Credit Facility"). See Note 4 to the consolidated financial
statements -- Debt Restructuring and Note 10 -- Long-term Debt and Obligations
under Capital Leases.
The Company had net loss of $46.2 million, net income of $151.8
million, and net loss of $43.4 million, for the years ended December 31, 2003,
2002, and 2001, respectively. The net income in 2002 was the result of a $181.0
million gain on debt restructuring associated with the PhoneTel Merger on July
24, 2002, partially offset by operating losses of $29.2 million which, along
with the losses in 2003 and 2001, were primarily attributable to increased
competition from providers of wireless communication services and the impact on
the Company's revenue of certain changes in customer calling patterns in favor
of 1-800 type calls. In addition, the Company was not in compliance with certain
financial covenants under its Junior Credit Facility and did not make certain
debt payments totaling $5.1 million that were due in July through November 2003.
On November 11, 2003 the Company executed an agreement with its Junior
Lenders (the "Forbearance Agreement") that granted forbearance with respect to
certain financial covenant defaults and cash payments due under the terms of the
Junior Credit Facility through January 30, 2004. Thereafter, on February 24,
2004, the Company executed an amendment to the Junior Credit Facility (the
"Second Amendment") that waives all defaults existing through the date of the
Second Amendment, reduces the minimum amount of earnings (as defined in the
agreement) that the Company is required to maintain, and reduces the minimum
payments due under the Junior Credit Agreement to $130,000 per month through
December 31 2005, including the monthly agent fee, plus 100% of any regulatory
receipts, as defined in the agreement, received by the Company. Further, the
Company has also engaged in discussions with its Junior Lenders regarding the
possibility of restructuring its outstanding debt. Any such restructuring could
potentially include a debt-for-equity exchange that may substantially dilute the
interests of the Company's existing shareholders. There can be no assurance that
the Company will be successful in negotiating a reduction in the outstanding
balance of its Junior Credit Facility. See Note 10 to the consolidated financial
statements - Long-term Debt and Obligations under Capital Leases.
In July 2003, a special committee of independent members of the
Company's Board of Directors (the "Special Committee") was formed to identify
and evaluate the strategic and financial alternatives available to the Company
to maximize value for the Company's stakeholders. Thereafter, the Board of
Directors appointed a new chief executive officer who has been actively engaged
with management in the execution of a plan to improve the operating results of
the Company. Significant elements of the plan executed or planned for 2003 and
2004 include (i) continuing cost savings and efficiencies resulting from the
merger with PhoneTel discussed in Note 5, (ii) the continued removal of
unprofitable payphones, (iii) reductions in telephone charges by changing to
competitive local exchange carriers ("CLECs") or alternative carriers, (iv) the
evaluation, sale or closure of unprofitable district operations, (v) outsourcing
payphone collection, service and maintenance activities to reduce such costs,
and (vi) the further curtailments of operating expenses. The Company is also
working toward the implementation of new business initiatives and other
strategic opportunities available to the Company.
Notwithstanding these activities and plans, the Company may
continue to face liquidity shortfalls and, as a result, might be required to
dispose of assets to fund its operations or curtail its capital and other
expenditures to meet its debt service and other obligations. There can be no
assurances as to the Company's ability to execute such
2
dispositions, or the timing thereof, or the amount of proceeds that the Company
could realize from such sales. As a result, doubt exists about the Company's
ability to continue as a going concern.
INDUSTRY OVERVIEW
Today's telecommunications marketplace was principally shaped by the
1984 court-approved divestiture by AT&T of its local telephone operations (the
"AT&T Divestiture") and the many regulatory changes adopted by the FCC and state
regulatory authorities in response to and subsequent to the AT&T Divestiture,
including the authorization of the connection of competitive or independently
owned payphones to the public switched network. The "public switched network" is
the traditional domestic landline public telecommunications network used to
carry, switch and connect telephone calls. The connection of independently owned
payphones to the public switched network has resulted in the creation of
additional business segments in the telecommunications industry. Prior to these
developments, only the consolidated Bell system or independent LECs were
permitted to own and operate payphones. Following the AT&T Divestiture and
subsequent FCC and state regulatory rulings, the independent payphone sector
developed as a competitive alternative to the consolidated Bell system and other
LECs by providing more responsive customer service, lower cost of operations and
higher commissions to the owners or operators of the premises at which a
payphone is located ("Location Owners").
Prior to the AT&T Divestiture, the LECs could refuse to provide
payphone service to a business operator or, if service was installed, would
typically pay no or relatively small commissions for the right to place a
payphone on the business premises. Following the AT&T Divestiture and the FCC's
authorization of payphone competition, IPPs began to offer Location Owners
higher commissions on coin calls made from the payphones in order to obtain the
contractual right to install the equipment on the Location Owners' premises.
Initially, coin revenue was the only source of revenue for the payphone
operators because they were unable to participate in revenues from non-coin
calls. However, the operator service provider ("OSP") industry emerged and
enabled the competitive payphone operators to compete more effectively with the
regulated telephone companies by paying commissions to payphone owners for
non-coin calls. For the first time, IPPs were able to receive non-coin call
revenue from their payphones. With this incremental source of revenue from
non-coin calls, IPPs were able to compete more vigorously on a financial basis
with RBOCs and other LECs for site location agreements, as a complement to the
improved customer service and more efficient operations provided by the IPPs. As
part of the AT&T Divestiture, the United States was divided into Local Access
Transport Areas ("LATAs"). RBOCs were authorized to provide telephone service
that both originates and terminates within the same LATA ("intraLATA") pursuant
to tariffs filed with and approved by state regulatory authorities. RBOCs
typically provide payphone service primarily in their own respective
territories, and are now authorized to share in the payphone revenues generated
from telecommunications services between LATAs ("interLATA"). Long-distance
companies, such as Sprint, AT&T and WorldCom, provide interLATA services, and in
some circumstances, also provide local or long-distance service within LATAs. An
interLATA long-distance telephone call generally begins with an originating LEC
transmitting the call from the originating payphone to a point of connection
with a long-distance carrier. The long-distance carrier, through its owned or
leased switching and transmission facilities, transmits the call across its
long-distance network to the LEC servicing the local area in which the recipient
of the call is located. The terminating LEC then delivers the call to the
recipient.
BUSINESS STRATEGY
Rationalization Of Low-Revenue Phones. In recent years, the Company has
experienced revenue declines as a result of increased competition from cellular
and other telecommunications products. As a result of declining revenues, the
Company's strategy is to remove low revenue payphones that do not meet the
Company's minimum criteria of profitability and to promote improved density of
the Company's payphone routes. During the most recent two years ending December
31, 2003 and 2002, the Company removed approximately 24,800 and 14,900 payphones
respectively. Although a portion of these removals resulted from competitive
conditions or decisions not to renew contracts with Location Owners under
unfavorable terms, a large portion of these removals were to eliminate
unprofitable payphones. The Company has an ongoing program to identify
additional payphones to be removed in 2004 based upon low revenue performance
and route density considerations.
Outsourcing Service, Maintenance and Collection Activities.
Notwithstanding improvements in payphone route densities and other efficiencies
achieved following the PhoneTel Merger, the Company continues to examine its
cost structure to identify additional ways to improve the profitability of the
business. During 2003, the Company
3
outsourced the assembly and repair of its payphone equipment and closed its
warehouse and repair facility in Tampa, Florida to reduce the cost to repair,
maintain and store its replacement payphone equipment. The Company incurred a
loss from exit and disposal activities relating to this facility of
approximately $0.3 million. In the fourth quarter of 2003, the Company
outsourced the collection, service and maintenance of its payphones in the
western region of the United States to reduce the cost of servicing its
geographically disbursed payphones in this area. The Company closed eleven
district offices and incurred a loss from exit and disposal activities of
approximately $0.5 million relating to these facilities. Subsequent to December
31, 2003, the Company outsourced the servicing of additional payphones and
closed three additional district offices in Texas to further reduce its
operating costs. Although there were costs associated with the outsourcing of
these activities, the Company believes future savings will more than offset
these costs and have a favorable impact on the operating results of the Company.
The Company plans to continue to identify additional outsourcing opportunities
and to implement those strategies that can further reduce its operating costs.
Utilize Advanced Payphone Technology. The Company's payphones utilize
"smart" technology which provides voice synthesized calling instructions,
detects and counts coins deposited during each call, informs the caller at
certain intervals of the time remaining on each call, identifies the need for
and the amount of an additional deposit in order to continue the call, and
provides other functions associated with the completion of calls. Through the
use of a non-volatile, electronically erasable, programmable memory chip, the
payphones can also be programmed and reprogrammed from the Company's central
computer facilities to update rate information or to direct different types of
calls to particular carriers. The Company's payphones can also distinguish coins
by size and weight, report to its central host computer the total amount of coin
in the coin box, perform self-diagnosis and automatically report problems to a
pre-programmed service number.
Apply Sophisticated Monitoring and Management Information Systems. The
Company utilizes a blend of enterprise-class proprietary and non-proprietary
software that continuously tracks coin and non-coin revenues from each payphone,
as well as expenses relating to each payphone, including commissions payable to
the Location Owners. The Company's technology also allows it to efficiently
track and facilitate the activities of its field technicians via interactions
from the pay telephone with the Company's computer systems and technical support
personnel at the Company's headquarters.
Provide Outstanding Customer Service. The technology used by the
Company enables it to (i) respond quickly to equipment malfunctions and (ii)
maintain accurate records of payphone activity which can be verified by
customers. The Company strives to minimize "downtime" on its payphones by
identifying service problems as quickly as possible. The Company employs both
advanced telecommunications technology and trained field technicians as part of
its commitment to provide superior customer service. The records generated
through the Company's technology also allow for the more timely and accurate
payment of commissions to Location Owners.
Consolidation of Carrier Services. As part of its strategy to reduce
costs and improve service quality, the Company has consolidated its coin and
non-coin services with a limited number of major carriers. This enables the
Company to maximize the value of its traffic volumes and has translated into
more favorable economic and service terms and conditions in these key aspects of
its business.
Pursue Regulatory Improvements. The Company continues to actively
pursue regulatory changes that will enhance its near and long-term performance
and viability. Notably, the Company is pressing, through regulatory channels,
the reduction in line and related charges and improvements to the dial around
compensation collection system that are critical to the economic viability of
the payphone industry generally and the Company's operations specifically.
4
OPERATIONS
As of December 31, 2003 and December 31, 2002, the Company owned and
operated approximately 47,000 and 69,000 payphones, respectively.
Coin Calls
The Company's payphones generate coin revenues primarily from local
calls. Historically, the maximum rate that LECs and IPPs could charge for local
calls was generally set by state regulatory authorities and in most cases was
$0.25 through October 6, 1997. In ensuring "fair compensation" for all calls,
the FCC determined that local coin rates from payphones should be generally
deregulated by October 7, 1997, but provided for possible modifications or
exemptions from deregulation upon a detailed demonstration by an individual
state that there are market failures within the state that would not allow
market-based rates to develop. On July 1, 1997, a federal court issued an order
which upheld the FCC's authority to deregulate local coin call rates. In
accordance with the FCC's ruling and the court order, certain LECs and IPPs,
including the Company, began to increase rates for local coin calls from $0.25
to $0.35 after October 7, 1997 and, beginning in November 2001, to $0.50. See
"Regulation -- Effect of Federal Regulation of Local and Dial-Around Calls."
Long distance coin calls are typically carried by long distance
carriers that have contracted to provide transmission services to the Company's
payphones. The Company pays a charge to the long-distance carrier each time the
carrier transports a long-distance call for which the Company receives coin
revenue from an end user.
Non-Coin Calls
The Company also receives revenues from non-coin calls made from its
payphones. Traditional non-coin calls include credit card, calling card, prepaid
calling card, collect and third-party billed calls where the caller dials "0"
plus the number or simply dials "0" for an operator.
The services needed to complete a non-coin call include providing an
automated or live operator to answer the call, verifying billing information,
validating calling cards and credit cards, routing and transmitting the call to
its destination, monitoring the call's duration and determining the charge for
the call, and billing and collecting the applicable charge. The Company has
contracted with operator service providers to handle these calls and perform all
associated functions, while paying the Company a commission on the revenues
generated thereby.
The Company realizes additional non-coin revenue from various carriers
pursuant to the 1996 Telecom Act and FCC regulations thereunder as compensation
for "dial-around" non-coin calls made from its payphones. A dial-around call is
made by dialing an access code for the purpose of reaching a long distance
carrier company other than the one designated by the payphone operator or using
a traditional "toll free" number, generally by dialing a 1-800/888/877/866
number, a 950-XXXX number or a seven-digit "1010XXXX" code.
Payphone Base
The Company selects locations for its payphones where there is
typically high demand for payphone service, such as convenience stores, truck
stops, service stations, grocery stores and shopping centers. For many
locations, historical information regarding an installed payphone is available
because payphone operators are often obligated pursuant to agreements to provide
this information to Location Owners for their payphones. In locations where
historical revenue information is not available, the Company relies on its site
survey to examine geographic factors, population density, traffic patterns and
other factors in determining whether to install a payphone. The Company's
marketing staff attempts to obtain agreements to install the Company's payphones
("Location Agreements") at locations with favorable historical data regarding
payphone revenues. The Company recognizes, however, that recent changes in
payphone traffic volumes and usage patterns being experienced on an
industry-wide basis warrant a continued assessment of the locational deployment
of its payphones.
The following table sets forth, for the last three fiscal years, the
number of Company payphones acquired, installed and removed during the year as
well as the net decrease in Company payphones in operation.
5
2003 2002 2001
-------- -------- --------
Acquired................................................... -- 28,000 --
Installed.................................................. 2,830 880 1,507
Removed.................................................... (24,830) (14,880) (13,507)
------- ------- -------
Net Increase/(Decrease).................................... (22,000) 14,000 (12,000)
======= ======= =======
Total payphones in service (approximately)................. 47,000 69,000 55,000
======= ======= =======
The Company had approximately 47,000 payphones in operation in
forty-six states and the District of Columbia as of December 31, 2003, compared
with approximately 69,000 in operation as of December 31, 2002. The five states
possessing the greatest numbers of installed telephones as of December 31, 2003
were: Florida (6,460), Texas (4,047), New York (3,371), Virginia (2,936), and
Georgia (2,812).
In 2003, the Company continued its aggressive monitoring of the
payphone base, which began in 1999, and removed under-performing payphones,
which are available for relocation at sites with greater potential for
profitability.
Location Agreements generally provide for revenue sharing with the
applicable Location Owner. The Company's Location Agreements generally provide
commissions based on fixed percentages of revenues and have three-to-five year
terms. The Company can generally terminate a Location Agreement on 30 days'
notice to the Location Owner if the payphone does not generate sufficient
revenue.
Service and Maintenance
The Company employs a system of field service technicians and
independent contractors, each of whom collects coin boxes and cleans and
maintains a route of payphones. The technicians and contractors also respond to
trouble calls made by Location Owners, by users of payphones or by the telephone
itself as part of its internal diagnostic procedures. Some technicians are also
responsible for the installation of new payphones. Due to the Company's polling
and electronic tracking and trouble reporting systems and the ability of the
field service technicians to perform on-site service and maintenance functions,
the Company is able to limit the frequency of trips to the payphones as well as
the number of employees needed to service the payphones.
Customers, Sales and Marketing
The Location Owners with whom the Company contracts are a diverse group
of small, medium and large businesses which are frequented by individuals
needing payphone access. The majority of the Company's payphones are located at
convenience stores, truck stops, service stations, grocery stores and shopping
centers. As of December 31, 2003, corporate payphone accounts of 50 or more
payphones represented more than 30 percent of the Company's installed payphone
base.
Service and Equipment Suppliers
The Company's primary suppliers provide payphone components, local line
access, and long-distance transmission and operator services. In order to
promote acceptance by end users accustomed to using LEC-owned payphone
equipment, the Company utilizes payphones designed to be similar in appearance
and operation to payphones owned by LECs.
The Company purchases some parts and equipment from various
manufacturers and otherwise utilizes parts from payphones removed from field
service for repair and installation of payphones. The Company has historically
obtained local line access from various LECs, including Verizon, SBC
Communications, Qwest and various other incumbent and competitive suppliers of
local line access. New sources of local line access have emerged as competition
continues to develop in local service markets. The Company currently utilizes a
number of CLECs to provide local line access at rates that are lower than the
rates that could be obtained from incumbent LECs. As part of the Company's
strategy to further reduce line costs, during the fourth quarter of 2003, the
Company entered into an agreement with a CLEC that will provide line access for
a minimum of 10,500 of its payphones. The Company is also searching for
additional opportunities to further reduce line costs and is evaluating the
rates of other competitive
6
local access carriers. The Company believes it will be able to substantially
reduce its telephone charges through these efforts. Long-distance services are
provided to the Company by various long-distance and operator service providers,
including Opticom, AT&T, and others.
The Company expects the basic availability of such products and
services to continue in the future; however, the continuing availability of
alternative sources at existing or lower rates cannot be assured. Although the
Company is not aware of any current circumstances that would require the Company
to seek alternative suppliers for any material portion of the products or
services used in the operation of its business, transition from the Company's
existing suppliers, if necessary, could have a disruptive effect on the
Company's operations and could give rise to unforeseen delays, additional
expenses or loss of revenue.
Assembly and Repair Of Payphones
Historically, the Company assembled and repaired payphone equipment for
its own use. The assembly of payphone equipment provided the Company with
technical expertise used in the operation, service, maintenance and repair of
its payphones. The Company assembled, refurbished or replaced payphones from
standard payphone components either obtained from the Company's sizable
inventory or purchased from component manufacturers. These components include a
metal case, an integrated circuit board incorporating a microprocessor, a
handset and cord, and a coin box and lock. On the occasion when components are
not available from inventory, the components can be purchased by the Company
from several suppliers. The Company does not believe that the loss of any single
supplier would have a material adverse effect on its assembly operations.
In March 2003 the Company closed its refurbishing facility located in
Tampa, Florida and has outsourced the assembly and repair of payphone equipment
to a third party provider. The Company believes that given its sizable inventory
of refurbished payphone equipment and other component parts, it can more
effectively deploy the cash resources to other portions of the Company's
business, which had previously been utilized in connection with the Tampa
refurbishing facility. See Note 5 to the consolidated financial statements for
exit and disposal activities.
The Company's payphones comply with all material regulatory
requirements regarding the performance and quality of payphone equipment and
have all of the operating characteristics required by the applicable regulatory
authorities, including free access to local emergency ("911") telephone numbers,
dial-around access to all available carriers, and automatic coin return
capability for incomplete calls.
Technology
The payphone equipment installed by the Company makes use of
microprocessors to provide voice synthesized calling instructions, detect and
count coin deposits during each call, inform the caller at certain intervals of
the time remaining on each call, identify the need for and the amount of an
additional deposit and other functions associated with completion of calls.
Through the use of non-volatile, electronically erasable, programmable read-only
memory chips, the payphones can also be programmed and reprogrammed from the
Company's central computer facilities to update rate information or to direct
different kinds of calls to particular carriers.
The Company's payphones can distinguish coins by size and weight,
report to a remote location the total coin in the coin box, perform
self-diagnosis and automatically report problems to a pre-programmed service
number, and immediately report attempts at vandalism or theft. Many of the
payphones operate on power available from the telephone lines, thereby avoiding
the need for and reliance upon an additional power source at the installation
location.
The Company utilizes proprietary and non-proprietary software that
tracks the coin and non-coin revenues from each payphone as well as expenses
relating to that payphone, including commissions payable to the Location Owners.
The Company provides all technical support required to operate the
payphones, such as computers and software and hardware specialists, at its
headquarters in Cleveland, Ohio. The Company's assembly and repair support
operations located in Tampa, Florida previously provided materials, equipment,
spare parts and accessories to the field. In 2003, this function was outsourced
to one of the Company's suppliers and the Tampa facility was closed.
7
(See Note 5 to the consolidated financial statements for exit and disposal
activities.) Each of the Company's division offices and/or each of the
technician's vans maintain inventories for immediate deployment in the field.
REGULATION
The FCC and state regulatory authorities have traditionally regulated
payphone and long-distance services, with regulatory jurisdiction being
determined by the interstate or intrastate character of the service and the
degree of regulatory oversight varying among jurisdictions. On September 20 and
November 8, 1996, the FCC adopted initial rules and policies to implement
Section 276 of the 1996 Telecom Act. The 1996 Telecom Act substantially
restructured the telecommunications industry, included specific provisions
related to the payphone industry and required the FCC to develop rules necessary
to implement and administer the provisions of the 1996 Telecom Act on both an
interstate and intrastate basis. Among other provisions, the 1996 Telecom Act
granted the FCC the power to preempt state payphone regulations to the extent
that any state requirements are inconsistent with the FCC's implementation of
Section 276.
Federal Regulation Of Local Coin and Dial-Around Calls
The Telephone Operator Consumer Services Improvement Act of 1990
("TOCSIA") established various requirements for companies that provide operator
services and for call aggregators, including PSPs, who send calls to those OSPs.
The requirements of TOCSIA as implemented by the FCC included call branding,
information posting, rate quotations, the filing of informational tariffs and
the right of payphone users to access any OSP to make non-coin calls. TOCSIA
also required the FCC to take action to limit the exposure of payphone companies
to undue risk of fraud upon providing this "open access" to carriers.
TOCSIA further directed the FCC to consider the need to provide
compensation for IPPs for dial-around calls. Accordingly, the FCC ruled in May
1992 that IPPs were entitled to dial-around compensation. Because of the
complexity of establishing an accounting system for determining per call
compensation for these calls, and for other reasons, the FCC temporarily set
this compensation at $6.00 per payphone per month based on an assumed average of
15 interstate carrier access code dial-around calls per month and a rate of
$0.40 per call. The failure by the FCC to provide compensation for 800 "toll
free" dial-around calls was challenged by the IPPs, and a federal court
subsequently ruled that the FCC should have provided compensation for these toll
free calls.
In 1996, recognizing that IPPs had been at a severe competitive
disadvantage under the existing system of regulation and had experienced
substantial increases in dial-around calls without a corresponding adjustment in
compensation, Congress enacted Section 276 to promote both competition among
payphone service providers and the widespread deployment of payphones throughout
the nation. Section 276 directed the FCC to implement rules by November 1996
that would:
- create a standard regulatory scheme for all public payphone
service providers;
- establish a per call compensation plan to ensure that all
payphone service providers are fairly compensated for each and
every completed intrastate and interstate call, except for 911
emergency and telecommunications relay service calls;
- terminate subsidies for LEC payphones from LEC regulated
rate-base operations;
- prescribe, at a minimum, nonstructural safeguards to eliminate
discrimination between LECs and IPPs and remove the LEC
payphones from the LEC's regulated asset base;
- provide for the RBOCs to have the same rights that IPPs have
to negotiate with Location Owners over the selection of
interLATA carrier services, subject to the FCC's determination
that the selection right is in the public interest and subject
to existing contracts between the Location Owners and
interLATA carriers;
- provide for the right of all PSPs to choose the local,
intraLATA and interLATA carriers subject to the requirements
of, and contractual rights negotiated with, Location Owners
and other valid state regulatory requirements;
8
- evaluate the requirement for payphones which would not
normally be installed under competitive conditions but which
might be desirable as a matter of public policy, and establish
how to provide for and maintain such payphones if it is
determined they are required; and
- preempt any state requirements which are inconsistent with the
FCC's regulations implementing Section 276.
In September and November 1996, the FCC issued its rulings implementing
Section 276 (the "1996 Payphone Order"). In the 1996 Payphone Order, the FCC
determined that the best way to ensure fair compensation to independent and LEC
PSPs for each and every call was to deregulate, to the maximum extent possible,
the price of all calls originating from payphones. For local coin calls, the FCC
mandated that deregulation of the local coin rate would not occur until October
1997 in order to provide a period of orderly transition from the previous system
of state regulation.
To achieve fair compensation for dial-around calls through deregulation
and competition, the FCC in the 1996 Payphone Order directed a two-phase
transition from a regulated market. In the first phase, November 1996 to October
1997, the FCC prescribed flat-rate compensation payable to the PSPs by the
interexchange carriers ("IXCs") in the amount of $45.85 per month per payphone.
This rate was arrived at by determining that the deregulated local coin rate was
a valid market-based surrogate for dial-around calls. The FCC applied a
market-based, deregulated coin rate of $0.35 per call to a finding from the
record that there was a monthly average of 131 compensable dial-around calls per
payphone. This total included both carrier access code calls dialed for the
purpose of reaching a long distance company other than the one designated by the
PSP as well as 800 "toll free" calls. The monthly, per phone flat-rate
compensation of $45.85 was to be assessed only against IXCs with annual
toll-call revenues in excess of $100 million and allocated among such IXCs in
proportion to their gross long-distance revenues. During the second phase of the
transition to deregulation and market-based compensation (initially from October
1997 to October 1998, but subsequently extended in a later order by one year to
October 1999), the FCC directed the IXCs to pay the PSPs on a per-call basis for
dial-around calls at the assumed deregulated coin rate of $0.35 per call. At the
conclusion of the second phase, the FCC set the market-based local coin rate,
determined on a payphone-by-payphone basis, as the default per-call compensation
rate in the absence of a negotiated agreement between the PSP and the IXC. To
facilitate per-call compensation, the FCC required the PSPs to transmit
payphone-specific coding digits which would identify each call as originating
from a payphone and required the LECs to make such coding available to the PSPs
as a tariffed item included in the local access line service.
In July 1997, a federal court (the "Court") responded to an appeal of
the 1996 Payphone Order, finding that the FCC erred in (1) setting the default
per-call rate at $0.35 without considering the differences in underlying costs
between dial-around calls and local coin calls, (2) assessing the flat-rate
compensation against only the carriers with annual toll-call revenues in excess
of $100 million, and (3) allocating the assessment of the flat-rate compensation
based on gross revenues rather than on a factor more directly related to the
number of dial-around calls processed by the carrier. The Court also assigned
error to other aspects of the 1996 Payphone Order concerning inmate payphones
and the accounting treatment of payphones transferred by an RBOC to a separate
affiliate.
In response to the Court's remand, the FCC issued its modified ruling
implementing Section 276 (the "1997 Payphone Order") in October of 1997. The FCC
determined that distinct and severable costs of $0.066 were attributable to coin
calls that did not apply to the costs incurred by the PSPs in providing access
for dial-around calls. Accordingly, the FCC adjusted the per call rate during
the second phase of interim compensation to $0.284 (which is $0.35 less $0.066).
While the FCC tentatively concluded that the $0.284 default rate should be
utilized in determining compensation during the first phase and reiterated that
PSPs were entitled to compensation for each and every call during the first
phase, it deferred a decision on the precise method of allocating the initial
interim period (November 1996 through October 1997) flat-rate payment obligation
among the IXCs and the number of calls to be used in determining the total
amount of the payment obligation.
On March 9, 1998, the FCC issued a Memorandum Opinion and Order, FCC
98-481, which extended and waived certain requirements concerning the provision
by the LECs of payphone-specific coding digits which identify a call as
originating from a payphone. Without the transmission of payphone-specific
coding digits, some of the IXCs have claimed they are unable to identify a call
as a payphone call eligible for dial-around compensation. With the stated
purpose of ensuring the continued payment of dial-around compensation, the FCC's
Memorandum
9
and Order issued on April 3, 1998 left in place the requirement for payment of
per-call compensation for payphones on lines that do not transmit the requisite
payphone-specific coding digits but gave the IXCs a choice for computing the
amount of compensation for payphones on LEC lines not transmitting the
payphone-specific coding digits of either accurately computing per-call
compensation from their databases or paying per-phone, flat-rate compensation
computed by multiplying the $0.284 per call rate by the nationwide average
number of 800 subscriber and access code calls placed from RBOC payphones for
corresponding payment periods. Accurate payments made at the flat rate are not
subject to subsequent adjustment for actual call counts from the applicable
payphone.
On May 15, 1998, the Court again remanded the per-call compensation
rate to the FCC for further explanation without vacating the $0.284 per call
rate. The Court opined that the FCC had failed to explain adequately its
derivation of the $0.284 default rate. The Court stated that any resulting
overpayment may be subject to refund and directed the FCC to conclude its
proceedings within a six-month period from the effective date of the Court's
decision.
In response to the Court's second remand, the FCC conducted further
proceedings and sought additional comment from interested parties to address the
relevant issues posed by the Court. On February 4, 1999, the FCC released the
Third Report and Order and Order on Reconsideration of the Second Report and
Order (the "1999 Payphone Order"), in which the FCC abandoned its efforts to
derive a "market-based" default dial-around compensation rate and instead
adopted a "cost-based" rate of $0.24 per dial-around call, which will be
adjusted to $0.238 effective April 21, 2002. Both PSPs and IXCs petitioned the
Court for review of the 1999 Payphone Order's determination of the dial-around
compensation rate. On June 16, 2000, the Court affirmed the 1999 Payphone Order
setting a 24-cent dial-around compensation rate. On all the issues, including
those raised by the IXCs and the payphone providers, the Court applied the
"arbitrary and capricious" standard of review and found that the FCC's rulings
were lawful and sustainable under that standard. The new 24-cent rate became
effective April 21, 1999. The 24-cent rate will also be applied retroactively to
the period beginning on October 7, 1997 and ending on April 20, 1999 (the
"intermediate period"), less a $0.002 amount to account for FLEX ANI payphone
tracking costs, for a net compensation of $0.238.
In a decision released January 31, 2002 (the "2002 Payphone Order") the
FCC partially addressed the remaining issues concerning the "true-up" required
for the earlier dial-around compensation periods. The FCC adjusted the per-call
rate to $.229, for the interim period only, to reflect a different method of
calculating the delay in IXC payments to PSPs for the interim period, and
determined that the total interim period compensation rate should be $33.89 per
payphone per month ($.229 times an average of 148 calls per payphone per month).
The 2002 Payphone Order deferred to a later order its determination of the
allocation of this total compensation rate among the various carriers required
to pay compensation for the interim period. In addition to addressing the rate
level for dial-around compensation, the FCC has also addressed the issue of
carrier responsibility with respect to dial-around compensation payments.
On October 23, 2002 the FCC released its Fifth Order on
Reconsideration and Order on Remand (the "Interim Order"), which resolved all
the remaining issues surrounding the interim/intermediate period true-up and
specifically addressed how flat rate monthly per-phone compensation owed to PSPs
would be allocated among the relevant dial-around carriers. The Interim Order
also resolved how certain offsets to such payments would be handled and a host
of other issues raised by parties in their remaining FCC challenges to the 1999
Payphone Order and the 2002 Payphone Order. In the Interim Order, the FCC
ordered a true-up for the interim period and increased the adjusted monthly rate
to $35.22 per payphone per month, to compensate for the three-month payment
delay inherent in the dial-around payment system. The new rate of $35.22 per
payphone per month is a composite rate, allocated among approximately five
hundred carriers based on their estimated dial-around traffic during the interim
period. The FCC also ordered a true-up requiring the PSPs, including the
Company, to refund an amount equal to $.046 (the difference between the old
$.284 rate and the current $.238 rate) to each carrier that compensated the PSP
on a per-call basis during the intermediate period. Interest on additional
payments and refunds is to be computed from the original payment date at the IRS
prescribed rate applicable to late tax payments. The FCC further ruled that a
carrier claiming a refund from a PSP for the Intermediate Period must first
offset the amount claimed against any additional payment due to the PSP from
that carrier. Finally, the Interim Order provided that any net claimed refund
amount owing to carriers cannot be offset against future dial-around payments
without (1) prior notification and an opportunity to contest the claimed amount
in good faith (only uncontested amounts may be withheld); and (2) providing PSPs
an opportunity to "schedule" payments over a reasonable period of time.
10
The Company and its billing and collection clearinghouse have
reviewed the order and prepared the data necessary to bill or determine the
amount due to the relevant dial-around carriers pursuant to the Interim Order.
Based upon available information, the Company recorded a $3.8 million charge as
an adjustment to revenues from dial-around compensation in the fourth quarter of
2002 representing the estimated amount due by the Company to certain dial-around
carriers under the Interim Order. Of this amount, $3.6 million and $3.8 million
is included in accounts payable and other accrued expenses in the accompanying
consolidated balance sheets at December 31, 2003 and 2002, respectively. In
January 2004, certain carriers deducted approximately $0.7 million from their
current dial-around compensation payments, thus reducing this liability. The
remaining amount outstanding is expected to be deducted from future quarterly
payments of dial-around compensation to be received from the applicable
dial-around carriers during 2004.
In March 2003, the Company received $4.9 million relating to
the sale of a portion of the Company's accounts receivable bankruptcy claim for
dial-around compensation due from WorldCom, of which $3.9 million relates to the
amount due from WorldCom under the Interim Order (see Note 16 to the
consolidated financial statements). In accordance with the Company's policy on
regulated rate actions, this revenue from dial-around compensation was
recognized in the first quarter of 2003, the period such revenue was received.
The Company also received $4.0 million and $0.4 million of net receipts from
other carriers under the Interim Order that was recognized as revenue in the
third and fourth quarters of 2003, respectively. Such revenues totaling $8.3
million have been reported as dial-around compensation adjustments in the
accompanying consolidated statements of operations for the year ended December
31, 2003. The Company also estimates that it is entitled to receive in excess of
$10.0 million of additional dial-around compensation from certain carriers, of
which $1.2 million was received and will be recognized as revenue subsequent to
December 31, 2003 under the Company's accounting policy. However, the amount the
Company will ultimately be able to collect is dependent upon the willingness and
ability of such carriers to pay, including the resolution of any disputes that
may arise under the Interim Order. In addition, there can be no assurance that
the timing or amount of such receipts, if any, will be sufficient to offset the
liability to certain other carriers that will be deducted from future
dial-around payments.
On August 2, 2002 and September 2, 2002 respectively, the APCC
and the RBOCs filed petitions with the FCC to revisit and increase the dial
around compensation rate level. Using the FCC's existing formula and adjusted
only to reflect current costs and call volumes, the APCC and RBOCs' petitions
support an approximate doubling of the current $0.24 rate. In response to the
petitions, on September 2, 2002 the FCC placed the petitions out for comment and
reply comment by interested parties, seeking input on how the Commission should
proceed to address the issues raised by the filings. On October 28, 2003 the FCC
adopted an Order and Notice of Proposed Rulemaking (the "October 2003
Rulemaking") to determine whether a change to the dial-around rate is warranted,
and if so, to determine the amount of the revised rate. In the October 2003
Rulemaking, the FCC tentatively concluded that the methodology adopted in the
Third Report and Order is the appropriate methodology to use in reevaluating the
default dial-around compensation rate and requested comments on, among other
things, the cost studies presented in the petitions. The Company believes that
the "fair compensation" requirements of Section 276 of the Telecom Act mandate
that the FCC promptly review and adjust the dial around compensation rate level.
While no assurances can be given as to the timing or amount of any increase in
the dial around rate level, the Company believes an increase in the rate is
reasonably likely given the significant reduction in payphone call volumes,
continued collection difficulties and other relevant changes since the FCC set
the $0.24 rate level.
Regulatory actions and market factors, often outside the
Company's control, could significantly affect the Company's dial-around
compensation revenues. These factors include (i) the possibility of
administrative proceedings or litigation seeking to modify the dial-around
compensation rate, and (ii) ongoing technical or other difficulties in the
responsible carriers' ability and willingness to properly track or pay for
dial-around calls actually delivered to them.
Effect of Federal Regulation of Local Coin and Dial-Around Calls
Dial-Around Calls. Based on the FCC's tentative conclusion in the 1997
Payphone Order, the Company during 1997 adjusted the amounts of dial-around
compensation previously recorded for the period November 7, 1996 to June 30,
1997 from the initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131
calls). As a result of this adjustment, the provision recorded for the year
ended December 31, 1997, related to reduced dial-around
11
compensation, is approximately $3.3 million. Based on the reduction in the
per-call compensation rate in the 1999 Payphone Order, the Company further
reduced non-coin revenues by $9.0 million during 1998. The adjustment included
approximately $6.0 million to adjust revenue recorded during the period November
7, 1996 to October 6, 1997 from $37.20 per-phone per-month to $31.18 per phone
per month ($0.238 per call multiplied by 131 calls). The remaining $3.0 million
of the adjustment was to adjust revenues recorded during the period October 7,
1997 through December 31, 1998 to actual dial-around call volumes for the period
multiplied by $0.238 per call. Based upon the Company's estimate of the
liability to certain carriers under the Interim Order, the Company recorded an
adjustment to reduce revenues from dial-around compensation by $3.8 million for
the year ended December 31, 2002. In 2003, the Company recognized additional
revenues of $8.3 million for adjustments to dial-around compensation relating to
the Interim Order.
The Company recorded dial-around compensation revenue, including
adjustments under the Interim Order, of approximately $21.5 million for the year
ended December 31, 2003; $11.5 million for the year ended December 31, 2002; and
$19.1 million for the year ended December 31, 2001.
The Company believes that it is legally entitled to fair compensation
under the 1996 Telcom Act for dial-around calls the Company delivered to any
carrier during the period November 7, 1996 to October 6, 1997. While the amount
of $0.24 per call ($0.238 before April 21, 2002) constitutes the current level
of "fair" compensation, as determined by the FCC, certain carriers have asserted
in the past, are asserting and are expected to assert in the future that the
appropriate level of fair compensation should be lower than $0.24 per call. If
the level of fair compensation is ultimately determined to be an amount less
than $0.24 per call, such determination could have a material adverse effect on
the Company's results of operations and financial position.
Local Coin Call Rates. To ensure "fair compensation" for local coin
calls, the FCC previously determined that local coin rates from payphones should
be generally deregulated by October 7, 1997, but provided for possible
modifications or exemptions from deregulation upon a detailed showing by an
individual state that there are market failures within the state that would not
allow market-based rates to develop. On July 1, 1997, a federal court issued an
order that upheld the FCC's authority to deregulate local coin call rates. In
accordance with the FCC's ruling and the court order, certain LECs and IPPs,
including the Company, have increased rates for local coin calls. Initially,
when the Company increased the local coin rate to $0.35, the Company experienced
a large drop in call volume, which coincides with the Cellular "one-rate" plan
introduction. When the Company subsequently raised its local coin rates to
$0.50, it did not experience call volume declines at the same levels. The
Company has experienced, and continues to experience, lower coin call volumes on
its payphones resulting not only from increased local coin calling rates, but
from the growth in wireless communication services, changes in call traffic and
the geographic mix of the Company's payphones, as well.
Other Provisions of The 1996 Telecom Act and FCC Rules
As a whole, the 1996 Telecom Act and FCC Rules significantly altered
the competitive framework of the payphone industry. The Company believes that
implementation of the 1996 Telecom Act has addressed certain historical
inequities in the payphone marketplace and has, in part, led to a more equitable
and competitive environment for all payphone providers. However, there remain
several key areas of implementation of the 1996 Telecom Act yet to be fully and
properly implemented such that the 1996 congressional mandate for widespread
deployment of payphones is not being realized. This circumstance creates an
uncertain environment in which the Company and the industry must operate. The
Company has identified the following such uncertainties:
- Various matters pending in several federal courts and raised
before the Congress which, while not directly challenging
Section 276, relate to the validity and constitutionality of
the 1996 Telecom Act, as well as other uncertainties related
to the impact, timing and implementation of the 1996 Telecom
Act.
- The 1996 Payphone Order required that LEC payphone operations
be removed from the regulated rate base on April 15, 1997. The
LECs were also required to make the access lines that are
provided for their own payphones equally available to IPPs and
to ensure that the cost to payphone providers for obtaining
local lines and services met the FCC's new services test
guidelines, which require that LECs price payphone access
lines at the direct cost to the LEC plus a reasonable
allocation of overhead. Proceedings are still pending
12
in various stages and formats before the FCC and numerous
state regulatory bodies across the nation to implement these
provisions.
- In the past, RBOCs were allegedly impaired in their ability to
compete with the IPPs because they were not permitted to
select the interLATA carrier to serve their payphones. Recent
changes to the FCC Rules remove this restriction. Under the
existing rules, the RBOCs are now permitted to participate
with the Location Owner in selecting the carrier of interLATA
services to their payphones, effective upon FCC approval of
each RBOC's Comparably Efficient Interconnection plans.
Existing contracts between Location Owners and payphone or
long-distance providers that were in effect as of February 8,
1996 were grandfathered and will remain in effect pursuant to
their terms.
- The 1996 Payphone Order preempts state regulations that may
require IPPs to route intraLATA calls to the LEC by containing
provisions that allow all payphone providers to select the
intraLATA carrier of their choice. Outstanding questions still
exist with respect to 0+ local and 0 - call routing, whose
classification will await the outcome of various state
regulatory proceedings or initiatives and potential FCC
action.
- The 1996 Payphone Order determined that the administration of
programs for maintaining public interest payphones should be
left to the states within certain guidelines. Various state
proceedings have been undertaken in reviewing this issue, but
no widespread or effective actions have been taken to stem the
tide of payphone removal around the nation. The FCC has
pending various "universal service" proposals under
consideration which may impact the Company, both positively
and negatively.
Billed Party Preference and Rate Disclosure
On January 29, 1998, the FCC released its Second Report and Order on
Reconsideration entitled In the Matter of Billed Party Preference for InterLATA
0+ Calls, Docket No. 92-77. Effective July 1, 1998, all carriers providing
operator services were required to give consumers using payphones the option of
receiving a rate quote before a call is connected when making a 0+ interstate
call. The system appears to be functioning adequately to meet its designated
goals.
State and Local Regulation
State regulatory authorities have been primarily responsible for
regulating the rates, terms and conditions for intrastate payphone services.
Regulatory approval to operate payphones in a state typically involves
submission of a certification application and an agreement by the Company to
comply with applicable rules, regulations and reporting requirements. The states
and the District of Columbia have adopted a variety of state-specific
regulations that govern rates charged for coin and non-coin calls, as well as a
broad range of technical and operational requirements. The 1996 Telecom Act
contains provisions that require all states to allow payphone competition on
fair terms for both LECs and IPPs. State authorities also in most cases regulate
LEC tariffs for interconnection of independent payphones, as well as the LECs'
own payphone operations and practices.
The Company is also affected by state regulation of operator services.
Most states have capped the rates that consumers can be charged for coin toll
calls and non-coin local and intrastate toll calls made from payphones. In
addition, the Company must comply with regulations designed to afford consumers
notice at the payphone location of the long-distance company or companies
servicing the payphone and the ability to access alternate carriers. The Company
believes that it is currently in material compliance with all such regulatory
requirements.
In accordance with requirements under the 1996 Telecom Act, state
regulatory authorities are currently reviewing the rates that LECs charge IPPs
for local line access and associated services. Local line access charges have
been reduced in certain states, and the Company believes that selected states'
continuing review of local line access charges, coupled with competition for
local line access service resulting from implementation of the 1996 Telecom Act,
may lead to more options available to the Company for local line access at
competitive rates. The Company cannot provide assurance, however, that such
options or local line access rates will become available in all states.
13
The Company believes that an increasing number of municipalities and
other units of local government have begun to impose taxes, license fees and
operating rules on the operations and revenues of payphones. The Company
believes that some of these fees and restrictions may be in violation of
provisions of the 1996 Telecom Act prohibiting barriers to entry into the
business of operating payphones and the policy of the Act to encourage wide
deployment of payphones. However, in at least one instance, involving a
challenge to a payphone ordinance adopted by the Village of Huntington Park,
California, the FCC declined to overturn a total ban on payphones in a downtown
area. The proliferation of local government licensing, restriction, taxation and
regulation of payphone services could have an adverse affect on the Company and
other PSPs unless the industry is successful in resisting or moderating this
trend.
MAJOR CUSTOMERS
No individual customer accounted for more than 10% of the Company's
consolidated revenues in 2003, 2002 or 2001.
COMPETITION
The Company competes for payphone locations directly with LECs and
other IPPs. The Company also competes, indirectly, with long-distance companies,
which can offer Location Owners commissions on long-distance calls made from
LEC-owned payphones. Most LECs and long-distance companies against which the
Company competes and some IPPs may have substantially greater financial,
marketing and other resources than the Company. In addition, many LECs, faced
with competition from the Company and other IPPs, have increased their
compensation arrangements with Location Owners to offer more favorable
commission schedules.
The Company believes that the competitive factors among payphone
providers are (1) the commission payments to a Location Owner, (2) the ability
to serve accounts with locations in several LATAs or states, (3) the quality of
service and the availability of specialized services provided to a Location
Owner and payphone users, and (4) responsiveness to customer service needs. The
Company believes it is currently competitive in each of these areas.
The Company competes with long-distance carriers that provide
dial-around services which can be accessed through the Company's payphones.
Certain national long-distance operator service providers and prepaid calling
card providers have implemented extensive advertising promotions and
distribution schemes which have increased dial-around activity on payphones
owned by LECs and IPPs, including the Company, thereby reducing traffic to the
Company's primary providers of long-distance service.
Notwithstanding the foregoing, the Company believes that its principal
competition is from providers of wireless communications services for both local
and long distance traffic. Certain providers of wireless communication services
have introduced rate plans that are competitively priced with certain of the
products offered by the Company and have negatively impacted the usage of
payphones throughout the nation.
EMPLOYEES
As of December 31, 2003, the Company had 293 full-time employees, none
of whom are the subject of a collective bargaining agreement. The Company
believes that its relationship with its employees is good.
ITEM 2. PROPERTIES
The Company leases approximately 16,668 square feet of space in
Cleveland, Ohio for executive office space. The Company also leases space for
its 17 district offices for payphone operations in various geographic locations
across the country. In the fourth quarter of 2003 and the first quarter of 2004,
the Company has closed 14 field offices and the payphones previously managed by
those offices are now being serviced by sub-contractors (see Note 5 to the
consolidated financial statements for exit and disposal activities).
14
ITEM 3. LEGAL PROCEEDINGS
In March 2000, the Company and its affiliate Telaleasing Enterprises,
Inc. were sued in Maricopa County, Arizona Superior Court by CSK Auto, Inc.
("CSK"). The suit alleges that the Company breached a location agreement between
the parties. CSK's complaint alleged damages in excess of $5 million. The
Company removed the case to the U.S. District Court for Arizona and moved to
have the matter transferred to facilitate consolidation with the related case in
California brought by TCG and UST. On October 16, 2000, the U.S. District Court
for Arizona denied the Company's transfer motion and ordered the case remanded
back to Arizona state court. On February 27, 2003 the parties agreed to a
settlement of this case, pursuant to which the case will be dismissed with
prejudice in exchange for four quarterly payments to the plaintiff in the amount
of $131,250, the total of which was recorded in the fourth quarter of 2002. As
of December 31, 2003, the Company has fully satisfied the obligation.
In February 2001, Picus Communications, LLC ("Picus"), a debtor in
Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern
District of Virginia, brought suit against Davel and its wholly owned
subsidiary, Telaleasing Enterprises, Inc., in the United States District Court
for the Eastern District of Virginia, claiming unpaid invoices of over $600,000
for local telephone services in Virginia, Maryland, and the District of
Columbia. The various pleadings and claims in this matter were consolidated in
an adversary proceeding and set for trial to begin on October 21, 2002. Prior to
the commencement of the trial, on October 9, 2002 Picus filed a motion in the
bankruptcy court to seek court approval of a settlement of all outstanding
claims between the parties. The settlement provides that (i) Picus will
cooperate with the Company to recover certain dial-around compensation
potentially owed to the Company for the calendar year of 2000 and the first
calendar quarter of 2001, (ii) within ten days after entry of an order approving
the settlement and December 15, 2002, the Company was required to and has paid
Picus $79,500, (iii) the Company paid Picus an additional $150,000 that was due
no later than May 15, 2003; and (iv) the Company will pay Picus forty percent
(40%) of the dial-around compensation for the calendar year of 2000 attributable
to the Picus lines, if any. If any of the aforementioned payments are not timely
paid by the Company, Picus will be entitled to obtain a judgment against Davel
for the full amount of its claim against the Company, plus interest, less any
amounts actually paid to Picus under the settlement agreement. As of December
31, 2003, the Company has fully satisfied the obligation
On or about October 15, 2002, Davel was served with a complaint, in an
action captioned Sylvia Sanchez et al. v. Leasing Associates Service, Inc.,
Armored Transport Texas, Inc., and Telaleasing Enterprises, Inc. Plaintiffs
claim that the Company was grossly negligent or acted with malice and such
actions proximately caused the death of Thomas Sanchez, Jr. a former Davel
employee. On or about January 8, 2002, the Plaintiffs filed their first amended
complaint adding a new defendant LAI Trust and on or about January 21, 2002
filed their second amended complaint adding new defendants Davel Communications,
Inc., DavelTel, Inc. and Peoples Telephone Company. DavelTel, Inc. and Peoples
Telephone Company are subsidiaries of the Company. The original complaint was
forwarded to Davel's insurance carrier for action; however, Davel's insurance
carrier denied coverage based upon the workers compensation coverage exclusion
contained in the insurance policy. The Company answered the complaint on or
about January 30, 2003. The second amended complaint has been forwarded to
Davel's insurance carrier for action. The parties are currently engaged in the
discovery process and the trial is scheduled for June 2004. While Davel believes
that it has meritorious defenses to the allegations contained in the second
amended complaint and intends to vigorously defend itself, Davel cannot at this
time predict its likelihood of success on the merits.
The Company is also a party to a contract with Sprint Communications
Company, L.P. ("Sprint") that provides for the servicing of operator-assisted
calls. Under this arrangement, Sprint has assumed responsibility for tracking,
rating, billing and collection of these calls and remits a percentage of the
gross proceeds to the Company in the form of a monthly commission payment, as
defined in the contract. The contract also requires the Company to achieve
certain minimum gross annual operator service revenue, measured for the
twelve-month period ended June 30 of each year. In making its June 30, 2002
compliance calculation under the minimum gross annual operator service revenue
provision, the Company identified certain discrepancies between its calculations
and the underlying call data information provide directly by Sprint. If the
data, as presented by Sprint, is utilized in the calculation, a shortfall could
result. The Company has provided Sprint with notification of its objections to
the underlying data, and upon further investigation, has discovered numerous
operational deficiencies in Sprint's provision of operator services that have
resulted in a loss of revenue to the Company, thus negatively impacting the
Company's performance relating to the gross annual operator service revenue
requirement set forth in the contract. Furthermore,
15
the Company advised Sprint that its analysis indicated that not only had it
complied with the provisions of the gross annual operator service revenue
requirement it also believed that Sprint had underpaid commissions to the
Company during the same time period. The Company notified Sprint of the details
surrounding the operational deficiencies and advised that its failure to correct
such operational deficiencies would result in a material breach of the contract.
Notwithstanding the Company's objections, Sprint advised the Company,
based upon its calculation of the Company's performance in connection with the
gross annual operator services revenue requirement, it would retroactively
reduce the percentage of commission paid to the Company in connection with the
contract for the twelve-month period ended June 30, 2002. Sprint withheld
$418,000 from the commission due and owing the Company in the month of September
2002 and failed to address the operational deficiencies discovered by the
Company. As a result of these actions, during the month of October 2002, the
Company advised Sprint that the contract was terminated due to Sprint's
continuing and uncured breaches and the Company shifted its traffic to an
alternative operator service provider. In response, Sprint withheld $380,170
from the commissions due and owing the Company in the month of October 2002.
Thereafter, the Company made a demand for any and all amounts due it under the
terms of the contract. In response, Sprint has asserted its claim for payment of
approximately $5.9 million representing the amount it had calculated as owing
under the gross annual operator services revenue requirement for the
twelve-month period ended June 30, 2002.
While the Company believes that its objections to Sprint's calculation
of the gross annual operator service revenue requirement are justifiable and has
not recorded any amounts associated with any minimum liability, it is possible
that some liability or receivable for this matter may ultimately be determined
as a result of the dispute, the amount of which, if any, is not presently
determinable.
The Company is involved in other litigation arising in the normal
course of its business which it believes will not materially affect its
financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December
31, 2003, no matters were submitted to a vote of the Company's shareholders.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Information. Davel Common Stock trades on the NASDAQ
over-the-counter bulletin board under the symbol `DAVL.OB'. The following table
sets forth, for the periods indicated, the high and low closing prices of Davel
Common Stock on the NASDAQ National Market System, or bulletin board system,
from January 1, 2002 through December 31, 2003.
HIGH LOW
---- ---
2002
First Quarter............................................................................ $ 0.05 $ 0.02
Second Quarter........................................................................... 0.04 0.02
Third Quarter............................................................................ 0.05 0.03
Fourth Quarter........................................................................... 0.04 0.01
2003
First Quarter............................................................................ $ 0.01 $ 0.01
Second Quarter........................................................................... 0.02 0.01
Third Quarter............................................................................ 0.03 0.01
Fourth Quarter........................................................................... 0.05 0.02
As of March 25, 2004, there were approximately 1,623 holders of record
of the Common Stock, not including stockholders whose shares were held in
"nominee" or "street" name. The closing sale price of the Company's Common Stock
on March 25, 2004 was $0.015 per share.
16
Dividends. The Company did not pay any dividends on its Common Stock
during 2002 and 2003 and does not intend to pay any Common Stock dividends in
the foreseeable future. It is the current policy of the Company's Board of
Directors to retain cash to repay indebtedness and to finance the growth and
development of the Company's business. The payment of dividends is effectively
prohibited by the Company's Junior Credit Facility. Payment of cash dividends,
if made in the future, will be determined by the Company's Board of Directors
based on the conditions then existing, including the Company's financial
condition, capital requirements, cash flow, profitability, business outlook and
other factors.
Recent Sales of Unregistered Securities. In the year ended December 31,
2003, the Company did not sell any securities that were not registered under the
Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of the Company. The data should be read in conjunction with
the consolidated financial statements, related notes thereto and other financial
information included herein.
YEAR ENDED DECEMBER 31
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
-------------------------------------------------------------
2003 2002 (2) 2001 2000 1999
--------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Revenue .......................................... $ 81,773 $ 76,952 $ 90,618 $ 126,271 $ 175,846
Expenses ......................................... 94,166 93,385 106,620 168,581 184,011
Asset Impairment Charges (1) ..................... 27,141 -- -- 42,032 48,924
--------- --------- --------- --------- ---------
Operating loss ................................... (39,534) (16,433) (16,002) (84,342) (57,089)
Interest and other expense, net .................. (6,657) (12,793) (27,412) (27,138) (23,412)
Income taxes ..................................... -- -- -- -- 1,755
Gain from extinguishment of debt ................. -- 180,977 -- -- --
--------- --------- --------- --------- ---------
Net income (loss) ................................ $ (46,191) $ 151,751 $ (43,414) $(111,480) $ (78,746)
========= ========= ========= ========= =========
Basic and diluted income (loss) per share:
Net income (loss) ................................ $ (0.08) $ 0.56 $ (3.89) $ (10.02) $ (7.40)
========= ========= ========= ========= =========
Weighted average common shares
outstanding, basic and diluted ................. 615,019 272,598 11,169 11,126 10,660
BALANCE SHEET DATA:
Total assets ..................................... $ 50,322 $ 106,616 $ 68,325 $ 93,187 $ 180,761
Current maturities of long-term debt and
obligations under capital leases ............... 1,994 11,449 237,726 239,083 21,535
Long-term debt and obligations under capital
leases, less current maturities ................ 125,962 118,229 308 839 206,509
Shareholders' deficit ............................ (102,501) (56,310) (229,813) (186,392) (75,079)
- ---------------
(1) The years ended December 31, 2003, 2000, and 1999 include asset
impairment charges associated with goodwill and fixed assets of
$27,141, $42,032, and $48,924, respectively.
(2) The year ended December 31, 2002 includes the results of PhoneTel
Technologies, Inc. from the date of the PhoneTel acquisition, July 24,
2002.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
Certain of the statements contained below are forward-looking
statements (rather than historical facts) that are subject to risks and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements.
17
GENERAL
During 2003, the Company derived its revenues from two principal
sources: coin calls and non-coin calls. Coin calls represent calls paid for by
callers with coins deposited in the payphone. Coin call revenues are recorded in
the amount of coins deposited in the payphones.
Non-coin calls include credit card, calling card, collect, and third
party billed calls, handled by operator service providers selected by the
Company. Non-coin call revenues are recognized based upon the commission
received by the Company from the carriers of these calls.
The Company also recognizes non-coin revenues from calls that are
dialed from its payphones to gain access to a long distance company other than
the one pre-programmed into the telephone or to make a traditional "toll free"
call (dial-around calls). Revenues from dial-around calls are recognized based
on estimates of calls made using most recent actual historical data and the
Federal Communications Commission mandated dial-around compensation rate in
effect. This is commonly referred to as "dial-around" access. See "Business --
Regulation."
The principal costs related to the ongoing operation of the Company's
payphones include telephone charges, commissions, service, maintenance and
network costs. Telephone charges consist of payments made by the Company to LECs
and long distance carriers for line charges and use of their networks.
Commission expense represents payments to Location Owners. Service, maintenance
and network costs represent the cost of servicing and maintaining the payphones
on an ongoing basis.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
information from the Company's Consolidated Statements of Operations, included
elsewhere in this Annual Report on Form 10-K, expressed as a percentage of total
revenues.
YEARS ENDED DECEMBER 31
-------------------------
2003 2002 2001
----- ------ ------
REVENUES:
Coin calls.......................................................... 61.3% 74.0% 68.1%
Non-coin calls...................................................... 28.5 31.0 31.9
Dial-around compensation adjustments................................ 10.2 (5.0) --
----- ----- -----
Total revenues...................................................... 100.0 100.0 100.0
----- ----- -----
COSTS AND EXPENSES:
Telephone charges................................................... 28.2 25.2 32.6
Commissions......................................................... 16.6 20.5 24.5
Service, maintenance and network costs.............................. 29.4 29.9 26.0
Depreciation and amortization....................................... 26.3 26.5 21.2
Selling, general and administrative................................. 13.7 15.5 13.4
Asset impairment charges............................................ 33.2 -- --
Exit and disposal activities........................................ 1.0 3.8 --
----- ----- -----
Total operating costs and expenses 148.4 121.4 117.7
----- ----- -----
Operating loss...................................................... (48.4)% (21.4)% (17.7)%
===== ===== =====
Critical Accounting Policies and Estimates
The Company's reported results of operations can be affected by the use
of estimates and the Company's critical accounting policies. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates, among others,
include amounts relating to the carrying values of the Company's accounts
receivable, payphone assets and location contracts and the related revenues and
expenses applicable to dial-around compensation and asset impairment. Actual
results could differ from those estimates.
18
Revenues from coin calls, reselling operator assisted and long distance
services, and compensation for dial-around calls are recognized in the period in
which the customer places the related call. The recognition of dial-around
revenues require complex and often subjective estimation processes that are
largely predicated on the Company's historical operating experience. In addition
certain costs and expenses, such as commissions, require the use of revenue
estimates in the accounting process. Significant differences in our actual
dial-around experience could affect these estimates. The FCC has the authority
pursuant to the Telecommunications Act of 1996 to affect rates related to
revenue from dial-around compensation, including retroactive rate adjustments
and refunds. (See "Business - Regulation"). Rate adjustments arising from FCC
rate actions that require refunds to interexchange or other carriers are
recorded in the first period that they become both probable of payment and
estimable in amount. Rate adjustments that result in payments to the Company by
interexchange or other carriers are recorded when received.
Under the Company's accounting policy relating to asset impairment, the
Company periodically reviews long-lived assets to be held and used and goodwill
for impairment whenever events or changes in circumstances indicate the asset
may be impaired and, as to goodwill, at least annually. The Company evaluates
potential impairment of long-lived assets, other than goodwill, based upon the
cash flows derived from each of the Company's operating districts, the lowest
level for which operating cash flows for such asset groupings are identifiable.
A loss relating to an impairment of assets occurs when the aggregate of the
estimated undiscounted future cash inflows expected to be generated by the
Company's asset groups (including any salvage values) are less than the related
assets' carrying value. Impairment is measured based on the difference between
the higher of the fair value of the assets or present value of the discounted
expected future cash flows and the assets' carrying value. The Company considers
impairment of goodwill whenever the carrying value of the Company's net assets,
after taking into account any impairment charges described above, exceeded the
fair value of the Company, which amount is based upon the present value of
expected future cash flows of the Company. In the event that the fair value of
the Company including goodwill exceeds the carrying value, the Company
calculates the implied value of the goodwill following the methodology provided
in Statements on Financial Accounting Standards No. 142, "Intangible Assets".
The excess carrying value of goodwill over its implied value, if any, results in
an impairment charge. No impairment was incurred in 2002 and 2001. The Company
incurred asset impairment losses relating to its payphones, location contracts
and goodwill of $27.1 million in 2003 (see Note 3 to the consolidated financial
statements).
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
On July 24, 2002, the Company acquired approximately 28,000 payphones
in connection with the PhoneTel Merger. Operating results for 2002 include the
revenues and expenses associated with these payphones for the period following
July 24, 2002. Operating results for 2003 include the revenues and expenses
relating to these payphones for the full twelve months of 2003. Offsetting the
additional revenue and expense amounts in the later part of 2002 and in 2003
arising from the acquisition of PhoneTel is the reduction in revenues and
expenses resulting from the decline in the Company's phone count and cost
containment efforts. The Company's had approximately 47,000 phones in service on
December 31, 2003 and approximately 69,000 phones in service on December 31,
2002. However, the average number of payphones in service for the years ended
December 31, 2003 and 2002 was approximately 59,800 and 62,000, respectively.
This decrease in the average number of payphones in 2003 is partly due to the
Company's increasingly aggressive program to remove low revenue phones and
partly due to a loss in customer locations.
Total revenues increased approximately $4.8 million, or 6.2%, from
approximately $77.0 million in the year ended December 31, 2002 to approximately
$81.8 million in the year ended December 31, 2003. This increase was primarily
attributable to the dial-around compensation adjustments offset by lower coin
and non-coin call revenues as discussed below.
Coin call revenues decreased approximately $6.9 million, or 12.1%, from
approximately $57.0 million in the year ended December 31, 2002 to approximately
$50.1 million in the year ended December 31, 2003. The decrease in coin call
revenues was due to the reduction in the average number of payphones in service
in 2003 and lower call volumes. Notwithstanding the PhoneTel Merger, the average
number of payphones declined due to the removal of unprofitable phone locations
and lower call volumes resulted from the increased competition from wireless and
other public communication services.
19
Non-coin call revenues, which is comprised primarily of dial-around
revenue and operator service revenue, decreased approximately $0.5 million, or
2.1%, from approximately $23.8 million in the year ended December 31, 2002 to
approximately $23.3 million in the year ended December 31, 2003. This decrease
was primarily attributable to a decrease in dial-around revenues offset by an
increase in operator service and other revenues. Dial-around revenue decreased
approximately $2.1 million, from approximately $15.3 million in the year ended
December 31, 2002 to approximately $13.2 million in the year ended December 31,
2003. The dial-around decrease is primarily attributable to reductions the
average number of payphones and the average number of dial-around calls due to
competition from wireless communication services and the continuing
underpayments of dial-around revenues by IXCs caused by deficiencies in the
established payment and tracking process. Long-distance revenues increased
approximately $0.5 million, from approximately $7.3 million in the year ended
December 31, 2002 to approximately $7.8 million in the year ended December 31,
2003. This increase is primarily due to a change in operator service providers
for a portion of the Company's payphone base that pays commission on gross
billings at a higher rate than the Company's former operator service provider.
Non-coin call revenues also includes other revenue, which increased
approximately $1.1 million from approximately $1.2 million in the year ended
December 31, 2002 to approximately $2.3 million in the year ended December 31,
2003. This increase relates primarily to telephone installation and repair
services provided to a former related party, which services were discontinued in
October 2003.
During the year ended December 31, 2003, the Company recorded $8.3
million of dial-around revenue adjustments from various carriers relating to the
industry-wide true-up required under the FCC's Interim Order (see Note 15 to the
consolidated financial statements). This adjustment included the sale of a
portion of the Company's accounts receivable bankruptcy claim due from WorldCom.
Of the proceeds received in 2003, $3.9 million related to the amount due from
WorldCom under the Interim Order applicable to dial-around compensation (see
Note 16 to the consolidated financial statements). In 2002, the Company recorded
a $3.8 million charge as a dial-around compensation adjustment for estimated
overpayments made by certain dial-around carriers under the FCC's Interim Order.
Although the Company estimates that it is entitled to receive additional amounts
in excess of $10.0 million relating to underpayments made by other carriers,
there can be no assurance that the Company will be able to collect these amounts
from those carriers. Any such refunds will be recognized as revenue in the
period such revenues are received.
Telephone charges increased approximately $3.6 million, or 18.6%, from
approximately $19.4 million in the year ended December 31, 2002 to approximately
$23.0 million in the year ended December 31, 2003. This increase is primarily
due to a reduction in regulatory refunds from LECs relating to the "New Services
Test" and end user common line charges ("EUCL charges") that are classified as
reductions in telephone charges in the Company's consolidated statements of
operations (see Note 16). The Company recorded $2.2 million of such refunds in
2003 compared to $7.7 of regulatory refunds in 2002. Without these refunds
telephone charges would have declined by $1.9 million, or 7.0%, primarily due to
a reduction in the average number payphones in service and lower line charges
resulting from the use of competitive local exchange carriers ("CLECs"). The
Company has executed additional contracts with LECs and CLECs and is pursuing
additional regulatory relief that it believes will further reduce local access
charges on a per-phone basis, but is unable to estimate the impact of further
telephone charge reductions at this time.
Commissions decreased approximately $2.2 million, or 13.9%, from
approximately $15.8 million in the year ended December 31, 2002 to approximately
$13.6 million in the year ended December 31, 2003. The decrease was primarily
attributable to lower commissionable revenues (as a result, in part, to a
decline in the average number of payphones) in 2003 and management actions to
re-negotiate contracts with lower rates upon renewal. The Company continues to
actively review its strategies related to contract renewals in order to maintain
its competitive position while retaining its customer base.
Service, maintenance and network costs increased approximately $1.0
million, or 4.3%, from approximately $23.0 million in the year ended December
31, 2002 to approximately $24.0 million in the year ended December 31, 2003.
This increase was primarily attributable to the additional cost associated with
the combined field organizations following the PhoneTel Merger. Field operating
costs of PhoneTel were included in service, maintenance and network costs for
twelve months in 2003 compared to five months in 2002. In 2003, the Company
implemented several cost reduction measures, including a substantial reduction
in the Company's workforce. In the fourth quarter of 2003 and the first quarter
of 2004, the Company also began to outsource the service, collection and
maintenance
20
of its payphones in certain higher cost districts. While the Company believes
these changes will have a favorable impact on operating results in 2004, no
assurances can be given regarding such effect.
Depreciation and amortization expenses increased $1.1 million, or 5.4%,
from $20.4 million in the year ended December 31, 2002 to $21.5 million in the
year ended December 31, 2003. This increase in expense is primarily a result of
depreciation and amortization of the assets acquired in the PhoneTel Merger
offset in part by lower depreciation and amortization due to the removal of
unprofitable payphones and the write-down in asset value relating to the
impairment charges described below.
Selling, general and administrative expenses decreased approximately
$0.8 million, or 6.7%, from approximately $12.0 million in the year ended
December 31, 2002 to approximately $11.2 million in the year ended December 31,
2003. The decrease was primarily attributable to a reduction in expenses
relating to the relocation of the Company's Corporate headquarters from Tampa,
Florida to Cleveland, Ohio following the PhoneTel Merger offset by an increase
in professional fees of approximately $1.0 million. An increase in professional
fees was due in part to legal and financial advisory fees incurred in 2003 in
connection with the evaluation of financial and strategic alternatives available
to the Company.
The cost relating to exit and disposal activities decreased by $2.1
million, or 72.4%, from $2.9 million in the year ended December 31, 2002 to
approximately $0.8 million in the year ended December 31, 2003. In connection
with the Company's plans to outsource certain payphone service, repair and
warehousing functions, the Company closed its warehouse and repair facility in
Tampa, Florida and eleven district office facilities during 2003. The Company
incurred lease termination, severance and other closing costs relating to these
facilities. In connection with the PhoneTel Merger in 2002, the Company
relocated it corporate headquarters from Tampa, Florida to Cleveland, Ohio. In
September 2002, the Company terminated its former headquarters facility lease,
abandoned or disposed of certain furniture, fixtures and leasehold improvements,
and incurred severance costs related to the termination of certain employees.
All exit activities relating to the Company's former headquarters were completed
prior to December 31, 2002.
Asset impairment losses totaling $27.1 million were incurred in the
year ended December 31, 2003. The loss consisted of a $9.6 million write-down in
the carrying value of the Company's payphone assets and location contracts and a
$17.5 million write-off of goodwill in accordance with SFAS No. 144 and SFAS No.
142, respectively (see Note 3 to the consolidated financial statements). These
impairment charges were recorded in the second quarter of 2003. Management
reevaluated the Company's projected performance and reached the conclusion that
financial results would not be sufficient to support the full carrying amount of
the assets. No comparable loss was incurred in the year ended December 31, 2002.
Interest expense in the year ended December 31, 2003 decreased
approximately $6.4 million, or 49.2%, from approximately $13.0 million in the
year ended December 31, 2002 to approximately $6.6 million in the year ended
December 31, 2003. This decrease is primarily due to the reduction in
indebtedness resulting from the debt restructuring described below (see Note 4
to the consolidated financial statements). In addition, no interest is
recognized on the Davel portion of the Company's Junior Credit Facility as a
result of accounting for the debt-for-equity exchange as a troubled debt
restructuring and recording all future payments at the time of the
restructuring. In connection with this debt restructuring, the Company also
recognized a gain of approximately $181.0 million in 2002 resulting from the
extinguishment of the Company's former credit facility (the "Old Credit
Facility").
Other income (expense) decreased approximately $342,000 to $98,000 in
expense in the year ended December 31, 2003 from $244,000 of income in the year
ended December 31, 2002. The decrease is primarily due to losses attributable to
the sale of assets in 2003, including a $192,000 loss on the sale of payphone
assets relating to three unprofitable districts in the northern Midwest states.
For the year ended December 31, 2003, the Company had a net loss of
$46.2 million compared to net income of $151.8 million for the year ended
December 31, 2002. The 2003 net loss included asset impairment charges of $27.1
million relating to the write-down in the carrying value of the Company's
payphone assets and goodwill. Net income in 2002 included a gain on debt
extinguishment totaling $181.0 million relating to the debt restructuring
described above. Without these items, the Company would have had a net loss of
$19.1 million in 2003 compared to $29.2 million in 2002.
21
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
On July 24, 2002, the Company acquired approximately 28,000 phones in
the PhoneTel Merger. The revenues and expenses associated with these phones for
the period of July 24 to December 31, 2002 are included in the results of
operations for the year ended December 31, 2002. Offsetting these revenue and
expense increases in the latter part of 2002 is the reduction in revenues and
expenses resulting from the impact of the Company's ongoing program to remove
unprofitable phones and the effects of implementing the PhoneTel Merger
servicing agreement. The servicing agreement, which was implemented in the third
quarter of 2001 in anticipation of the PhoneTel Merger, was designed to commence
cost savings prior to the merger by combining field service operations on a
geographic basis to gain efficiencies resulting from the increased concentration
of payphone service routes.
The Company operated approximately 14,000 more phones on December 31,
2002 than on December 31, 2001, net of the phones acquired in the PhoneTel
Merger and the program to remove unprofitable phones. The Company's had
approximately 69,000 phones in service on December 31, 2002 and approximately
55,000 phones in service on December 31, 2001. However, the average number of
phones in service for the years ended December 31, 2002 and 2001 was
approximately 62,000 for both the years due to the 2001 reduction in phones
resulting from the Company's ongoing program to remove low revenue phones.
Total revenues decreased approximately $13.6 million, or 15.1%, from
approximately $90.6 million in the year ended December 31, 2001 to approximately
$77.0 million in the year ended December 31, 2002. This decrease was primarily
attributable to the removal of unprofitable phone locations, lower call volumes
on the Company's payphones resulting from the growth in wireless and other
public communication services, and changes in call traffic. This decrease was
also due to the dial-around compensation adjustment described below.
Coin call revenues decreased approximately $4.7 million, or 7.7%, from
approximately $61.7 million in the year ended December 31, 2001 to approximately
$57.0 million in the year ended December 31, 2002. The decrease in coin call
revenues was primarily attributable to lower call volumes on the Company's
payphones due to increased competition from wireless and other public
communication services and the impact of increasing the coin call rate from
$0.35 to $0.50 beginning November 2001. The decrease in call volume was
partially offset by the increase in the coin call rate.
Non-coin call revenues, which is comprised primarily of dial-around
revenue and operator service revenue, decreased approximately $5.2 million, or
17.8%, from approximately $29.0 million in the year ended December 31, 2001 to
approximately $23.8 million in the year ended December 31, 2002. This decrease
was primarily attributable to lower call volumes on the Company's payphones
resulting from the growth in wireless communication services and changes in call
traffic. Dial-around revenue decreased approximately $3.8 million, from
approximately $19.1 million in the year ended December 31, 2001 to approximately
$15.3 million in the year ended December 31, 2002. The dial-around decrease is
primarily attributable to reductions in the number of dial-around calls due to
competition from wireless communication services and the continuing
underpayments of dial-around revenues caused by deficiencies in the established
payment and tracking process. The decrease in dial-around revenue is also due to
a $0.9 million reduction relating to the WorldCom bankruptcy filing in July
2002. Long-distance revenues decreased approximately $2.5 million, from
approximately $9.8 million in the year ended December 31, 2001 to approximately
$7.3 million in the year ended December 31, 2002 due to lower call volumes for
the reasons stated above. Operator services are provided by third parties that
pay Davel a commission on their gross billings. Non-coin call revenues also
includes other revenue, which increased approximately $1.1 million from
approximately $0.1 million in the year ended December 31, 2001 to approximately
$1.2 million in the year ended December 31, 2002. This increase relates
primarily to telephone installation and repair services provided to a former
related party.
In 2002, the Company recorded a $3.8 million dial-around compensation
adjustment for estimated overpayments by certain IXCs that were received by the
Company in prior years. There was no comparable charge in 2001 relating to the
industry-wide true-up among payphone providers and long-distance carriers
pursuant to the FCC's Interim Order. See note 15 to the consolidated financial
statements.
Telephone charges decreased approximately $6.4 million, or 22.7%, from
approximately $29.6 million in the year ended December 31, 2001 to approximately
$23.2 million in the year ended December 31, 2002. The decrease
22
is due lower line charges resulting from the use of competitive local exchange
carriers ("CLECs"), regulatory changes resulting in lower rates charged by LECs,
and other management actions to attain lower rates. Telephone charges in 2002
were also impacted by refunds totaling $3.1 million received from BellSouth for
prior period charges pursuant to a recently adopted "New Service Test" in
Tennessee, $3.8 million of "New Services Test" refunds in North Carolina and
Maryland, other LEC refunds from prior periods resulting from regulatory rulings
of $0.8 million, and a favorable adjustment related to a litigation settlement
of $0.8 million. LEC refunds received as a result of regulatory rulings in 2001
totaled $2.4 million. A $1.3 million charge in 2002 and a $0.7 million charge in
2001 associated with the settlement of a dispute with MCI partially offset these
savings.
Commissions decreased approximately $6.4 million, or 28.9%, from
approximately $22.2 million in the year ended December 31, 2001 to approximately
$15.8 million in the year ended December 31, 2002. The decrease was primarily
attributable to lower commissionable revenues and management actions to
re-negotiate contracts with lower rates upon renewal. Commissions for the year
ended December 31, 2002 were also favorably impacted by lower commission rates
relating to PhoneTel location contracts and favorable adjustments of $0.6
million resulting from contract terminations. The Company continues to actively
review its strategies related to contract renewals in order to maintain its
competitive position while retaining its customer base.
Service, maintenance and network costs decreased approximately $0.5
million, or 2.2%, from approximately $23.5 million in the year ended December
31, 2001 to approximately $23.0 million in the year ended December 31, 2002. The
decrease was primarily attributable to the additional payphones and related
expenses resulting from the PhoneTel Merger offset by the effects of savings
generated from rationalization of field offices, increased geographic and route
density of the payphones, and the Company's ability to improve efficiency on
servicing the Company's payphones. Decreases in network billing costs (primarily
payphone polling costs) of $0.9 million and district office expenses of $0.4
million were offset by an increase in vehicle insurance expense of $1.1 million.
Net decreases of $0.3 million in a variety of other expense items comprised the
remaining changes.
Depreciation and amortization expenses increased $1.2 million, or 6.2%,
from $19.2 million in the year ended December 31, 2001 to $20.4 million in the
year ended December 31, 2002. The increase in expense is primarily a result of
depreciation and amortization of the assets acquired in the PhoneTel Merger
offset by lower depreciation and amortization due to the program to remove
unprofitable payphones and, to a lesser extent, the write-off of assets upon
relocation of the Company's former headquarters from Tampa, Florida to
Cleveland, Ohio following the PhoneTel Merger.
Selling, general and administrative expenses decreased approximately
$0.1 million, or 1.3%, from approximately $12.1 million in the year ended
December 31, 2001 to approximately $12.0 million in the year ended December 31,
2002. The decrease in expense was primarily attributable to a reduction in
salaries and salary-related expenses of approximately $1.0 million, which
occurred as a result of continued reductions in headcount in light of the lower
number of payphones in service, and a decrease in professional fees of
approximately $1.2 million. These decreases were offset by an increase in
insurance (primarily directors and officers and general liability insurance) of
$1.0 million and a $0.5 million charge relating to the settlement of a lawsuit.
A variety of other expense items provided a net increase in selling, general and
administrative expenses of $0.6 million compared to 2001.
In connection with the PhoneTel Merger, the